TEST BANK for Introductory Financial Accounting for Business 2nd Edition by Edmonds Thomas . ISBN 97 by StudyGuide

CHAPTER 1: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = IDecrease = DNot Affected = NA Walker Company issued common stock for $150,000 cash.

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Name the group that has the primary authority for establishing U.S. GAAP.

9) Who are the three distinct types of participants in the market for business resources? Briefly describe the role of each group of participants.

10)

What is meant by the term "stakeholders"?

11) What is meant by the term "global GAAP"? How does it impact U.S. companies? What body is responsible for setting global standards?

12)

Briefly distinguish between financial accounting and managerial accounting.

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13) Explain some of the similarities and differences between not-for-profit organizations and other types of businesses.

14)

What financial statement elements are reported on a balance sheet?

15)

From what three sources does a business obtain its assets?

16) How does providing services for cash affect the accounting equation? Is it considered an asset source, asset use, or asset exchange transaction?

17) How does the payment of cash dividends to stockholders affect the accounting equation? Is it considered an asset source, asset use, or asset exchange transaction?

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18)

If total stockholder's equity is $150,000 and liabilities are $75,000, what are total assets?

19)

What is meant by the term stockholders' equity?

20)

Give three examples of asset use transactions.

21)

What does a company's statement of cash flows tell you about the company?

22) If a corporation issues common stock for $50,000 cash, in which section of the statement of cash flows will this transaction be reported?

23)

Which financial statement reports revenue and expenses?

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24)

Name and briefly describe each of the four financial statements.

25) Define the term "accounting period." How does this term relate to the "matching concept" as it pertains to the income statement?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 26) Indicate whether each of the following statements about markets is true or false. 1.a) Financial resources can be provided to a business by consumers. 2.b) Resource owners are the businesses that transform resources into products that satisfy consumer desires. 3.c) Labor resources include both the physical and intellectual labor of a business's employees. 4.d) Businesses purchase their resources from resource owners. 5.e) Consumers are the main providers of resources in any market.

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27) Indicate whether each of the following statements about accounting information is true or false. 1.a) Financial accounting is primarily intended to satisfy the information needs of internal stakeholders. 2.b) Managerial accounting information includes financial and nonfinancial information. 3.c) The accounting information intended to satisfy the needs of a company's employees is managerial accounting information. 4.d) GAAP requires that companies adhere to financial accounting standards. 5.e) Managerial accounting information is usually less detailed than financial accounting information.

28) Indicate whether each of the following statements about liabilities is true or false. 1.a) Liabilities are reported on the balance sheet. 2.b) The acquisition of a bank loan increases both assets and liabilities. 3.c) The accounting equation requires that liabilities be equal to stockholders’ equity. 4.d) The amount of a company's liabilities is equal to the difference between its assets and its stockholders’equity. 5.e) Liabilities are reported on the statement of cash flows of a business.

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29) Indicate whether each of the following statements about retained earnings is true or false. 1.a) A dividend paid to stockholders decreases retained earnings. 2.b) Issuing common stock for cash increases retained earnings. 3.c) The amount of net income for a period must equal retained earnings. 4.d) The purchase of a truck decreases retained earnings. 5.e) Net income increases retained earnings.

30) Indicate whether each of the following statements about the types of transactions is true or false. 1.a) An asset source transaction increases total assets and increases claims to assets. 2.b) The issuance of stock to owners for cash would be an example of an asset exchange transaction. 3.c) Purchasing equipment for cash is an example of an asset use transaction. 4.d) Paying a dividend to stockholders is an example of an asset use transaction. 5.e) Making a payment on a bank loan is an example of an asset exchange transaction.

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31) Indicate whether each of the following statements about financial statements is true or false. 1.a) A cash dividend paid to stockholders is reported in the investing activities section of the statement of cash flows. 2.b) A cash dividend paid to stockholders is reported on the statement of changes in stockholders' equity. 3.c) A cash dividend paid to stockholders is reported on the income statement. 4.d) The balance sheet reports the ending balances of permanent accounts as of the last day of the accounting period. 5.e) Changes in retained earnings during the accounting period are reported on the income statement.

32) Indicate whether each of the following statements about equity is true or false. 1.a) Expenses decrease retained earnings. 2.b) Stockholders' equity and liabilities can be viewed either as sources of assets or claims to assets of the business. 3.c) Retained earnings is increased by loans received from a bank. 4.d) Dividends paid to stockholders decrease common stock. 5.e) Generally, assets are reported at the actual price paid for them when purchased regardless of subsequent changes in market value.

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33) Bates Company entered into the following transactions during its first year in business. Assume that all transactions involve the receipt or payment of cash. 1.1) Issued common stock to investors for $25,000 cash. 2.2) Borrowed $18,000 from the local bank. 3.3) Provided services to customers for $28,000. 4.4) Paid expenses amounting to $21,400. 5.5) Purchased a plot of land costing $22,000. 6.6) Paid a dividend of $15,000 to its stockholders. 7.7) Repaid $12,000 of the loan listed in item 2. Required: 1.(a) Fill in the three column headings of the accounting equation in the first row of the table shown below. 2.(b) Show the effects of the above transactions on the accounting equation. a. ________ = ________ + ________ b. Event Number 1.1) 2.2) 3.3) 4.4) 5.5) 6.6) 7.7)

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34)

Each of the following requirements is independent of the others.

1.a) Valdez Corporation has liabilities of $95,000 and stockholders’ equity of $115,000. What is the amount of Valdez's assets? ________ 2.b) Global Company has assets of $320,000 and liabilities of $95,000. What is the amount of Global's stockholders’ equity? ________ 3.c) Brown Company has assets of $90,000 and liabilities of $25,000. What is the amount of Brown's claims? ________

35) The following business events occurred for Ringgold Company during Year 1, its first year in operation: 1.1. Issued stock to investors for $45,000 cash 2.2. Borrowed $25,000 cash from the local bank 3.3. Provided services to its customers and received $32,000 cash 4.4. Paid expenses of $28,000 5.5. Paid $22,000 cash for land 6.6. Paid dividend of $12,000 to stockholders 7.7. Repaid $10,000 of the loan listed in item 2 Required: 1.a) Show the effects of the above transactions on the accounting equation, below. Include dollar amounts of increases and decreases. Enter "NA" for elements of the accounting equation that are not affected by the transaction. If one element of the accounting equation is affected by an increase and also by a decrease, enter each part on a separate line (i.e. asset exchange transaction where one asset increases and another asset decreases). (The effects of the first transaction is shown below.) 2.b) After entering all the events, calculate the total amounts of assets, liabilities, and equity at the end of the year.

Event number

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Assets

Liabilities

+ Equity

45,000

2. 3. 4. 5. 6. 7. Total

36)

Ramirez Company experienced the following events during Year 1:

1.Acquired $50,000 cash by issuing common stock 2.Borrowed $25,000 cash from a creditor 3.Provided services to customers for $38,000 cash 4.Paid $32,000 cash for operating expenses 5.Paid a cash dividend of $2,500 to stockholders 6.Purchased land with cash, $20,000 Required: 1.a) Show how each of these events affects the accounting equation. Enter "NA" for elements of the accounting equation that are not affected by the transaction. If one element of the accounting equation is affected by an increase and also by a decrease, enter each part on a separate line (i.e. asset exchange transaction where one asset increases and another asset decreases). (The effects of the first event are shown below.) 2.b) Calculate the total amount of assets, liabilities, common stock, and retained earnings at the end of the period.

Event number

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Assets

= Liabilities

+ Stockholder's Equity Common Stock + Retained

50,000

Earnings NA

2. 3. 4. 5. 6. Total

37) At the beginning of Year 2, the accounting records of Grace Company included the accounts and balances shown on the first row of the table below. During Year 2, the following transactions occurred: 1.Received $95,000 cash for providing services to customers 2.Paid salaries expense, $50,000 3.Purchased land for $12,000 cash 4.Paid $4,000 on note payable 5.Paid operating expenses, $22,000 6.Paid cash dividend, $2,500 Required: 1.a) Record the transactions in the appropriate accounts. Record the amounts of revenue, expense, and dividends in the retained earnings column. Enter 0 for items not affected. Provide appropriate titles for these accounts in the last column of the table. (The effects of the first event are shown below.)

Event

Assets Cash

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Land

= Liabilities + Notes Payable

Stockholder's Accounts Equity Titles for RE Common + Retained Stock Earnings

Beginning 29,000 32,000

18,000

33,000

10,000

1 2 3 4 5 6

1.b) What is the amount of total assets as of December 31, Year 2? 2.c) What is the amount of total stockholders' equity as of December 31, Year 2?

38) Montgomery Company experienced the following events during Year 1 (all were cash events): 1.Issued a note 2.Paid operating expenses 3.Issued common stock 4.Provided services to customers 5.Repaid part of the note in event 1 6.Paid dividends to stockholders Required: Indicate how each of these events affects the accounting equation by writing the letter "I" for increase, the letter "D" for decrease, and "NA" for no effect under each of the elements of the accounting equation. Use only one item of entry in each column. (The effects of the first event are shown below.) Event number

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Assets

= Liabilities

Stockholder's Equity Common Stock + Retained Earnings

2. 3. 4. 5. 6.

39) Indicate how each of the following transactions affects assets by entering "+" for increase, "−" for decrease, or "+/− " if an event increases one asset account and decreases another asset account. Enter only one item for each answer. ________ 1) Issued stock to investors. ________ 2) Borrowed cash from the bank. ________ 3) Provided services for cash. ________ 4) Paid operating expenses. ________ 5) Purchased land for cash. ________ 6) Paid cash dividend to the stockholders. ________ 7) Repaid the bank loan.

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40) Classify each of the following events as an asset source (designate as "AS"), asset use (designate as "AU"), asset exchange (designate as "AX"), or not an asset source (designate as "NA"). ________ 1) Borrowed cash from the bank ________ 2) Issued stock for cash ________ 3) Purchased land for cash ________ 4) Performed services and collected cash ________ 5) Paid cash for operating expense ________ 6) Purchased equipment for cash ________ 7) Paid dividends to stockholders ________ 8) Repaid the bank loan with cash

41) Grimes Corporation reports the following cash transactions for the year ending December 31, Year 1, its first year of operation: 1.1) Issued common stock for $35,000 2.2) Borrowed $25,000 from a local bank 3.3) Purchased land for $40,000 4.4) Provided services to clients for $38,000 5.5) Paid operating expenses of $30,500 6.6) Paid $2,000 cash dividends to stockholders Required: 1.a) What are the total assets for Grimes Corporation at December 31, Year 1? 2.b) Prepare an income statement for Year 1.

42)

Young Company reported the following balance sheet for the end of Year 1:

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Young Company Balance Sheet For the Year Ended December 31, Year 2 Assets Cash Land Total assets

$58,800 25,500 $84,300

Liabilities: Notes payable Stockholders' equity

$18,000

Common stock Retained earnings Total stockholders' equity

50,000 16,300 66,300

Total liabilities and stockholders' equity

$84,300

During Year 2, Young reported the following transactions: ● Repaid $9,000 to a local bank on a note payable ● Provided services to clients for $27,400 cash ● Paid operating expenses of $20,200 ● Paid $4,500 cash dividends to stockholders Required: Prepare Young Company's balance sheet as of December 31, Year 2.

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43) Use the following information to prepare an income statement for Penelope Company for the period ending December 31, Year 1. All transactions were for cash. 1.A) Received revenue from services provided to customers, $30,500. 2.B) Paid $19,000 cash for land. 3.C) Issued $16,000 of common stock. 4.D) Paid dividends to stockholders, $3,000. 5.E) Paid operating expenses, $25,400.

44) The following events are for Holiday Travel Services for Year 1, the first year of operations. Assume that all transactions involve the receipt or payment of cash. 1.1) The business acquired $50,000 from stock issued to owners. 2.2) Creditors loaned the company $27,500. 3.3) The company provided services to its customers and received $75,400. 4.4) The company paid expenses amounting to $63,250. 5.5) The company purchased land for $25,000. 6.6) The company paid a dividend of $5,500 to its owners. Required: 1.a) Show the effects of the above transactions on the accounting equation. (Start by using appropriate element and account headings). For those events that affect retained earnings, provide the appropriate account titles in a separate column. Enter a "0" if a transaction does not affect a given account.

Event Number +

Accounts Titles for RE +

1 2 3

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4 5 6 Total

1.b) Prepare an income statement and balance sheet for and as of the end of Year 1.

45)

The following transactions apply to Wilson Fitness Center for Year 1.

1.1) Started the business by issuing $48,000 of common stock for cash. 2.2) Provided services to clients and received $65,500 cash. 3.3) Borrowed $10,500 from the bank. 4.4) Paid $8,500 for rent of equipment. 5.5) Purchased land for $15,000. 6.6) Paid $46,600 of salary expense. 7.7) Cash dividends of $4,000 were paid to the stockholders. Required: 1.a) What are the total assets of the business at the end of Year 1? 2.b) Prepare a statement of cash flows for Year 1.

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46) The following is a partial set of financial statements prepared for the company's first year of operations. All transactions were for cash. Required: Fill in the missing information by determining the amounts represented by letters a through d. Income Statement Revenue Expense Net income

$ a 6,200 $ b

Statement of Changes in Stockholders' Equity Beginning common stock Plus: Issuance of common stock Ending common stock Beginning retained earnings Add: Net income Ending retained earnings Total stockholders' equity

$ 0 11,000 11,000 $ 0 3,500 $ c $ d

47) The following is a partial set of financial statements prepared for the company's first year of operations. All transactions were for cash. Required: Fill in the blanks indicated by the alphabetic letters in the following financial statements. Income Statement Service revenue Operating expenses

$ 44,000 a

Net income Statement of Changes in Stockholders' Equity Beginning common stock Add: Common stock issued Ending common stock Beginning retained earnings Add: Net income Less: Dividends

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$ b $ 80,000 0 $ 80,000 $ 0 c d

Ending retained earnings

16,000

Total stockholders' equity

$ e Balance Sheet

Assets Cash Land Total assets

$ f 20,000 $ 120,000

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

80,000 h i $ 120,000

Statement of Cash Flows Cash flows from operating activities Cash receipt from revenue Cash payment for expense Net cash flow from operating activities Cash flows for investing activities

$ 44,000 j k

Cash payment for land Cash flows from financing activities

(20,000)

Cash receipt from loan Cash receipt from stock issue Cash dividend paid to owners Net cash flow from financing activities

l 80,000 (12,000) 92,000

Net increase in cash

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$ 100,000

48) The following transactions apply to the Garber Corporation for Year 1, its first year in business. 1.1) Issued stock to investors, $48,000. 2.2) The company borrowed $42,000 cash from the bank. 3.3) Services were provided to customers and $50,000 cash was received. 4.4) The company acquired land for $44,000. 5.5) The company paid $34,000 rent for the building where it does its business. 6.6) The company paid $3,200 for supplies that were used during the period. 7.7) The company sold the land acquired in item 5 for $44,000. 8.8) A dividend of $1,000 was paid to the owners. 9.9) Repaid $20,000 of the loan described in item 2. Required: 1.a) Prepare an income statement, statement of changes in equity, and balance sheet for Year 1. 2.b) Prepare a statement of cash flows for Year 1.

49) Rosemont Company began operations on January 1, Year 1, and on that date issued stock for $60,000 cash. In addition, Rosemont borrowed $50,000 cash from the local bank. The company provided services to its customers during Year 1 and received $35,000. It purchased land for $70,000. During the year, it paid $10,000 cash for salaries. Stockholders were paid cash dividends of $8,000 during the year. Required: 1.a) List the transactions from the information above (for example, issued common stock for $60,000) and indicate in which section of the statement of cash flows each transaction would be reported. 2.b) What would the amount be for net cash flows from operating activities? 3.c) What would be the end-of-year balance for the cash account? 4.d) What would be the amount of the total assets for the Rosemont Company at the end of Year 1? 5.e) What would be the end-of-year balance for the Retained Earnings account?

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50) The Campbell Company began operations on January 1, Year 1 and on that date issued $60,000 of common stock for cash. In addition, the company borrowed $40,000 from the bank. It provided services to its customers during Year 1 and received $72,000 cash. During the year, it paid $80,000 cash for land, $50,000 for salaries, and $10,000 in cash dividends to the owners. Required: 1.1) Show the effects of the above transactions on the accounting equation. (Start by using appropriate element and account headings). Enter a "0" if a transaction does not affect a given account. 2.2) Prepare an income statement for the Year 1 accounting period.

51) Pinehurst Company was formed in Year 1 and experienced the following accounting events during the year: 1.Issued common stock for $15,000 cash 2.Earned cash revenue of $28,000 3.Paid cash expenses of $20,500. These were the only events that affected the company during the year. Required: 1.a) Show the effects of the above transactions on the accounting equation. (Start by using appropriate element and account headings). Leave the cell blank if a transaction does not affect a given account. 2.b) Prepare an income statement for Year 1 and a balance sheet as of December 31, Year 1.

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52) Fieldstone Company was founded on January 1, Year 1. During Year 1, the company experienced the following events: 1.Received cash revenue of $25,500 2.Paid cash expenses of $20,000 3.Issued common stock for $30,000 cash 4.Paid cash dividend of $2,000 to owners. Required: 1.a) Show the effects of the above transactions on the accounting equation. (Start by using appropriate element and account headings). Leave the cell blank if a transaction does not affect a given account. 2.b) Prepare the Year 1 income statement and balance sheet for Fieldstone Company.

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53) Kent Corporation is trying to prepare their annual financial statements. From the list below, indicate whether the item should appear on the Income Statement, Balance Sheet, Statement of Changes in Stockholders' Equity or Statement of Cash Flows. Use IS for Income Statement, BS for Balance Sheet, SE for Statement of Changes in Stockholders' Equity and CF for Statement of Cash Flows. Note that some items may appear on more than one financial statement. 1.Total Assets 2.Land 3.Common Stock 4.Net Change in Cash 5.Revenue 6.Notes Payable 7.Stockholders' Equity 8.Total Liabilities 9.Expenses 10.Net Income 11.Ending Cash Balance 12.Beginning Cash Balance 13.Dividends

54) Lace Corporation is trying to prepare the balance sheet for year-end. Indicate whether each of the following financial statement components should be reported within Assets, Liabilities, or Stockholders’ equity. 1.Common Stock 2.Land 3.Note Payable 4.Cash 5.Retained Earnings

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55) Using the information provided in Garber Corporation's balance sheet. Calculate the following financial statement elements as a percentage of assets: 1.a) the total liabilities 2.b) common stock 3.c) retained earnings 4.d) total stockholder's equity 5.e) total liabilities and stockholders' equity

Garber Corporation Balance Sheet As of December 31, Year 1 Assets Cash Land Total assets

$ 81,800 0 $ 81,800

Liabilities Notes payable Stockholders' equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

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$ 22,000

48,000 11,800 59,800 $ 81,800

56) Car Company recorded this month's transactions in the accounting equation shown below. Based on the accounting equation, what is the maximum dividend the company could pay to shareholders? Event

25,500

Stockholder's Equity Common + Retained Stock Earnings 25,500

(20,000)

30,000

(2,000)

Totals

33,500

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Assets Cash

Liabilities

30,000 (2,000) 30,000

3,500

Answer Key Test name: Chap 01_2e_Test Bank 1) Assets I

Liabilities NA

Common Stock I

Retained Earnings NA

Issuing common stock is an asset source transaction that increases the business's assets (Cash) and its stockholders' equity (Common Stock). 2) Assets I

Liabilities I

Common Stock NA

Retained Earnings NA

Borrowing cash is an asset source transaction that increases a business's assets (Cash) and its liabilities (Notes Payable). 3) Assets I

Liabilities NA

Common Stock NA

Retained Earnings I

This is an asset source transaction that increases the business's assets (Cash) and stockholders' equity (Retained Earnings). 4) Assets I/D

Liabilities NA

Common Stock NA

Retained Earnings NA

Purchasing land for cash is an asset exchange transaction that increases one asset (Land) and decreases another asset (Cash). 5) Version 1

Assets D

Liabilities NA

Common Stock NA

Retained Earnings D

Paying expenses is an asset use transaction that decreases the business's assets (Cash) and decreases its stockholders' equity (Retained earnings). 6) Assets D

Liabilities NA

Common Stock NA

Retained Earnings D

Paying a cash dividend is an asset use transaction that decreases a business's assets (Cash) and its stockholders' equity (Retained earnings). 7) Assets I

Liabilities I

Common Stock NA

Retained Earnings NA

Issuing a note to purchase a building is an asset source transaction that increases a business's assets (Building) and increases its liabilities (Notes Payable). 8) The Financial Accounting Standards Board (FASB) The Financial Accounting Standards Board (FASB) is a privately funded organization with the primary authority for establishing accounting standards in the United States. 9) Markets include consumers, businesses, and resource owners. Consumers use resources. Business convert resources to the form that consumers want. Resource owners control the distribution of resources to conversion agents.

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10) Stakeholders are the parties that are interested in operations of an organization. Stakeholders often are users or potential users of accounting information. Stakeholders include resource providers, financial analysts, brokers, attorneys, government regulators and news reporters. 11) International Financial Reporting Standards (IFRS) have been adopted by most countries outside of the United States, and are becoming "global GAAP." Many believe that U.S. companies will be allowed to use either IFRS or U.S. GAAP in the future, and there is an ongoing process to reduce the differences between IFRS and GAAP. The International Accounting Standards Board (IASB), headquartered in London, is responsible for forming these standards. 12) Financial accounting is designed to satisfy the needs of external resource providers (external users) and must adhere to Generally Accepted Accounting Principles. Managerial accounting, however, provides information that is useful to managers within a business (internal users), and does not have to follow GAAP. 13) Similarities: Both types of organizations commonly use specific resources to satisfy consumer demand. These resources are financial resources, physical resources, and labor resources. Accounting systems are used by both types of organizations to measure the cost of the goods and services that are provided, the efficiency and effectiveness of the organizations' operations, and the ability of the organizations to continue to provide goods and services. Differences: Not-for-profit organizations are established primarily for motives other than making a profit, while most other businesses are motivated by profit. As a result, factors other than profitability influence the resource allocation priorities of not-for-profit organizations. 14) A business's balance sheet shows the elements: assets, liabilities, and stockholders' equity. Version 1

15) A business obtains its assets from creditors, from investors, and from operations. 16) Providing services for cash increases assets and increases stockholders’ equity. It is considered an asset source transaction. 17) Paying dividends decreases assets (Cash) and decreases stockholders' equity (Retained Earnings). It is considered an asset use transaction. 18) $225,000 Assets = Liabilities $75,000 + Stockholders’ Equity $150,000; Assets = $225,000 19) When a business acquires assets from investors, it commits to keep the assets safe and to use the assets in a manner that benefits the investors. The business also grants the investor an ownership interest in the business, thereby allowing the investor (owner) to share in the profits generated by the business. In accounting terms investors are called stockholders. A business's commitment to its stockholders is called stockholders' equity. 20) Paid loan, paid expense, and paid dividends to stockholders. Asset use transactions involve a decrease in assets (for example, Cash) and will also result in a decrease in either liabilities (Notes Payable) or stockholders' equity (Retained Earnings). 21) The statement of cash flows tells how a company obtained and used cash during the accounting period. The statement of cash flows explains the change in cash from the beginning to the end of the period. 22) Issuing stock is reported in the financing activities section. All cash exchanged between a company and its stockholders is considered a financing activity.

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23) The Income Statement The income statement reports on how a business performed during a specific accounting period. Business performance is defined as the benefits earned from customers (revenue) minus the sacrifices that were incurred (expenses) to earn those benefits (revenues). 24) The balance sheet lists the assets of a business and corresponding claims (liabilities and stockholders' equity) on those assets. It draws its name from the accounting equation. The income statement matches revenue (benefits) with the expenses (sacrifices) that were incurred to generate the revenue. The statement of changes in stockholders' equity is used to explain the effects of transactions on stockholders' equity during an accounting period. The statement of cash flows explains how a company obtained and used cash during the accounting period. The statement of cash flows classifies cash receipts (inflows) and payments (outflows) into three categories: financing activities, investing activities, and operating activities. 25) An accounting period is the span of time covered by the financial statements, normally one year; the span of time for which income is measured. The practice of pairing together on the income statement revenues and expenses that were incurred in the same accounting period is known as the matching concept. 26) a) F b) F c) T d) T e) F Financial resources are provided to a business by investors and creditors. Businesses, not resource owners, transform resources into products. Resource owners are the main providers of resources in any market.

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27) a) F b) T c) T d) T e) F Financial accounting is primarily intended for external, not internal, stakeholders. Managerial accounting information is usually more detailed than financial accounting information. 28) a) F b) T c) F d) T e) F Liabilities are reported on the balance sheet. The accounting equation requires that assets be equal to liabilities plus stockholders’ equity. Liabilities are reported on the balance sheet, not on the statement of cash flows. 29) a) T b) F c) F d) F e) T Issuing common stock for cash increases the common stock account, not retained earnings. Net income increases retained earnings, but does not necessarily equal its total. The purchase of a truck increases one asset (Truck) and decreases another asset (Cash) or increases a liability (Note Payable). Retained earnings includes all net income that a company has earned in its existence that has not been paid out in dividends. 30) a) T b) F c) F d) T e) F The issuance of stock to owners for cash is an example of an asset source, not asset exchange, transaction. Purchasing equipment for cash is an example of an asset exchange transaction in which one asset (Cash) decreases and another asset (Equipment) increases. Making a payment on a bank loan is an example of an asset use, not asset exchange, transaction.

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31) a) F b) T c) F d) T e) F A cash dividend paid to stockholders is reported in the financing activities section of the statement of cash flows. A cash dividend paid to stockholders is reported on the statement of changes in stockholders’ equity, not on the income statement. Changes in retained earnings for the accounting period are reported on the statement of changes in stockholders’ equity, not on the income statement. 32) a) T b) T c) F d) F e) T Loans received from a bank increase assets and liabilities, but do not affect retained earnings. Dividends paid to stockholders decrease retained earnings, not common stock. 33) Accounting Equation (a) and (b) Assets

Liabilities

Equity

25,000

18,000

28,000

(21,400)

22,000

18,000

(22,000) 6.

(15,000)

(12,000)

22,600

6,000

Totals

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(15,000)

16,600

34) 1.a) $210,000 2.b) $225,000 3.c) $90,000 a) Assets = liabilities +stockholders’ equity = $95,000 + 115,000 = $210,000 b) Assets − liabilities = stockholders’ equity. Stockholders’ equity = $320,000 − 95,000 = $225,000 c) Assets = claims. Total amount of claims = $90,000 35) Event number 1.

Assets

Liabilities

Equity

45,000

25,000

32,000

(28,000)

22,000

(22,000)

(12,000)

(10,000)

52,000

15,000

37,000

Total

(12,000)

36) Event number

Assets

= Liabilities

Stockholder's Equity Common + Retained Stock Earnings 50,000 NA

50,000

25,000

38,000

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(32,000)

(2,500)

20,000 (20,000)

78,500

25,000

50,000

3,500

Total

37) a) Event

Assets Cash

Land

Beginni 29,000 ng 1 95,000

32,00 0 0

= Liabiliti + Stockholder's es Equity Notes Common + Retained Payable Stock Earnings 18,000 33,00 10,000 0 0 0 95,000

(50,00 0)

(12,00 0) (4,000 ) (22,00 0)

12,00 0 0

(4,000 ) 0

(22,00 0)

2,500

(2,500 )

4 5

Accounts Titles for RE

Service Revenue Salarie s Expense

Operati ng Expense Dividen d

b) What is the amount of total assets as of December 31, Year 2? c) What is the amount of total stockholders' equity as of December 31, Year 2? 38) Event number

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Assets

= Liabilities

Stockholder's Equity Common Stock + Retained Earnings

39) 1) +, 2) +, 3) +, 4) −, 5) +/−, 6) −, 7) − 40) 1) AS 2) AS 3) AX 4) AS 5) AU 6) AX 7) AU 8) AU 41) a) Total assets = $35,000 + $25,000 + $38,000 − $30,500 − $2,000 = $65,500x b) Grimes Corporation Income Statement For the Year Ended December 31, Year 1 Revenue Operating expenses Net income

$38,000 (30,500) $ 7,500

42) Young Company Balance Sheet For the Year Ended December 31, Year 2 Assets Cash Land Total assets

$52,500 25,500 $78,000

Liabilities: Notes payable Stockholders' equity

$ 9,000

Common stock Retained earnings

50,000 19,000

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Total stockholders' equity Total liabilities and stockholders' equity

69,000 $78,000

Ending balances: Cash ($58,800−$9,000+$27,400−$20,200−$4,500); Land − No change; Notes payable ($18,000 − $9,000); Common stock − No change; Retained earnings ($16,300+$27,400−$20,200−$4,500) 43) Penelope Company Income Statement For the Year Ended December 31, Year 1 Revenue Operating expenses Net income

$ 30,500 (25,400) $ 5,100

Only revenue and expenses are reported on the income statement. Purchasing land, paying dividends, and issuing common stock do not affect the income statement. 44) a) Event Number

Assets

= Liabilitie + Stockholder's s Equity = Notes + Common + Retained Payable Stock Earnings 0 50,00 0 0 27,500 0 0

Cash

Land

50,000

27,500

75,400

(63,250 )

(25,000 ) (5,500)

25,00 0 0

5,500

59,150

25,00 0

27,500

50,00 0

6,650

6 Tota l

Other Account Titles

Service Revenue Operatin g Expense

Dividend s

b) Version 1

Holiday Travel Services Income Statement For the Year Ended December 31, Year 1 Service revenue Operating expenses Net income

$75,400 (63,250) $12,150

Holiday Travel Services Balance Sheet As of December 31, Year 1 Assets Cash Land Total assets

$59,150 25,000 $84,150

Liabilities Notes payable Stockholders' equity

$27,500

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

50,000 6,650 56,650 $84,150

45) a) Total assets = $48,000 + $65,500 + $10,500 − $8,500 + $15,000 − $15,000 − $46,600 − $4,000 = $64,900 b) Wilson Fitness Center Statement of Cash Flows For the Year Ended December 31, Year 2 Cash flows from operating activities Cash receipt from revenue Cash payment for expense Net cash flow from operating activities Cash flows for investing activities Cash payment for land Cash flows from financing activities Cash receipt from loan

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$ 65,500 (55,100) $ 10,400

$ (15,000)

10,500

Cash receipt from stock issue Cash dividend paid to owners Net cash flow from financing activities Net increase in cash Plus: Beginning cash balance Ending cash balance

48,000 (4,000) $ 54,500 49,900 0 $ 49,900

46) a) $9,700, b) $3,500, c) $3,500, d) $14,500

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47) a = 16,000 b = 28,000 c = 28,000 d = 12,000 e = 96,000 f = 100,000 g = 24,000 h = 16,000 i = 96,000 j = (16,000) k = 28,000 l = 24,000 Solve for "l" first: l + 80,000 − 12,000 = 92,000; l = 24,000 Next, solve for "k": k − 20,000 + 92,000 = 100,000; k = 28,000 Next, solve for "j": 44,000 − j = 28,000; j = 16,000 Next, solve for "a": a = j; a = 16,000 Next, solve for "b": 44,000 − 16,000 = b; b = 28,000 Next, solve for "c": c = b; c = 28,000 Next, solve for "d": 0 + 28,000 − d = 8,000; d = 12,000 (can also be taken from statement of cash flows) Next, solve for "e": 80,000 + 16,000 = 96,000 Next, solve for "f": f + 20,000 = 120,000; f = 100,000 Next, solve for "h": h = 16,000 (taken from statement of changes in stockholders’ equity) Next, solve for "i": 80,000 + 16,000 = i; i = 96,000 Last, solve for "g": g + 96,000 = 120,000; g = 24,000 48) a) Garber Corporation Income Statement For the Year Ended December 31, Year 1 Service revenue

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$ 50,000

Operating expenses

(37,200)

Net income

$ 12,800

Garber Corporation Statement of Changes in Stockholders' Equity For the Year Ended December 31, Year 1 Beginning common stock Add: Common stock issued Ending common stock Beginning retained earnings Add: Net income Less: Dividends Ending retained earnings Total stockholders' equity

$ 0 48,000 48,000 0 12,800 (1,000) 11,800 $ 59,800

Garber Corporation Balance Sheet As of December 31, Year 1 Assets Cash Land Total assets

$ 81,800 0 $ 81,800

Liabilities Notes payable Stockholders' equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

$ 22,000

48,000 11,800 59,800 $ 81,800

b) Garber Corporation Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities Cash receipt from revenue Cash payment for expense

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$ 50,000 (37,200)

Net cash flow from operating activities Cash flows for investing activities

12,800

Cash receipt from sale of land Cash payment for land Net cash flow for investing activities Cash flows from financing activities

44,000 (44,000) 0

Cash receipt from loan Cash receipt from stock issue Cash repayment of loan Cash dividend paid to owners Net cash flow from financing activities Net increase in cash Plus: Beginning cash balance

42,000 48,000 (20,000) (1,000) 69,000 81,800 0

Ending cash balance

$ 81,800

49) 1.a) Transaction

Description

Issued stock for $60,000 cash Borrowed $50,000 cash from bank Provided services to customers, $35,000 Purchased land for $70,000 Paid cash for salaries, $10,000 Paid cash dividends, $8,000

2 3 4 5 6

Section of Statement of Cash Flows Financing activities Financing activities Operating activities Investing activities Operating activities Financing activities

2.b) Net cash flows from operating activities = $25,000 ($35,000 − 10,000) 3.c) Cash account balance: $57,000 ($60,000 + $50,000 + $35,000 − $70,000 − $10,000 − $8,000) 4.d) Total Assets = $127,000 (Cash = $57,000; Land = $70,000) 5.e) Retained earnings balance: $17,000 ($35,000 − 10,000 − 8,000)

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50) 1.1) Event

Assets Cash Land

= Liabilities + Stockholder's Equity Notes Common + Retained Payable Stock Earnings 0 60,000 0

Issued stock

60,000

Borrowed cash

40,000

Revenue

72,000

Land purchase (80,000)

80,000

Salaries

(50,000)

Dividends

(10,000)

Ending balances

32,000

80,000

40,000

60,000

12,000

2.2) Campbell Company Income Statement For the Year Ended December 31, Year 1 Service revenue $ 72,000 Operating expenses (50,000) Net income $ 22,000

51) 1.a) Event

Assets Cash

= Liabilities + Stockholder's Equity Common + Retained Stock Earnings 15,000

15,000

28,000

(20,500)

Pinehurst Company Balance Sheet As of December 31, Year 1

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Assets Cash Liabilities Stockholders' equity

$ 22,500 $ 0

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

15,000 7,500 22,500 $ 22,500

2.b) Pinehurst Company Income Statement For the Year Ended December 31, Year 1 Service revenue $ 28,000 Operating expenses (20,500) Net income

$ 7,500

52) a) Event

Assets Cash

Liabilities

25,500

Stockholder's Equity Common + Retained Stock Earnings 25,500

(20,000)

30,000

(2,000)

Totals

33,500

30,000 (2,000) 30,000

3,500

b) Fieldstone Company Income Statement For the Year Ended December 31, Year 1 Service revenue Operating expenses

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$ 25,500 (20,000) 45

Net income

$ 5,500 Fieldstone Company Balance Sheet As of December 31, Year 1

Assets Cash Total Assets Liabilities Stockholders' equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

$ 33,500 $ 33,500 $ 0

30,000 3,500 33,500 $ 33,500

53) 1.BS 2.BS 3.BS and SE 4.CF 5.IS 6.BS 7.BS and SE 8.BS 9.IS 10.IS and SE 11.BS and CF 12.CF 13.SE and CF

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54) 1.Stockholders’ equity 2.Assets 3.Liabilities 4.Assets 5.Stockholders’ equity 55) 1.$22,000/ $81,800 = 26.89% 2.$48,000/ $81,800 = 58.68% 3.$11,800/ $81,800 = 14.43% 4.$59,800/ $81,800 = 73.11% 5.$81,800/ $81,800 = 100% 56) The maximum dividend a company can pay depends on two factors: the amount of cash and the amount of retained earnings. In this case, Car Company is limited by the amount of retained earnings and can only pay a $3,500 dividend to its owners.

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CHAPTER 1 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) In a market, creditors are resource providers. ⊚ true ⊚ false

In a market, a company that manufactures cars would be referred to as a business. ⊚ true ⊚ false

The value created by a business is created by its assets. ⊚ true ⊚ false

The types of resources needed by a business are financial, physical, and labor resources. ⊚ true ⊚ false

5) Financial accounting information is usually less detailed than managerial accounting information. ⊚ true ⊚ false

6) The Financial Accounting Standards Board is a privately funded organization with authority for establishing accounting standards for businesses in the US. ⊚ true ⊚ false

A business and the person who owns the business are separate reporting entities. ⊚ true ⊚ false

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Land is an element of the financial statements. ⊚ true ⊚ false

9) Liabilities are obligations of a business to relinquish assets, provide services, or accept other obligations. ⊚ true ⊚ false

10)

Liabilities are not a source of assets for a business. ⊚ true ⊚ false

11) Retained earnings reduces a company's commitment to use its assets for the benefit of its stockholders. ⊚ true ⊚ false

12) The historical cost concept requires that most assets be recorded at the amount paid for them, regardless of increases in market value. ⊚ true ⊚ false

13)

An asset source transaction increases a business’s assets and the claims to assets. ⊚ true ⊚ false

14)

Borrowing money from the bank is an example of an asset source transaction. ⊚ true ⊚ false

15)

An asset use transaction does not affect the total amount of claims to a company's assets.

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⊚ ⊚

true false

16)

The four financial statements prepared by a business bear no relationship to each other. ⊚ true ⊚ false

17)

The dividends a business pays to its owners appear on the income statement. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 18) Which of the following groups has the primary responsibility for establishing generally accepted accounting principles for business entities in the United States? A) Securities and Exchange Commission B) U.S. Congress C) International Accounting Standards Board D) Financial Accounting Standards Board

19) The Heritage Company is a manufacturer of office furniture. Which term best describes Heritage's role in society? A) Business B) Regulatory agency C) Consumer D) Resource owner

20) Which resource providers lend financial resources to a business with the expectation of repayment with interest?

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A) Consumers B) Creditors C) Investors D) Owners

21) Which type of accounting information is intended to satisfy the needs of external users of accounting information? A) Cost accounting B) Managerial accounting C) Tax accounting D) Financial accounting

22)

Which of the following statements is false regarding managerial accounting information? A) It is often used by investors. B) It is more detailed than financial accounting information. C) It can include nonfinancial information. D) It focuses on divisional rather than overall profitability.

23) Financial accounting standards are known collectively as GAAP. What does that acronym stand for? A) Generally Accepted Accounting Principles B) Generally Applied Accounting Procedures C) Governmentally Approved Accounting Practices D) Generally Authorized Auditing Principles

24) International accounting standards are formulated by the IASB. What does that acronym stand for?

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A) Internationally Accepted Standards Board B) International Accounting Standards Board C) International Accountability Standards Bureau D) International Accounting and Sustainability Board

25) Jack Henry borrowed $800,000 from Walt Bank to open a new bike store called Wooden Wheels. Jack transferred $650,000 of the cash he borrowed to the store on the first day of the year. How many reporting entities exist in this scenario? A) One reporting entity. B) Two reporting entities. C) Three reporting entities. D) Four reporting entities.

26) Jack Henry borrowed $800,000 from Walt Bank to open a new bike store called Wooden Wheels. Jack transferred $650,000 of the cash he borrowed to Wooden Wheels on the first day of the year. Which of the following appropriately reflects the cash transactions between these reporting entities? Option A. B. C. D.

Jack Henry $150,000 increase $800,000 increase $800,000 decrease $650,000 increase

Wooden Wheels $650,000 increase $650,000 increase $800,000 increase $150,000 increase

Walt Bank $800,000 decrease $150,000 decrease $650,000 decrease $800,000 decrease

A) Option A B) Option B C) Option C D) Option D

27) Ellen Gatsby and her siblings, Ben and Sarah, started Gatsby Company when they each invested $100,000 in the company. After the investments there will be

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A) One reporting entity. B) Two reporting entities. C) Three reporting entities. D) Four reporting entities.

28)

Which of the following is an example of revenue? A) Cash received as a result of a bank loan. B) Cash received from investors from the sale of common stock. C) Cash received from customers at the time services were provided. D) Cash received from the sale of land for its original selling price.

29)

Which of the following is not an element of the financial statements? A) Stockholders’ Equity B) Liabilities C) Assets D) Cash

30)

Which of the following is an accurate definition of the term asset? A) An obligation to creditors. B) A resource that will be used to produce revenue. C) A transfer of wealth from the business to its owners. D) A sacrifice incurred from operating the business.

31)

Which of the following is a source of assets? A) Creditors B) Investors C) Operations D) All the answers represent sources of assets.

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32)

If total assets decrease, then A) liabilities must increase and retained earnings must decrease. B) common stock must decrease and retained earnings must increase. C) liabilities, common stock, or retained earnings must decrease. D) liabilities, common stock, or retained earnings must increase.

33)

Liabilities A) represent obligations to repay debts. B) may increase when assets increase. C) are found on the claims side of the accounting equation. D) All of the answers are characteristics of liabilities.

34) Which term describes assets earned from operations that have been reinvested into the business? A) Liability B) Dividend C) Common stock D) Retained earnings

35)

Which of the following is the most accurate depiction of the accounting equation? A) Assets = Liabilities + Common Stock + Retained Earnings B) Assets = Liabilities + Common Stock − Expenses C) Assets = Liabilities + Retained Earnings − Dividends D) Assets = Liabilities + Common Stock + Dividends

36) Which term describes a distribution of the Company’s assets back to the owners of the business?

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A) Liability B) Dividend C) Retained earnings D) Common stock

37) Finn Company reported assets of $1,000 and stockholders’ equity of $600. What amount will Finn report for liabilities? A) $400 B) $600 C) $1,600 D) Cannot be determined

38) Algonquin Company reported assets of $50,000, liabilities of $22,000 and common stock of $15,000. Based on this information only, what is the amount of the company’s retained earnings? A) $7,000. B) $57,000. C) $13,000. D) $87,000.

39) Stosch Company's balance sheet reported assets of $92,000, liabilities of $25,000 and common stock of $22,000 as of December 31, Year 1. Retained earnings on the December 31, Year 2 balance sheet is $58,000 and Stosch paid a $24,000 dividend during Year 2. What is the amount of net income for Year 2? A) $45,000 B) $37,000 C) $13,000 D) $24,000

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40) Stosch Company's balance sheet reported assets of $40,000, liabilities of $15,000 and common stock of $12,000 as of December 31, Year 1. Retained earnings on the December 31, Year 2 balance sheet is $18,000 and Stosch paid a $14,000 dividend during Year 2. What is the amount of net income for Year 2? A) $17,000 B) $19,000 C) $13,000 D) $21,000

41) Hazeltine Company issued common stock for $200,000 cash. What happened as a result of this event? A) Assets increased. B) Stockholders’ Equity increased. C) Claims increased. D) Assets, claims, and Stockholders’ Equity all increased.

42) Ballard Company reported assets of $500 and liabilities of $200. What amount will Ballard's report for stockholders' equity? A) $300 B) $500 C) $700 D) Cannot be determined.

43) A company's total assets increased during the period while its liabilities and common stock were unchanged. No dividends were declared or paid during the period. Which of the following would explain this situation? A) Revenues were greater than expenses during the period. B) Retained earnings were less than net income during the period. C) No dividends were paid during the period. D) The company must have purchased assets with cash during the period.

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44)

Li Company paid cash to purchase land.What happened as a result of this business event? A) Total assets decreased. B) Total assets were unaffected. C) Total stockholders’ equity decreased. D) Both total assets and total stockholders’ equity decreased.

45) Turner Company reported assets of $20,000 (including cash of $9,000), liabilities of $8,000, common stock of $7,000, and retained earnings of $5,000. Based on this information, what can be concluded? A) 25% of Turner's assets are the result of prior earnings. B) $5,000 is the maximum dividend that can be paid to shareholders. C) 40% of Turner's assets are the result of borrowing from creditors. D) 25% of Turner's assets are from prior earnings, $5,000 is the maximum possible dividend, and 40% of assets are the result of borrowed resources.

46) As of December 31, Year 2, Bristol Company had $100,000 of assets, $40,000 of liabilities and $25,000 of retained earnings. What percentage of Bristol’s assets were obtained through investors? A) 60% B) 25% C) 40% D) 35%

47) On January 1, Year 2, Chavez Company had beginning balances as follows: total assets of $12,500, total liabilities of $4,500, and common stock of $3,000. During Year 2, Chavez paid dividends to its stockholders of $2,000. Given that retained earnings amounted to $6,000 at the end of Year 2, what was Chavez's net income for Year 2?

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A) $3,000 B) $5,000 C) $7,000 D) $2,000

48) When a business provides services for cash, what is the effect on the accounting equation are affected? A) Revenue and Expense B) Cash and Retained Earnings C) Cash and Expense D) Cash and Dividends

49) During Year 2, Millstone Company provided $6,500 of services for cash, paid cash dividends of $1,000 to owners, and paid $4,000 cash for expenses. Liabilities were unchanged. Which of the following statements accurately describes the effect of these events on the elements of the company's financial statements? A) Assets increased by $6,500. B) Assets increased by $1,500. C) Stockholders’ equity increased by $2,500. D) Assets increased by $5,500.

50) At the end of Year 2, retained earnings for the Baker Company was $2,650. Revenue earned by the company in Year 2 was $2,900, expenses paid during the period were $1,550, and dividends paid during the period were $950. Based on this information alone, what was the amount of retained earnings at the beginning of Year 2? A) $2,250 B) $3,050 C) $5,800 D) $1,300

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51) At the end of Year 2, retained earnings for the Baker Company was $3,500. Revenue earned by the company in Year 2 was $1,500, expenses paid during the period were $800, and dividends paid during the period were $500. Based on this information alone, what was the amount of retained earnings at the beginning of Year 2? A) $3,300 B) $3,700 C) $2,800 D) $3,800

52)

Which of the following is not an example of an asset use transaction? A) Paying cash dividends B) Paying cash expenses C) Paying off the principal of a loan D) Paying cash to purchase land

53)

Borrowing cash from the bank is an example of which type of transaction? A) Asset source B) Claims exchange C) Asset use D) Asset exchange

54) Tandem Company borrowed $32,000 of cash from a local bank. Which of the following choices accurately reflects how this event affects the accounting equation?

A. B. C. D.

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Assets

Liabilities

Common Stock

NA 32,000 32,000 32,000

= = = =

32,000 NA NA 32,000

+ + + +

NA 32,000 NA NA

+ + + +

Retained Earnings 32,000 NA 32,000 NA

A) Option A B) Option B C) Option C D) Option D

55) Which of the following could describe the effects of an asset exchange transaction on a company's total assets, total liabilities and total stockholders’ equity?

A. B. C. D.

Assets

Liabilities

Stockholders’ Equity

+ − + − + −

= = = =

NA NA NA NA

+ + + +

NA + − + −

A) Option A B) Option B C) Option C D) Option D

56) Which of the following describes the effects of an asset use transaction on the accounting equation?

A. B. C. D.

Assets

Liabilities

Stockholders’ Equity

+ − + − NA

= = = =

+ NA NA +

+ + + +

NA − NA NA

A) Option A B) Option B C) Option C D) Option D

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57)

Which of the following cash transactions would not affect total assets? A) Borrowing cash from a bank. B) Issuing common stock for cash. C) Purchasing land for cash. D) Providing services for cash.

58)

Kelly Company experienced the following events during its first accounting period.

(1) Issued common stock for $10,000 cash. (2) Earned $8,000 of cash revenue. (3) Paid $1,000 cash to purchase land. (4) Paid cash dividends amounting to $500. (5) Paid $4,400 of cash expenses. Based on this information the amount of net income is A) $2,100. B) $2,600. C) $3,600. D) $5,600.

59) Which of the following shows the effects of paying a cash dividend on the accounting equation? Assets − +/− − −

A. B. C. D.

= = = = =

Accounting Equation Liabilities + Stockholders’ Equity + + NA NA + NA NA + + NA + −

A) Option A B) Option B C) Option C D) Option D

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60) Which of the following shows the effects of providing services for cash on the accounting equation? Assets + + − −

A. B. C. D.

= = = = =

Accounting Equation Liabilities + Stockholders’ Equity NA + NA NA + + NA + + NA + −

A) Option A B) Option B C) Option C D) Option D

61) The statement of changes in stockholders’ equity shows changes in which of the following accounts? A) Retained Earnings and Assets B) Assets and Liabilities C) Common Stock and Retained Earnings D) Liabilities and Common Stock

62) Which of the following transactions would be reported on the statement of changes in stockholders’ equity? A) Borrowed $5,000 cash from the bank. B) Paid a $100 cash dividend to the owners. C) Purchased land for $2,000 cash. D) Paid $1,500 cash to pay off a portion of its note payable.

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63) At the beginning of Year 2, Jones Company had a balance in common stock of $300,000 and a balance of retained earnings of $15,000. During Year 2, the following transactions occurred: ● Issued common stock for $90,000 ● Earned net income of $50,000 ● Paid dividends of $8,000 ● Issued a note payable for $20,000 Based on the information provided, what is the total stockholders' equity on December 31, Year 2? A) $147,000 B) $357,000 C) $427,000 D) $447,000

64) Which of the following appears in the investing activities section of the statement of cash flows? A) Cash inflow from interest revenue. B) Cash inflow from the issuance of common stock. C) Cash outflow for the payment of dividends. D) Cash outflow for the purchase of land.

65) Jackson Company had a net increase in cash from operating activities of $9,600 and a net decrease in cash from financing activities of $3,400. If the beginning and ending cash balances for the company were $4,600 and $14,200, what was the net cash change from investing activities? A) An outflow or decrease of $3,400. B) An inflow or increase of $1,200. C) An inflow or increase of $3,400. D) Zero.

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66) Jackson Company had a net increase in cash from operating activities of $10,000 and a net decrease in cash from financing activities of $2,000. If the beginning and ending cash balances for the company were $4,000 and $11,000, what was the net cash change from investing activities? A) An outflow or decrease of $1,000 B) An inflow or increase of $2,000 C) An inflow or increase of $1,000 D) Zero

67) The financial statements of Calloway Company prepared at the end of the current year contained the following elements and corresponding amounts: Assets = $30,000; Liabilities = ?; Common Stock = $6,000; Revenue = $13,000; Dividends = $1,250; Beginning Retained Earnings = $4,250; Ending Retained Earnings = $8,000. Based on this information, what was the amount of expenses reported on Calloway's income statement for the current year? A) $3,750 B) $8,000 C) $9,250 D) $16,000

68) The financial statements of Calloway Company prepared at the end of the current year contained the following elements and corresponding amounts: Assets = $50,000; Liabilities = ?; Common Stock = $15,000; Revenue = $22,000; Dividends = $1,500; Beginning Retained Earnings = $3,500; Ending Retained Earnings = $7,500. Based on this information, what was the amount of expenses reported on Calloway's income statement for the current year? A) $18,500 B) $13,000 C) $16,500 D) $10,000

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69) The financial statements of Calloway Company prepared at the end of the current year contained the following elements and corresponding amounts: Assets = $50,000; Liabilities = ?; Common Stock = $15,000; Revenue = $22,000; Dividends = $1,500; Beginning Retained Earnings = $3,500; Ending Retained Earnings = $7,500. What was the amount of total liabilities reported on the balance sheet as of the end of the current year? A) $27,500 B) $31,500 C) $35,000 D) $42,500

70) Which of the following financial statements provides information about a company as of a specific point in time? A) Income statement B) Balance sheet C) Statement of cash flows D) Statement of changes in stockholders' equity

71) In which section of a statement of cash flows would the payment of cash dividends be reported? A) Investing activities. B) Operating activities. C) Financing activities. D) Dividends are not reported on the statement of cash flows.

72) Which financial statement matches asset increases from operating a business with asset decreases from operating the business?

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A) Balance sheet B) Statement of changes in equity C) Income statement D) Statement of cash flows

73) Chow Company earned $2,700 of cash revenue, paid $1,600 for cash expenses, and paid a $500 cash dividend to its owners. Which of the following statements is true? A) The net cash inflow from operating activities was $1,100. B) The net cash outflow for investing activities was $500. C) The net cash inflow from operating activities was $600. D) The net cash outflow for investing activities was $1,100.

74) Chow Company earned $1,500 of cash revenue, paid $1,200 for cash expenses, and paid a $200 cash dividend to its owners. Which of the following statements is true? A) The net cash inflow from operating activities was $100. B) The net cash outflow for investing activities was $200. C) The net cash inflow from operating activities was $300. D) The net cash outflow for investing activities was $100.

75) Yi Company provided services to a customer for $5,500 cash. Based on this information alone, which of the following statements is true? A) Total assets increased and total stockholders’ equity decreased. B) Total assets were unchanged. C) Liabilities decreased and net income increased. D) Total assets increased and net income increased.

76) During Year 2, Chico Company earned $2,450 of cash revenue, paid $1,100 of cash expenses, and paid a $600 cash dividend to its owners. Based on this information alone, which of the following statements is not true?

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A) Net income amounted to $1,350 B) Total assets increased by $750 C) Cash inflow from operating activities was $1,350 D) Cash outflow from financing activities was $750

77) During Year 2, Chico Company earned $1,950 of cash revenue, paid $1,600 of cash expenses, and paid a $150 cash dividend to its owners. Based on this information alone,which of the following statements is not true? A) Net income amounted to $350. B) Total assets increased by $200. C) Cash inflow from operating activities was $350. D) Cash outflow from financing activities was $200.

78) Glavine Company repaid a bank loan with cash. The cash flow from this event should be reported as: A) an outflow for investing activities on the Statement of Cash Flows. B) an outflow for financing activities on the Statement of Cash Flows. C) an inflow for investing activities on the Statement of Cash Flows. D) an inflow for operating activities on the Statement of Cash Flows.

79) Retained earnings at the beginning and ending of the accounting period were $850 and $1,800, respectively. Revenues of $3,300 and dividends paid to stockholders of $750 were reported during the period. What was the amount of expenses reported for the period? A) $2,550. B) $2,350. C) $950. D) $1,600.

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80) Retained earnings at the beginning and ending of the accounting period were $300 and $800, respectively. Revenues of $1,100 and dividends paid to stockholders of $200 were reported during the period. What was the amount of expenses reported for the period? A) $500 B) $400 C) $900 D) $700

81) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $42,000 2.2) borrowed $27,000 from its bank 3.3) provided consulting services for $40,000 4.4) paid back $16,000 of the bank loan 5.5) paid rent expense for $9,500 6.6) purchased equipment costing $13,000 7.7) paid $3,100 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $22,000 What is Yowell's net cash flow from operating activities? A) Inflow of $8,500 B) Inflow of $35,500 C) Inflow of $5,400 D) Inflow of $18,000

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82) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $40,000 2.2) borrowed $25,000 from its bank 3.3) provided consulting services for $39,000 4.4) paid back $15,000 of the bank loan 5.5) paid rent expense for $9,000 6.6) purchased equipment costing $12,000 7.7) paid $3,000 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $21,000 What is Yowell's net cash flow from operating activities? A) Inflow of $6,000 B) Inflow of $9,000 C) Inflow of $18,000 D) Inflow of $30,000

83) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $50,000 2.2) borrowed $35,000 from its bank 3.3) provided consulting services for $48,000 4.4) paid back $20,000 of the bank loan 5.5) paid rent expense for $11,500 6.6) purchased equipment costing $17,000 7.7) paid $3,500 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $26,000 What is Yowell's ending notes payable balance? A) $0 B) $15,000 C) $20,000 D) $35,000

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84) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $40,000 2.2) borrowed $25,000 from its bank 3.3) provided consulting services for $39,000 4.4) paid back $15,000 of the bank loan 5.5) paid rent expense for $9,000 6.6) purchased equipment costing $12,000 7.7) paid $3,000 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $21,000 What is Yowell's ending notes payable balance? A) $0 B) $25,000 C) ($15,000) D) $10,000

85) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $68,000 2.2) borrowed $53,000 from its bank 3.3) provided consulting services for $66,000 4.4) paid back $29,000 of the bank loan 5.5) paid rent expense for $16,000 6.6) purchased equipment costing $26,000 7.7) paid $4,400 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $35,000 What is Yowell's net income? A) $11,600 B) $50,000 C) $33,400 D) $15,000

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86) Yowell Company began operations on January 1, Year 1. During Year 1, the company engaged in the following cash transactions: 1.1) issued stock for $40,000 2.2) borrowed $25,000 from its bank 3.3) provided consulting services for $39,000 4.4) paid back $15,000 of the bank loan 5.5) paid rent expense for $9,000 6.6) purchased equipment costing $12,000 7.7) paid $3,000 dividends to stockholders 8.8) paid employees' salaries for work completed during the year, $21,000 What is Yowell's net income? A) $9,000 B) $30,000 C) $18,000 D) $6,000

87) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,000 cash from the issue of common stock. 2.2) Borrowed $470 from a bank. 3.3) Earned $700 of revenues. 4.4) Paid expenses of $260. 5.5) Paid a $60 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $375 of common stock. 2.2) Repaid $255 of its debt to the bank. 3.3) Earned revenues of $800. 4.4) Incurred expenses of $380. 5.5) Paid dividends of $110. What is Packard Company's net cash flow from financing activities for Year 2?

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A) $265 outflow B) $10 inflow C) $255 outflow D) $365 inflow

88) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. What is Packard Company's net cash flow from financing activities for Year 2? A) $220 outflow B) $320 outflow C) $5 inflow D) $225 inflow

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89) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,900 cash from the issue of common stock. 2.2) Borrowed $1,370 from a bank. 3.3) Earned $1,600 of revenues. 4.4) Paid expenses of $440. 5.5) Paid a $240 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $1,275 of common stock. 2.2) Repaid $885 of its debt to the bank. 3.3) Earned revenues of $1,700. 4.4) Incurred expenses of $740. 5.5) Paid dividends of $290. The amount of total liabilities on Packard’s Year 1 balance sheet is A) $485 B) $910 C) $1,370 D) $1,810

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90) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. The amount of total liabilities on Packard’s Year 1 balance sheet is A) $200 B) $340 C) $420 D) $670

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91) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,750 cash from the issue of common stock. 2.2) Borrowed $1,220 from a bank. 3.3) Earned $1,450 of revenues. 4.4) Paid expenses of $410. 5.5) Paid a $210 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $1,125 of common stock. 2.2) Repaid $780 of its debt to the bank. 3.3) Earned revenues of $1,550. 4.4) Incurred expenses of $680. 5.5) Paid dividends of $260. What is the amount of total stockholders’ equity that will be reported on Packard’s balance sheet at the end of Year 1? A) $2,790 B) $570 C) $2,580 D) $1,540

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92) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. What is the amount of total stockholders’ equity that will be reported on Packard’s balance sheet at the end of Year 1? A) $1,350 B) $900 C) $250 D) $1,300

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93) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,100 cash from the issue of common stock. 2.2) Borrowed $570 from a bank. 3.3) Earned $800 of revenues. 4.4) Paid expenses of $280. 5.5) Paid a $80 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $475 of common stock. 2.2) Repaid $325 of its debt to the bank. 3.3) Earned revenues of $900. 4.4) Incurred expenses of $420. 5.5) Paid dividends of $130. The amount of assets on Packard’s Year 2 balance sheet is A) $2,740. B) $2,610. C) $530. D) $560.

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94) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. The amount of assets on Packard’s Year 2 balance sheet is A) $2,115. B) $440. C) $2,215. D) $395.

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95) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,400 cash from the issue of common stock. 2.2) Borrowed $870 from a bank. 3.3) Earned $1,100 of revenues. 4.4) Paid expenses of $340. 5.5) Paid a $140 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $775 of common stock. 2.2) Repaid $535 of its debt to the bank. 3.3) Earned revenues of $1,200. 4.4) Incurred expenses of $540. 5.5) Paid dividends of $190. What is the net cash inflow from operating activities that will be reported on Packard’s statement of cash flows for Year 1? A) $760 B) $1,495 C) $620 D) $1,100

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96) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. What is the net cash inflow from operating activities that will be reported on Packard’s statement of cash flows for Year 1? A) $400 B) $650 C) $350 D) $820

97) Which of the following would be reported in the cash flow from financing activities section of a statement of cash flows? A) Paid cash for dividends. B) Received cash for common stock. C) Sold land for cash. D) Paying cash for dividends and receiving cash from common stock.

98) Santa Fe Company was started on January 1, Year 1, when it acquired $9,600 cash by issuing common stock. During Year 1, the company earned cash revenues of $5,900, paid cash expenses of $3,550, and paid a cash dividend of $1,100. Which of the following is true based on this information?

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A) The December 31, Year 1 balance sheet would show total equity of $8,500. B) The Year 1 statement of cash flows would show a net cash inflow from financing activities of $8,500. C) The Year 1 statement of cash flows would show net cash inflow from operating activities of $5,900. D) The Year 1 income statement would show net income of $1,250.

99) Santa Fe Company was started on January 1, Year 1, when it acquired $9,000 cash by issuing common stock. During Year 1, the company earned cash revenues of $4,500, paid cash expenses of $3,750, and paid a cash dividend of $250. Which of the following is true based on this information? A) The December 31, Year 1 balance sheet would show total equity of $8,750. B) The Year 1 income statement would show net income of $500. C) The Year 1 statement of cash flows would show net cash inflow from operating activities of $4,500. D) The Year 1 statement of cash flows would show a net cash inflow from financing activities of $8,750.

100) Robertson Company paid $1,850 cash for rent expense. What happened as a result of this business event? A) Total stockholders’ equity decreased. B) Liabilities decreased. C) The net cash flow from operating activities decreased. D) Both total stockholders’ equity and net cash flow for operating activities decreased.

101) Mayberry Company paid $30,000 cash to purchase land. What happened as a result of this business event?

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A) Total stockholders’ equity was not affected. B) The net cash flow from investing activities decreased. C) Total assets were not affected. D) Total assets and total stockholders’ equity were not affected, and net cash flow from investing activities decreased.

102) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $4,800 cash from issuing common stock. 2.Borrowed $3,100 from a bank. 3.Earned $4,000 of revenues. 4.Incurred $2,580 in expenses. 5.Paid dividends of $580. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,400 cash from the issue of common stock. 2.Repaid $1,930 of its debt to the bank. 3.Earned revenues, $5,400. 4.Incurred expenses of $3,110. 5.Paid dividends of $1,720. What was the net cash flow from financing activities reported on Lexington's statement of cash flows for Year 2? A) $2,250 outflow B) $2,250 inflow C) $1,400 inflow D) $1,400 outflow

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103) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $6,000 cash from issuing common stock. 2.Borrowed $4,400 from a bank. 3.Earned $6,200 of revenues. 4.Incurred $4,800 in expenses. 5.Paid dividends of $800. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,000 cash from the issue of common stock. 2.Repaid $2,600 of its debt to the bank. 3.Earned revenues, $9,000. 4.Incurred expenses of $5,500. 5.Paid dividends of $1,280. What was the net cash flow from financing activities reported on Lexington's statement of cash flows for Year 2? A) $2,880 outflow B) $2,880 inflow C) $1,000 outflow D) $1,000 inflow

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104) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $3,300 cash from issuing common stock. 2.Borrowed $2,350 from a bank. 3.Earned $3,250 of revenues. 4.Incurred $2,430 in expenses. 5.Paid dividends of $430. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $650 cash from the issue of common stock. 2.Repaid $1,405 of its debt to the bank. 3.Earned revenues, $4,650. 4.Incurred expenses of $2,810. 5.Paid dividends of $820. What is the amount of total assets that will be reported on Lexington's balance sheet at the end of Year 1? A) $3,830 B) $6,420 C) $950 D) $6,040

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105) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $6,000 cash from issuing common stock. 2.Borrowed $4,400 from a bank. 3.Earned $6,200 of revenues. 4.Incurred $4,800 in expenses. 5.Paid dividends of $800. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,000 cash from the issue of common stock. 2.Repaid $2,600 of its debt to the bank. 3.Earned revenues, $9,000. 4.Incurred expenses of $5,500. 5.Paid dividends of $1,280. What is the amount of total assets that will be reported on Lexington's balance sheet at the end of Year 1? A) $11,000 B) $12,000 C) $1,600 D) $7,600

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106) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $4,000 cash from issuing common stock. 2.Borrowed $2,700 from a bank. 3.Earned $3,600 of revenues. 4.Incurred $2,500 in expenses. 5.Paid dividends of $500. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,000 cash from the issue of common stock. 2.Repaid $1,650 of its debt to the bank. 3.Earned revenues, $5,000. 4.Incurred expenses of $2,950. 5.Paid dividends of $1,240. What was the amount of retained earnings that will be reported on Lexington's balance sheet at the end of Year 1? A) $1,100. B) $3,600. C) $600. D) $3,100.

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107) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $6,000 cash from issuing common stock. 2.Borrowed $4,400 from a bank. 3.Earned $6,200 of revenues. 4.Incurred $4,800 in expenses. 5.Paid dividends of $800. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,000 cash from the issue of common stock. 2.Repaid $2,600 of its debt to the bank. 3.Earned revenues, $9,000. 4.Incurred expenses of $5,500. 5.Paid dividends of $1,280. What was the amount of retained earnings that will be reported on Lexington's balance sheet at the end of Year 1? A) $6,200 B) $5,400 C) $1,400 D) $600

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108) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $4,600 cash from issuing common stock. 2.Borrowed $3,000 from a bank. 3.Earned $3,900 of revenues. 4.Incurred $2,560 in expenses. 5.Paid dividends of $560. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,300 cash from the issue of common stock. 2.Repaid $1,860 of its debt to the bank. 3.Earned revenues, $5,300. 4.Incurred expenses of $3,070. 5.Paid dividends of $1,600. What was the amount of liabilities on Lexington's balance sheet at the end of Year 2? A) $1,300. B) ($1,860). C) $1,040. D) $1,140.

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109) Lexington Company engaged in the following transactions during Year 1, its first year in operation: (Assume all transactions are cash transactions.) 1.Acquired $6,000 cash from issuing common stock. 2.Borrowed $4,400 from a bank. 3.Earned $6,200 of revenues. 4.Incurred $4,800 in expenses. 5.Paid dividends of $800. Lexington Company engaged in the following transactions during Year 2: (Assume all transactions are cash transactions.) 1.Acquired an additional $1,000 cash from the issue of common stock. 2.Repaid $2,600 of its debt to the bank. 3.Earned revenues, $9,000. 4.Incurred expenses of $5,500. 5.Paid dividends of $1,280. What was the amount of liabilities on Lexington's balance sheet at the end of Year 2? A) $1,000. B) $1,800. C) ($2,600). D) $480.

110) As of December 31, Year 1, Mason Company had $500 cash. During Year 2, Mason earned $1,200 of cash revenue and paid $800 of cash expenses. What is the amount of cash that will be reported on the balance sheet at the end of Year 2? A) $900 B) $400 C) $1,700 D) $2,500

111)

Expenses are reported on which of the following financial statement(s)?

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A) Income statement B) Balance sheet C) Statement of changes in stockholders' equity D) Income statement and statement of changes in stockholders’ equity

112) Dividends paid by a company are reported on which of the following financial statement(s)? A) Income statement B) Statement of changes in stockholders' equity C) Statement of cash flows D) Statement of changes in stockholders’ equity and statement of cash flows

113)

Liabilities are reported on which of thefollowing financial statement(s)? A) Income statement B) Balance sheet C) Statement of cash flows D) Statement of changes in stockholders' equity

114) Frank Company earned $15,000 of cash revenue. Which of the following accurately reflects how this event affects the company's accounting equation?

A. B. C. D.

Assets

Liabilities

15,000 15,000 15,000 15,000

= = = =

NA NA NA 15,000

+ Common Stock + + + + +

15,000 7,500 NA NA

+ + + +

Retained Earnings NA 7,500 15,000 NA

A) Option A B) Option B C) Option C D) Option D

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115) Jackson Company paid $500 cash for salary expenses. Which of the following accurately reflects how this event affects the company's accounting equation?

A. B. C. D.

Assets

Liabilities

Stockholders’ Equity

500 (500) (500) (500)

= = = =

500 NA (500) NA

+ + + +

NA (500) NA 500

A) Option A B) Option B C) Option C D) Option D

116) Perez Company paid a $300 cash dividend. Which of the following accurately reflects how this event affects the company's financial statements? Assets

Liabilities

300 (300) (300) 300

= = = =

300 NA NA NA

A. B. C. D.

+ Common Stock + + + + +

NA (300) NA NA

Retained Earnings NA NA (300) 300

+ + + +

A) Option A B) Option B C) Option C D) Option D

117) Garrison Company acquired $23,000 by issuing common stock. Which of the following accurately reflects how this event affects the company's accounting equation?

A. B. C. D.

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Assets

Liabilities

Common Stock

23,000 NA NA 23,000

= = = =

NA 23,000 NA NA

+ + + +

23,000 (23,000) 23,000 NA

+ + + +

Retained Earnings NA NA (23,000) 23,000 44

A) Option A B) Option B C) Option C D) Option D

118) Which of the following could represent the effects of an asset source transaction on the accounting equation?

A. B. C. D.

Assets

Liabilities

+ − + − NA

= = = =

+ NA NA +

+ + + +

Stockholders’ Equity NA − NA −

A) Option A B) Option B C) Option C D) Option D

119) Reynolds Company experienced an accounting event that affected its financial statements as indicated below: Assets +

= =

Liabilities NA

+ +

Stockholders’ Equity +

Which of the following accounting events could have caused these effects on Reynolds' accounting equation? A) Paid a cash dividend. B) Earned cash revenue. C) Borrowed money from a bank. D) The information provided does not represent a completed event.

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120) Chico Company experienced an accounting event that affected its accounting equation as indicated below: Assets

Liabilities

Common Stock

Retained Earnings NA

Which of the following accounting events could have caused these effects on Chico's accounting equation? A) Issued common stock. B) Paid cash expenses. C) Borrowed money from a bank. D) Paid a cash dividend.

121) Delta Company experienced an accounting event that affected its accounting equation as indicated below: Assets

Liabilities

Common Stock

−

Retained Earnings −

Which of the following accounting events could have caused these effects on Delta's accounting equation? A) Purchased land for cash. B) Incurred a cash expense. C) Borrowed money from a bank. D) Earned cash revenue.

122) Which of the following would not describe the effects of an asset source transaction on the accounting equation? Assets

Liabilities

+ + +

= = =

+ NA NA

A. B. C.

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+ Common Stock + + + +

NA NA +

+ + +

Retained Earnings NA + NA

+ −

A) Option A B) Option B C) Option C D) Option D

123)

The statement of changes in stockholders’ equity presents A) an explanation of the changes in the beginning and ending balances of stockholders’

equity. B) a comparison of the benefits and the sacrifices a company experiences from its operations. C) information in three categories including operating, investing, and financing activities. D) a list of a company’s assets and the sources of those assets.

124) Which of the financial statements are required by the Generally Accepted Accounting Principles (GAAP)?

A) Income Statement B) Statement of Changes in Stockholders’ Equity C) Statement of Cash Flows D) Balance Sheet E) All of these financial statements are required by GAAP

125)

Net income appears on which of the following financial statements? A) Balance Sheet B) Balance Sheet and Statement of Changes in Stockholders’ Equity C) Income Statement D) Income Statement and Statement of Changes in Stockholders’ Equity

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126) Which of the following are shown on the balance sheet? 1.Total assets 2.Land 3.Common Stock 4.Net Change in Cash 5.Revenue 6.Notes Payable 7.Retained Earnings 8.Total Liabilities and Stockholders’ Equity 9.Expenses 10.Net Income 11.Beginning cash balance 12.Dividends

A) a, b, c, f, g, h B) e, i, j C) a, b, c, f, g, h, k, l D) a, g, h

127) Which of the following are shown on the income statement? 1.Total assets 2.Land 3.Common Stock 4.Net Change in Cash 5.Revenue 6.Notes Payable 7.Stockholders' Equity 8.Total Liabilities and Stockholders’ Equity 9.Expenses 10.Net Income 11.Ending cash balance 12.Beginning cash balance 13.Dividends

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A) a, b, c, f, g, h B) e, i, j C) d, e, i, j, m D) e, i, j, m

128)

A net loss occurs when A) expenses are greater than revenues B) liabilities are greater than assets C) cash inflow is less than cash outflow D) the ending cash balance is lower than the beginning cash balance

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Answer Key Test name: Chap 01_2e_Test Bank_MCQs_TF 1) TRUE This is true. Resource providers include creditors and investors. 2) TRUE This is true. Businesses transform resources into goods and services, such as cars, that are desirable to consumers. 3) FALSE This is false. A business creates value by earning income, so earnings or income describe that value, not assets. 4) TRUE This is true. The types of resources needed by a business are financial, physical, and labor resources. 5) TRUE This is true. Financial accounting information is usually less detailed than managerial accounting information. 6) TRUE This is true. The Financial Accounting Standards Board is charged with establishing accounting standards for US businesses. It is not an agency of the US government, but rather a privately funded organization. 7) TRUE This is true. A business must report its income, assets, liabilities and equity separate from the owner of that business. 8) FALSE This is false. Land is an account within the element assets. The elements of the financial statements include assets, liabilities, stockholders’ equity. Stockholders’ equity can be further broken down into two additional elements: common stock, and retained earnings. Version 1

9) TRUE This is true. Liabilities represent the future obligations of a business entity. 10) FALSE This is false. There are three sources of assets. First, a business can borrow assets from creditors. The second source of assets is investors. The third source of assets is operations. 11) FALSE This is false. If a business retains the assets, it commits to use those assets for the benefit of the stockholders. This increase in the business’s commitments to its stockholders is normally called retained earnings. 12) TRUE This is true. Once an asset is recorded, it is not adjusted for increases in market value. 13) TRUE This is true. An asset source transaction increases a business's assets and either liabilities or equity, which make up claims to assets. 14) TRUE This is true. Borrowing money from the bank is an example of an asset source transaction because the asset cash increases as well as the liability notes payable. 15) FALSE This is false. Because asset use transactions result in a decrease in total assets, total claims must decrease as well. 16) FALSE This is false. All four financial statements are interconnected. 17) FALSE

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This is false. Dividends are not expenses. Therefore, they are not reported on the income statement. Dividends are reported on the statement of changes in stockholders’ equity and the statement of cash flows. 18) D The Financial Accounting Standards Board is a privately funded group charged with establishing accounting standards for the U.S. It is not a branch of the U.S. government. 19) A Businesses serve as conversion agents in the marketplace, transforming basic resources provided by resource owners into goods and services that consumers demand. Regulatory agencies set policies that affect the way that businesses operate. 20) B Businesses borrow money from creditors, and repay the amount borrowed, plus an additional fee known as interest. Investors, in contrast, provide financial resources in exchange for ownership interest in the business. Consumers demand goods and services from businesses. 21) D Financial accounting is intended to satisfy the needs of external users of accounting information. Managerial accounting, including cost accounting, is intended for the needs of internal users, or managers, of a business. Tax accounting is specifically intended for tax regulatory agencies. 22) A

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Managerial accounting provides information primarily for internal users, or managers, of businesses. Managers require more detailed information about a business than do external users, and sometimes that information is nonfinancial in nature. Managerial accounting information focuses on divisional rather than overall profitability and is not typically made available to external users, such as investors. 23) A Generally Accepted Accounting Principles are established by the Financial Accounting Standards Board. 24) B The International Accounting Standards Board establishes accounting standards for most countries outside of the U.S. 25) C The three reporting entities are Jack Henry, Walt Bank, and Wooden Wheels. A separate set of accounting records would be kept for each entity. 26) A Jack Henry’s cash increase of $150,000 is calculated by subtracting the $650,000 in cash he transferred to Wooden Wheels from the $800,000 in cash he borrowed from Walt Bank. Wooden Wheels will report an increase in cash of $650,000 from the transfer of cash from Jack Henry. Finally, Walt Bank will report a decrease in cash of $800,000 due to the loan it provided Jack Henry. 27) D The four reporting entities are Ellen Gatsby, Ben Gatsby, Sarah Gatsby and Gatsby Company. 28) C

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Cash received from providing services to customers is an example of revenue and is an asset source transaction. Cash received from the result of a bank loan results in a liability, Notes Payable. Cash investments made by owners increase the stockholders' equity account Common Stock. Cash received from the sale of land for its original selling price is an asset exchange transaction that decreases one asset, Land, and increases another asset, Cash. 29) D Cash is not an element of the financial statements. It is an account that is part of the element assets. 30) B Assets are resources that a business uses to conduct its operations. Examples include cash, inventory, equipment, building, land, etc. In the process of conducting operations, a business uses some assets in order to produce greater quantities of other assets. For example, Walmart may use (sell) some of its inventory in order to receive cash from a customer. The cash received is revenue. In this case, the remaining inventory is a resource (asset) that will be used (sold) in the future to produce revenue. 31) D Businesses obtain assets from three sources. Specifically, businesses can borrow assets from creditors, acquire them from investors (owners), or generate them through operations. 32) C If total assets decrease, then assets were used. Since the accounting equation must balance (i.e. assets must equal claims), the decrease on the asset (left) side of the accounting equation must be offset by a decrease on the claims (right) side of the equation. Since liabilities, common stock, and retained earnings appear on the right side of the equation, a decrease in an asset account must be offset by a decrease in one of these right side accounts. Version 1

33) D When a business borrows money from a creditor it accepts an obligation (liability) to repay the money to the creditor in the future. Borrowing money causes the business’ assets and its liabilities to increase. In the accounting equation, assets must equal claims. Liabilities and stockholders’ equity represent the claims on assets. 34) D When a company has an increase in assets from operations and chooses to reinvest the profits into the business it is referred to as retained earnings. If the business chooses to distribute the increase in assets from operations to the owners of the business it is called a dividend. A liability would represent an obligation to repay debt to an external party. Common stock represents the proportionate share of ownership each stockholder has in the business. 35) A The accounting equation shows the equality between a company’s assets and the sources of those assets. The sources include liabilities, common stock and retained earnings. Therefore, Assets = Liabilities + Common Stock + Retained Earnings. 36) B When a company redistributes its assets back to the owners of the business it is referred to as a dividend. A liability would represent an obligation to repay debt to an external party. Retained earnings are the profits that have been retained within the company rather than distributed to the owners. Common stock represents the proportionate share of ownership each stockholder has in the company. 37) A In the accounting equation, assets equal claims (liabilities + stockholders’ equity). If assets are $1,000, total claims must also be $1,000. Therefore, liabilities must be $1,000 − $600, or $400. Version 1

38) C Assets = Liabilities + Stockholders’ Equity; Stockholders’ Equity includes common stock and retained earnings. $50,000 = $22,000 + $15,000 + Retained earnings; Retained earnings = $13,000 39) B If assets on December 31, Year 1 totaled $92,000, total claims (including liabilities, common stock, and retained earnings) on that date must have also been $92,000. If liabilities were $25,000 and common stock was $22,000, retained earnings on December 31, Year 1 must have been $45,000. At the end of Year 2, the company reported $58,000 in retained earnings, a $13,000 increase. During Year 2, Stosch paid a $24,000 cash dividend, which reduced retained earnings. Therefore, Year 2 net income must have been $13,000 greater than the dividend paid. $24,000 + $13,000 = $37,000. 40) B If assets on December 31, Year 1 totaled $40,000, total claims (including liabilities, common stock, and retained earnings) on that date must have also been $40,000. If liabilities were $15,000 and common stock was $12,000, retained earnings on December 31, Year 1 must have been $13,000. At the end of Year 2, the company reported $18,000 in retained earnings, a $5,000 increase. During Year 2, Stosch paid a $14,000 cash dividend, which reduced retained earnings. Therefore, Year 2 net income must have been $5,000 greater than the dividend paid. $14,000 + $5,000 = $19,000. 41) D Issuing common stock increases both assets (Cash) and stockholders’ equity (Common Stock). Stockholders’ equity and liabilities collectively make up claims in the accounting equation. 42) A

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In the accounting equation, assets equal claims (liabilities + stockholders’ equity). If assets are $500, total claims must also be $500. Therefore,stockholders' equity must be $500 − $200, or $300. 43) A Assets = Liabilities + Stockholders’ Equity Assets = Liabilities + Common stock + Retained earnings If a company’s total assets increased while liabilities and common stock were unchanged, retained earnings must have increased. In order for retained earnings to increase, the company must have reported net income. In other words, its revenues must have been greater than its expenses. 44) B Paying cash for land is an asset exchange transaction that increases one asset (Land) and decreases another asset (Cash). The result is no overall change in total assets. 45) D Retained earnings of $5,000 is equal to 25% of the company’s assets, indicating that 25% of Turner’s assets are from prior earnings. $8,000, or 40%, of Turner’s assets are liabilities, indicating that those assets are the result of borrowed resources. A company can pay out no more in dividends than it has in its Retained Earnings account. 46) D If assets total $100,000, claims must also total $100,000. Claims include liabilities, common stock and retained earnings. Because liabilities and retained earnings equal $65,000, common stock must be $35,000. The common stock account represents the assets that were obtained through investors. $35,000 is 35% of $100,000. 47) A

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On January 1, Year 2: Assets = Liabilities + Common Stock + Retained Earnings $12,500 = $4,500 + $3,000 + Retained Earnings Retained Earnings = $5,000 During Year 2: Beginning retained earnings + Net income − Dividends = Ending retained earnings $5,000 + Net Income − $2,000 = $6,000 Net Income = $3,000 48) B Providing services for cash increases a company's assets (Cash) and stockholders’ equity (Retained Earnings). 49) B Cash, an asset, increased by $1,500 (calculated as receipts of $6,500 − payment of $1,000 − payment of $4,000). Stockholders’ equity also increased by $1,500 (calculated as revenue of $6,500 − dividends of $1,000 − expenses of $4,000). 50) A Beginning Retained Earnings + Revenue − Expenses − Dividends = Ending Retained Earnings Beginning Retained Earnings + $2,900 − $1,550 − $950 = $2,650 Beginning Retained Earnings = $2,250 51) A Beginning Retained Earnings + Revenue − Expenses − Dividends = Ending Retained Earnings Beginning Retained Earnings + $1,500 − $800 − $500 = $3,500 Beginning Retained Earnings = $3,300 52) D

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Paying cash to purchase land is an asset exchange transaction. The asset account, Cash, decreases and the asset account, Land, increases. Total assets are not affected. 53) A Borrowing cash is an asset source transaction that increases a business's assets (Cash) and increases its liabilities (Notes Payable). 54) D Borrowing cash increases assets (Cash) and increases liabilities (Notes Payable). 55) A An asset exchange transaction is one that increases one asset account and decreases another, resulting in no net change in assets. There are no changes to the company's liabilities and stockholders' equity either. Buying land for cash is an example of an asset exchange transaction. 56) B An asset use transaction is one that decreases a business's assets and decreases either liabilities or stockholders’ equity. In this asset use transaction, assets and stockholders’ equity decreased. An example of an asset use transaction with this effect would be paying cash for salary expense. 57) C Purchasing land for cash is an asset exchange transaction that does not affect total assets. Issuing stock to owners is an asset source transaction that increases assets. Borrowing cash from a bank is an asset source transaction that increases assets. Providing services for cash is an asset source transaction that increases assets. 58) C

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Net income is $3,600 (Revenue of $8,000 − Expenses of $4,400). Expenses are economic sacrifices incurred to produce revenue. In this case, the company’s sacrifice was a decrease in assets (Cash). Note that dividends are not expenses. Dividends are not paid in order to produce revenue. Instead they are transfers of wealth from the business to its owners. Purchasing land is not an expense because it is not an economic sacrifice incurred to produce revenue. 59) D A cash dividend decreases the asset account Cash and decreases the stockholders’ equity account Retained Earnings. 60) B Providing services for cash increases assets (Cash) and increases stockholders’ equity (Retained Earnings). 61) C Stockholders’ equity is made up of: Common Stock and Retained Earnings. The statement of changes in stockholders’ equity shows changes in those two accounts over the period. 62) B Dividends are reported as a deduction from retained earnings on the Statement of Changes in Stockholders’ Equity. The other transactions listed (borrowing cash from the bank, purchasing land for cash and paying off a portion of a note payable) do not affect stockholders’ equity. 63) D

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The total stockholder’s equity equals Ending Common Stock + Ending Retained Earnings. First, ending common stock is calculated as: beginning common stock + stock Issued or $300,000 + $90,000 = $390,000 ending common stock. Next, ending retained earnings is calculated as: beginning retained earnings + Net income − Dividends or $15,000 + $50,000 − $8,000 = $57,000 ending retained earnings. Finally, ending common stock of $390,000 + ending retained earnings of $57,000 = total stockholders’ equity of $447,000. Paying back a portion of a note payable does not affect stockholders’ equity and therefore it is not included in the calculation. 64) D Purchasing land (a long-lived asset) for cash is an investing activity. Issuing common stock and paying dividends are both financing activities. Cash inflow from interest revenue is an operating activity. 65) C Beginning cash balance + Increase from operating activities − Decrease from financing activities +/− Increase or decrease from investing activities = Ending cash balance $4,600 + $9,600 − $3,400 +/− Increase or decrease from investing activities = $14,200 $3,400 = Increase in investing activities 66) A Beginning cash balance + Increase from operating activities − Decrease from financing activities +/− Increase or decrease from investing activities = Ending cash balance $4,000 + $10,000 − $2,000 +/− Increase or decrease from investing activities = $11,000 $1,000 = Decrease from investing activities 67) B

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Beginning retained earnings + Revenue − Expenses − Dividends = Ending retained earnings $4,250 + $13,000 − Expenses − $1,250 = $8,000 Expenses = $8,000 68) C Beginning retained earnings + Revenue − Expenses − Dividends = Ending retained earnings $3,500 + $22,000 − Expenses − $1,500 = $7,500 Expenses = $16,500 69) A Assets = Liabilities + Common Stock + Ending Retained Earnings $50,000 = Liabilities + $15,000 + $7,500 Liabilities = $27,500 70) B The balance sheet provides information about a company as of a specific point in time, the other three statements provide information about a period of time such as a month, a quarter, or a year. 71) C Paying cash dividends, and any cash exchanged between a company and its stockholders, is a financing activity. 72) C The income statement matches asset increases from operations (revenues) with asset decreases from operations (expenses). 73) A Cash revenue and cash expenses are operating activities. Paying dividends is a financing activity. $2,700 revenue − $1,600 expense = $1,100 cash inflow from operating activities. 74) C

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Cash revenue and cash expenses are operating activities. Paying dividends is a financing activity. $1,500 revenue − $1,200 expense = $300 cash inflow from operating activities. 75) D Providing services to a customer for cash increases assets and stockholders’ equity on the balance sheet. It also increases revenue, and therefore, net income on the income statement. 76) D Revenue minus expenses equal net income of $1,350 (calculated as $2,450 − $1,100). Total assets increased by $750 (calculated as $2,450 − $1,100 − $600). Cash from operating activities increased by $1,350 (calculated as $2,450 − $1,100). 77) D Revenue minus expenses equal net income of $350 (calculated as $1,950 − $1,600). Total assets increased by $200 (calculated as $1,950 − $1,600 − $150). Cash from operating activities increased by $350 (calculated as $1,950 − $1,600). 78) B Repaying a bank loan is a cash outflow for financing activities that decreases assets (Cash) and decreases liabilities (Notes Payable). 79) D Beginning retained earnings + Revenues − Expenses − Dividends = Ending retained earnings $850 + $3,300 − Expenses −$750 = $1,800 Expenses = $1,600 80) B Beginning retained earnings + Revenues − Expenses − Dividends = Ending retained earnings $300 + $1,100 − Expenses − $200 = $800 Expenses = $400 Version 1

81) A $40,000 inflow from consulting services − $9,500 outflow for rent expense − $22,000 outflow for salaries expense = $8,500 inflow 82) B $39,000 inflow from consulting services − $9,000 outflow for rent expense − $21,000 outflow for salaries expense = $9,000 inflow 83) B Beginning notes payable balance $0 + $35,000 loan − $20,000 repayment = $15,000 ending balance 84) D Beginning notes payable balance $0 + $25,000 loan − $15,000 repayment = $10,000 ending balance 85) D $66,000 revenue − $16,000 rent expense − $35,000 salaries expense = $15,000 net income 86) A $39,000 revenue − $9,000 rent expense − $21,000 salaries expense = $9,000 net income 87) B Net cash flow from financing activities = $375 inflow from stock − $255 outflow for loan repayment − $110 outflow for dividends = $10. 88) C Net cash flow from financing activities = $325 inflow from stock − $220 outflow for loan repayment − $100 outflow for dividends = $5 89) C $0 beginning balance + $1,370 borrowed from the bank = $1,370 total liabilities 90) C $0 beginning balance + $420 borrowed from the bank = $420 total liabilities Version 1

91) C Stockholders’ equity = Common stock + Retained earnings At end of Year 1: Stockholders’ equity = $1,750 common stock issued + ($0 beginning balance + $1,450 revenue − $410 expenses − $210 dividend) = $2,580 92) D Stockholders’ equity = Common stock + Retained earnings At end of Year 1: Stockholders’ equity = $950 common stock issued + ($0 beginning balance + $650 revenue − $250 expenses − $50 dividend) = $1,300 93) B Total assets at end of Year 1 = $1,100+ $570 + $800 − $280 − $80 = $2,110 Total assets at end of Year 1 becomes the beginning balance of total assets for Year 2. $2,110 beginning balance + $475 − $325 + $900 − $420 − $130 = $2,610 94) A Total assets at end of Year 1 = $950 + $420 + $650 − $250 − $50 = $1,720 Total assets at end of Year 1 becomes the beginning balance of total assets for Year 2. $1,720 beginning balance + $325 − $220 + $750 − $360 − $100 = $2,115 95) A $1,100 inflow from revenue − $340 outflow for expenses = $760 inflow 96) A $650 inflow from revenue − $250 outflow for expenses = $400 inflow 97) D Version 1

Paying cash for dividends and receiving cash for common stock are financing activities. Selling land for cash is an investing activity. 98) B $9,600 cash inflow from issuing stock − $1,100 cash outflow for dividends = $8,500 net cash inflow from financing activities 99) D $9,000 cash inflow from issuing stock − $250 cash outflow for dividends = $8,750 net cash inflow from financing activities. 100) D Paying cash for rent expense decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings). Liabilities are not affected. It is reported as a cash outflow for operating activities on the statement of cash flows. 101) D Paying cash to purchase land is an asset exchange transaction that decreases one asset (Cash) and increases another asset (Land); therefore, there is no overall effect on total assets, total liabilities, or total stockholders’ equity. It is reported as a cash outflow from investing activities on the statement of cash flows. 102) A $1,400 cash inflow from issuing stock − $1,930 cash outflow for loan repayment − $1,720 cash outflow for dividends = $2,250 cash outflow for financing activities 103) A $1,000 cash inflow from issuing stock − $2,600 cash outflow for loan repayment − $1,280 cash outflow for dividends = $2,880 cash outflow for financing activities 104) D $0 beginning balance + $3,300 (cash) + $2,350 (cash) + $3,250 (cash) − $2,430 (cash) − $430 (cash) = $6,040 Version 1

105) A $0 beginning balance + $6,000 (cash) + $4,400 (cash) + $6,200 (cash) − $4,800 (cash) − $800 (cash) = $11,000 106) C $0 beginning balance + $3,600 revenue − $2,500 expense − $500 dividends = $600 107) D $0 beginning balance + $6,200 revenue − $4,800 expense − $800 dividends = $600 108) D $3,000 beginning balance − $1,860 loan repayment = $1,140 109) B $4,400 beginning balance − $2,600 loan repayment = $1,800 110) A $500 beginning balance + $1,200 revenue − $800 expenses = $900 111) A Expenses and revenues are reported on the income statement. Net income is reported on the statement of stockholders’ equity, but expenses are not. 112) D Dividends are not included on the income statement. They are, however, reported as a deduction from retained earnings on the statement of changes in stockholders’ equity and as a cash outflow from financing activities on the statement of cash flows. 113) B Liabilities are an element on the balance sheet. As such, liabilities do not appear on the income statement, statement of cash flows, or the statement of changes in stockholders’ equity. 114) C

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Earning cash revenue increases assets (Cash) and stockholders’ equity (Retained Earnings). 115) B Paying cash for expenses decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings). 116) C Paying cash dividends decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings). 117) A Issuing common stock increases assets (Cash) and stockholders’ equity (Common Stock). 118) A An asset source transaction increases assets and can either increase liabilities (in the case of borrowing cash) or stockholders’ equity (in the case of issuing stock or earning revenue). 119) B Earning cash revenue must have been the event that affected the financial statements as indicated because earning cash revenue increases assets (Cash) and increases stockholders’ equity (Retained Earnings). 120) A Issuing common stock would increase assets (Cash) and increase stockholders’ equity (Common Stock). 121) B Incurring a cash expense would decrease assets (Cash) and decrease stockholders’ equity (Retained Earnings). 122) D

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An asset source transaction is any transaction that results in a net increase in assets. It could be accompanied by an increase in liabilities (as in the case of borrowing cash), an increase in common stock (as in the case of issuing common stock), or an increase in retained earnings (as in the case of earning revenue). 123) A The income statement compares the benefits and sacrifices the company experiences from its operations. The statement of cash flows shows the cash inflows and outflows in categories such as operating, investing, and financing activities. The balance sheet shows the company’s assets and the sources of those assets. 124) E GAAP requires all four financial statements. 125) D Net income is shown on the Income Statement. It is also shown as an addition to Retained Earnings on the Statement of Changes in Stockholders’ Equity. 126) A The balance sheet lists a company’s assets, liabilities and stockholders’ equity. From the information given, total assets, land, common stock, notes payable, retained earnings, and total liabilities and stockholders’ equity would be listed on the balance sheet. 127) B The Income Statement lists a company’s Revenue, Expenses and Net Income for the period. 128) A When expenses are greater than revenues there is a net loss. When revenues are greater than expenses there is net income.

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CHAPTER 2: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Walker Company issued common stock for $150,000 cash. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

2) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Nguyen Company borrowed $50,000 cash from Metropolitan Bank. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

3) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Bell Company provided consulting services for $20,000 cash. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

4) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Pierce Company paid $40,000 cash to purchase land. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

5) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Perez Company paid $220,000 cash for salaries expense. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

6) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Epstein Company paid $20,000 in cash dividends to its stockholders. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

7) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA North Company issued a note to purchase a building. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

8) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Banks Company performed $5,000 of services for customers on account. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

9) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Todd Company collected $2,000 cash from customers in partial settlement of its accounts receivable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

10) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Angstrom Company provided $2,600 of services for a customer who paid $1,000 cash immediately and promised to pay an additional $1,600 one month later. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

11) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Amity Company signed contracts for $25,000 of services to be performed in the future. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

12) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA At the end of the accounting period, Signet Company recorded accrued salaries. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

13) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Carson Company accrued $100 of interest expense. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

14) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Venture Company paid $50 of interest expense that had been previously accrued. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

15)

Statement of Cash Flows

When is revenue recognized under accrual accounting?

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16)

What does the balance in accounts receivable represent?

17) When are expenses recognized under accrual accounting in relation to the payment of cash?

18)

What is the effect on the accounting equation of a cash payment to creditors?

19) Why are adjustments necessary in an accrual accounting system? What are some common examples?

20)

What effect does the recording of revenue normally have on total assets?

21) What effect does providing services on account have on the statement of cash flows? What effect does it have on the balance sheet?

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22)

Explain the meaning of the "matching concept."

23)

Explain the meaning of the fraud triangle and each of its elements.

24)

Discuss the importance of ethics in the accounting profession.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 25) Wheaton Company performed services for a customer on account. Indicate whether each of the following statements about this transaction is true or false. 1.a) Assets and stockholders’ equity both increase when the revenue is recognized. 2.b) This transaction did not affect cash flows. 3.c) The Company recorded an increase in revenue and a decrease in accounts receivable. 4.d) Recognition of revenue would be delayed until cash was collected. 5.e) This transaction is an example of an asset exchange transaction.

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26) Wyatt Company paid $57,000 in January, Year 2 for salaries that had been earned by employees in December, Year 1. Indicate whether each of the following statements about financial statement effects of the January, Year 2 event is true or false. 1.a) The income statement for Year 2 is not affected because the salaries expense had been recognized at the end of December, Year 1. 2.b) Cash flows from operating activities decreased on the Year 2 statement of cash flows. 3.c) Payment of the salaries in Year 2 increased a liability. 4.d) The Year 2 statement of changes in stockholders' equity would not be affected because the salaries expense had been recognized at the end of December, Year 1. 5.e) Both assets and stockholders’ equity decreased in Year 2 as a result of this transaction.

27) XYZ Company used $5,000 cash to pay off its accounts payable. With respect to this event, indicate whether each of the following statements is true or false. 1.a) Total assets would decrease. 2.b) Expenses would increase. 3.c) Total liabilities would remain the same.

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28) Indicate whether each of the following statements regarding the four types of accounting events is true or false. 1.a) Asset exchange transactions involve an increase in one asset and a decrease in another asset. 2.b) An asset source transaction involves an increase in assets and an increase in a corresponding claims account. 3.c) An asset use transaction cannot result in an increase in stockholders’ equity. 4.d) Asset exchange transactions cannot affect cash flows. 5.e) Some claims exchange transactions involve an increase in a liability account and a decrease in an stockholders’ equity account.

29) Indicate whether each of the following statements regarding preparing financial statements is true or false. 1.a) Accounts receivable is a liability account. 2.b) Salaries payable is on the income statement. 3.c) Interest expense is on the income statement. 4.d) Accounts payable is on the statement of cash flows. 5.e) Notes payable is a liability account. 6.f) Interest payable is an asset account.

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30) Indicate whether each of the following statements about corporate governance is true or false. 1.a) The Financial Accounting Standards Board issues a code of ethical behavior by which public accountants must abide. 2.b) The Sarbanes Oxley Act created the Public Company Accounting Oversight Board (PCAOB). 3.c) Because of the Sarbanes Oxley Act, audit firms are not permitted to provide many nonaudit services to audit clients. 4.d) The fraud triangle identifies opportunity, pressure, and rationalization as the three elements that are typically present when fraud is committed. 5.e) An executive found guilty of falsely certifying a company's financial statements faces up to a $100,000 fine and five years in prison.

31) On January 1, Year 1, Wilson Company borrowed $70,000 from State Bank. The note stipulates a 3-year term with a 3 percent interest rate. On December 31, Year 1, Wilson recorded an adjusting entry to accrue interest expense. Based solely on these events, indicate whether each of the following statements is true or false. 1.a) The Year 1 income statement is not affected because interest expense has been accrued but not paid. 2.b) The Year 1 statement of cash flows will show a $70,000 cash inflow from investing activities. 3.c) Accruing interest expense in Year 1 increased a liability. 4.d) Accruing interest expense is a claims exchange transaction. 5.e) Both assets and stockholders’ equity decreased in Year 1 as a result of this transaction.

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32) For each of the following transactions, indicate the type by entering AS for asset source transactions, AU for asset use transactions, AE for asset exchange transactions, and CE for claims exchange transactions. 1.1) ________ Paid $2,000 in dividends to its stockholders 2.2) ________ Recorded the accrual of $1,000 in salaries to be paid later 3.3) ________ Issued common stock for $20,000 in cash 4.4) ________ Earned revenue to be collected next year 5.5) ________ Paid the salaries accrued in #2 above 6.6) ________ Received cash from customers in #4 above 7.7) ________ Purchased land for cash

33) Classify each of the following transactions for the purpose of the statement of cash flow as operating activities (OA), investing activities (IA), financing activities (FA), or not reported on the statement of cash flows (NA). 1.________ Sold land 2.________ Provided consulting services on account 3.________ Borrowed funds from the bank 4.________ Paid cash to settle accrued salary expense 5.________ Collected accounts receivable

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34) Maggie Stern started a consulting business, Stern Consulting, on January 1, Year 1. The following events occurred in Year 1: 1.1) Acquired $9,000 cash by issuing common stock 2.2) Provided services on account, $27,500 3.3) Paid cash for $13,500 in operating expenses 4.4) Collected $11,000 of the revenue that was previously recorded on account 5.5) Paid a cash dividend of $5,000 to the stockholders Required: a) Show the effects of the above transactions on the accounting equation. Assets

Liabilities

Stockholders' Equity

1) 2) 3) 4) 5) Total

b) Prepare an income statement and statement of cash flows for Year 1.

35) Turner Company started its business by issuing $10,000 of common stock on January 1, Year 1. The company performed $38,000 of services for customers on account in Year 1. It collected $32,500 of this amount in Year 1, recorded expenses on account of $29,500, paid $21,000 of the payables owed, and paid a $500 dividend to the stockholders. Required: 1.a) Determine the amount of total assets at the end of Year 1. 2.b) Determine the amount of cash on hand at the end of Year 1. 3.c) Determine the amount of net income for Year 1. 4.d) Prepare a balance sheet as of December 31, Year 1.

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36) The Maryland Corporation was started on January 1, Year 1, with the issuance of $50,000 of stock. During Year 1, the company provided $75,000 of services on account and collected $68,000 of that amount. Maryland incurred $63,000 of expenses, and paid $50,000 of that amount during Year 1. On December 31, Year 1, Maryland paid investors a $2,000 cash dividend and accrued $4,000 of salary expense. Required: 1.1) Determine the net income for year ended December 31, Year 1. 2.2) Prepare Maryland Corporation's Statement of Cash Flows for the year ended December 31, Year 1. 3.3) Determine the balance in Maryland's Retained Earnings account as of December 31, Year 1.

37) Consider the following independent scenarios: 1.a) At January 1, Year 2, accounts receivable was $24,000. Cash collected on accounts receivable during Year 2 was $55,000. At December 31, Year 2, accounts receivable was $30,000. What were the revenues earned on account during Year 2? 2.b) At January 1, Year 2, accounts payable was $19,000. During Year 2, expenses on account were $68,000. At December 31, Year 2, accounts payable was $15,000. What was the amount of cash payments on accounts payable that were made during Year 2?

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38) In a company's annual report, the reader will find a company's income statement, statement of changes in stockholder's equity, balance sheet, and statement of cash flows. These financial statements can help the reader to answer specific questions. Required: Identify which financial statement would be most useful in answering the following questions. If more than one financial statement can answer the question, identify all applicable statements. 1.1) How much cash was collected from customers in partial settlement of accounts receivable during the current year? 2.2) What was the total amount of land owned by the company? 3.3) What was the total revenue earned by the company during the most recent year? 4.4) What were the types of claims that the company has against its assets? 5.5) What was the total amount of cash received by the issuance of common stock? 6.6) Was the company profitable during the most recent year? 7.7) What was the amount of cash dividends paid to the stockholders during the most recent year? 8.8) What was the total amount of cash borrowed by the company during the most recent year? 9.9) What was the ending balance of retained earnings? 10.10) What was the amount of change in the cash balance during the current year?

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39) The following transactions apply to Kellogg Company. 1.1) Issued common stock for $20,000 cash 2.2) Provided services to customers for $38,000 on account 3.3) Purchased land for $15,000 cash 4.4) Incurred $29,000 of operating expenses on account 5.5) Collected $35,000 cash from customers for services provided in event #2 6.6) Paid $27,000 on accounts payable 7.7) Paid $2,000 dividends to stockholders Required: 1.a) Identify the dollar amount effect on the statement of cash flows, if any, for each of the above transactions. 2.b) If applicable, indicate whether each transaction involves operating, investing, or financing activities.

Event

(a) Effect on Statement of Cash Flows

(b) Activity Type

1) 2) 3) 4) 5) 6) 7)

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40) Grant Hylton started a consulting business, Hylton Consulting, on January 1, Year 1, and the business engaged in the following transactions during the year: 1.1) Issued $40,000 of common stock for cash 2.2) Provided services on account, $46,500 3.3) Incurred $37,500 of operating expense, but only paid $32,000 of this amount 4.4) Collected $39,000 of the revenue that was previously recorded on account 5.5) Paid a cash dividend of $4,000 to the stockholders Required: 1.a) Show the effects of the above transactions on the accounting equation Event 1)

Assets

Liabilities

SH Equity

2) 3) 4) 5) Totals

2.b) Prepare an income statement and statement of cash flows for Year 1.

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41) Jenna Fisk started her business by issuing $8,000 of common stock on January 1, Year 1. Jenna performed $18,500 of service on account during Year 1, and she collected $16,200 of this amount by the end of Year 1. She also paid operating expenses of $14,900 and paid a $600 dividend to the stockholders during Year 1. Required: 1.a) Determine the amount of total assets at the end of Year 1. 2.b) Determine the amount of cash on hand at the end of Year 1. 3.c) Determine net income for Year 1. 4.d) Prepare a balance sheet as of December 31, Year 1.

42) Cascade Corporation began business operations and experienced the following transactions during Year 1: 1.1) Issued common stock for $20,000 cash 2.2) Provided services to customers for $80,000 on account 3.3) Incurred $36,000 of operating expenses on account 4.4) Collected $46,000 cash from customers 5.5) Paid $30,000 on accounts payable Required: Record the above transactions on a horizontal statements model to reflect their effect on Cascade's financial statements. In the last column, enter OA, IA, or FA for the type of cash flow activity, if applicable. Assets Cash

Accounts Receivable

= Liabilities + Accounts Payable

Stockholders' Equity Common Retained Stock Earnings

Cash Flows

1) 2)

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3) 4) 5) Totals

43) Indicate for each of the following items if the item would be reported on the income statement (IS), statement of changes in stockholders' equity (SE), balance sheet (BS), or statement of cash flows (CF). Some items may appear on more than one statement; if so, identify all applicable statements. 1.1) Salaries payable 2.2) Land 3.3) Dividends paid to stockholders 4.4) Interest expense 5.5) Accounts payable 6.6) Salaries expense 7.7) Retained earnings 8.8) Revenue 9.9) Cash flows from operating activities 10.10) Beginning common stock 11.11) Issued stock to investors for cash 12.12) Accounts receivable

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44) Classify each of the following transactions for the purpose of the statement of cash flows as operating activities (OA), investing activities (IA), financing activities (FA), or not reported on the statement of cash flows (NA). 1.1) ________ Collected accounts receivable 2.2) ________ Made adjusting entry to accrue salary expense at the end of the year 3.3) ________ Borrowed funds from the bank 4.4) ________ Paid cash to settle accounts payable 5.5) ________ Issued common stock for $30,000 cash 6.6) ________ Paid cash to acquire land

45) For each of the following transactions, indicate the type by entering "AS" for asset source transaction, "AU" for asset use transaction, "AE" for asset exchange transaction, and "CE" for claims exchange transaction. 1.1) ________ Paid $10,000 for a plot of land. 2.2) ________ Recorded the accrual of $1,000 in salaries to be paid the following week. 3.3) ________ Issued common stock for $20,000 in cash. 4.4) ________ Incurred operating expense on account. 5.5) ________ Paid off its accounts payable. 6.6) ________ Earned revenue to be collected at a future date. 7.7) ________ Paid $2,000 in dividends to its stockholders. 8.8) ________ Received cash from customers in #6 above. 9.9) ________ Paid the salaries accrued in #2 above. 10.10) ________ Borrowed money from a local bank.

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46) Determine whether each of the following events are asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE) transactions. 1.1) ________ Borrowed $6,000 from creditors 2.2) ________ Issued common stock to investors for $8,000 cash 3.3) ________ Accrued interest expense 4.4) ________ Provided services to customers and collected $35,000 cash 5.5) ________ Paid creditors $10,000 6.6) ________ Provided services to customers on account, $12,000 7.7) ________ Collected $2,000 from customers in partial settlement of accounts receivable 8.8) ________ Recognized accrued salary expense of $2,000

47) Oregon Company began operations on January 1, Year 1, by issuing $10,000 in common stock to the stockholders. During the year, services in the amount of $32,000 were provided to customers on account, and 80% of this amount was collected by year-end. During the year, operating expenses incurred on account were $24,000, and 60% of this amount was paid by yearend. The company paid $1,000 of dividends to stockholders during the year. During the year, Oregon paid salaries of $3,000, and on December 31, Year 1, the company accrued salaries of $2,800. Oregon recorded all appropriate year-end adjustments. 1.1) What would Oregon report for service revenue for Year 1? 2.2) What would Oregon report for salaries expense for Year 1? 3.3) What would the amount be for net cash flows from operating activities for Year 1? 4.4) What is the net income for Year 1? 5.5) What would the balance in the retained earnings account be at December 31, Year 1?

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48) Sammy Company shows the following transactions for the accounting period ending December 31, Year 1: 1.1) Sold books to customers for $68,000 on account 2.2) Collected $56,000 from customers 3.3) Issued common stock for $16,000 cash 4.4) Accrued salary expense of $20,000 cash 5.5) Paid operating expenses of $8,000 Show how the above transactions and year-end adjustments affect the accounting equation. Put the amount in parentheses if the transaction reduces that section of the equation. Leave cells blank for items not affected. Cash

Assets Accounts Receivable

Liabilities Accounts Payable

Stockholders' Equity Common Retained Stock Earnings

1. 2. 3. 4. 5. Totals

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49) Consider the following independent scenarios: 1.a) At January 1, Year 2 accounts receivable was $20,000. Revenue earned on account was $100,000. Cash collected on accounts receivable during Year 1 was $45,000. What was the ending balance in accounts receivable on December 31, Year 2? 2.b) At January 1, Year 2, accounts payable was $17,000. During Year 2, expenses on account were $72,000. The amount of cash paid on accounts payable was $20,000. What was the ending balance in accounts payable on December 31, Year 2?

50) Tucker Company shows the following transactions for the accounting period ending December 31, Year 1: 1.1) Issued common stock for $16,000 cash 2.2) Borrowed $40,000 cash from the bank 3.3) Performed $60,000 of services on account 4.4) Paid operating expenses of $8,000 in cash 5.5) Accrued salary expense of $20,000 6.6) Accrued interest expense of $500 Show how the above transactions and year-end adjustments affect the accounting equation. Put the amount in parentheses if the transaction reduces that section of the equation. Leave cells blank for items not affected. Assets Cash

Accounts Receivable

Liabilities Salaries Interest Notes Payable Payable Payable

Stockholders' Equity Common Retained Stock Earnings

1. 2. 3. 4. 5.

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6. Totals

51) Thurston Company started its business on January 1, Year 1 by issuing $15,000 of common stock. On March 1, Thurston issued a $27,000, 6% five-year note to Community Bank. Customers paid Thurston $54,000 for services performed in Year 1. The company paid $33,000 for operating expenses, and paid a $900 dividend to the stockholders. At year-end, Thurston recognized interest expense on the note. Required: 1.a) What is the amount of interest expense Thurston will recognize in Year 1? 2.b) What is the net income for Year 1?

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52) Osage Corporation began business operations and experienced the following transactions during Year 1: 1.1) Issued common stock for $25,000 cash 2.2) Issued a $20,000, 6% 4-year note to the bank on February 1 3.3) Provided services to customers for $80,000 cash 4.4) Paid $38,000 for operating expenses 5.5) Accrued interest expense on the note 6.6) Paid a $4,000 dividend to shareholders Required: Record the above transactions on a horizontal financial statements model to reflect their effect on Osage's financial statements. In the last column, enter OA, IA, FA for the type of cash flow activity, or NA if there is no activity. Stockholders' Revenu − Expens = N Cash Equity e e I Flow s Cash = Notes Interes + Commo Retaine Paymen t n d t Payment Stock Earning s

Asset s

Liabilities

1. 2. 3. 4. 5. 6. Total s

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Answer Key Test name: Chap 02_2e_Problem Materials 1) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I NA NA NA

Statement of Cash Flows I

Issuing common stock is an asset source transaction that increases the business's assets (Cash) and its stockholders' equity (Common Stock). It does not affect the income statement but is reported as a cash inflow from financing activities in the statement of cash flows. 2) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows I

Borrowing cash is an asset source transaction that increases a business's assets (Cash) and its liabilities (Notes Payable). It does not affect the income statement but is reported as a cash inflow from financing activities in the statement of cash flows. 3) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I NA I

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Statement of Cash Flows I

This is an asset source transaction that increases the business's assets (Cash). When a business provides services, it earns revenue. Revenue increases net income, which increases stockholders’ equity (Retained Earnings). This event is reported as a cash inflow from operating activities in the statement of cash flows. 4) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I/D NA NA NA NA NA

Statement of Cash Flows D

Purchasing land for cash is an asset exchange transaction that increases one asset (Land) and decreases another asset (Cash). It does not affect the income statement, and is reported as an investing activity in the statement of cash flows. 5) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows D

Paying expenses is an asset use transaction that decreases the business's assets (Cash) and decreases its stockholders’ equity (Retained Earnings). Note that the expense decreases net income, and retained earnings. It is reported as a cash outflow from operating activities in the statement of cash flows. 6) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

Paying a cash dividend is an asset use transaction that decreases a business's assets (Cash) and its stockholders’ equity (Retained Earnings). It does not affect net income, and is reported as a cash outflow from financing activities in the statement of cash flows. 7) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows NA

Issuing a note to purchase a building is an asset source transaction that increases a business's assets (Building) and increases its liabilities (Notes Payable). It does not affect net income or the statement of cash flows. 8) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I NA I

Statement of Cash Flows NA

Performing services on account increases assets (Accounts Receivable) and stockholders' equity (Retained Earnings). On the income statement, the increase in revenue increases net income. The collection of cash will occur in the future. Because cash is not collected or paid, the statement of cash flows is not affected for this event. 9) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

I/D

Collecting on accounts receivable increases one asset (Cash) and decreases another asset (Accounts Receivable). It is an asset exchange transaction. It does not affect the income statement but is reported as a cash inflow from operating activities on the statement of cash flows. 10) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I NA I

Statement of Cash Flows I

This event increases revenue, net income, and stockholders' equity (Retained Earnings) by $2,600. Cash increases by $1,000 and accounts receivable increases by $1,600, which results in an increase in assets of $2,600. It is reported as a $1,000 cash inflow from operating activities on the statement of cash flows. 11) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA NA NA NA NA NA

Statement of Cash Flows NA

This event does not affect the financial statements at all. Revenue is recorded when services are performed, not when the contract is signed. 12) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

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Statement of Cash Flows NA

On the balance sheet, accruing salaries expense increases liabilities (Salaries Payable) and stockholders' equity (Retained Earnings). Recognizing the salary expense decreases net income. Because cash was not paid or collected, there is no impact on the statement of cash flows. 13) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

Accruing interest expense increases liabilities (Interest Payable) and decreases stockholders' equity (Retained Earnings). It increases expenses and decreases net income. However, there is no effect on the statement of cash flows because the actual cash payment for interest will be made in the future. 14) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

Statement of Cash Flows D

Paying accrued interest expense decreases assets (Cash) and decreases liabilities (Interest Payable). It does not affect the income statement because the company recognized the interest expense previously. It is reported as a cash outflow from operating activities on the statement of cash flows.

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15) Recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands, is commonly called accrual accounting. Accrual accounting requires that companies recognize revenue when the work is done regardless of when cash is collected. 16) Accounts receivable is an asset account. Its balance represents expected future cash receipts arising from permitting customers to buy now and pay later. Accounts receivable is an asset account because it represents something that is owed to the company. 17) Accrual accounting requires that companies recognize expenses in the period in which they are incurred regardless of when cash is paid. In accrual transactions, that means that expenses are recorded before cash payments. Expenses are recognized when incurred, regardless of when payment is made. 18) Assets decrease; liabilities decrease Making a cash payment to creditors decreases assets (Cash) and decreases liabilities (Accounts Payable). 19) An adjustment updates account balances prior to preparing financial statements. Adjustments record revenues and expenses that should be recognized in the current accounting period but have not yet been recorded. Some common adjustments include recognizing accrued salaries expense and accrued interest expense. The matching concept requires adjustments for certain transactions in order to recognize revenues and expenses in the proper accounting period. These adjustments are made at the end of the period.

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20) The recording of revenue normally has the effect of increasing total assets (usually cash or accounts receivable). If revenue is earned at the same time cash is collected, cash is increased. If revenue is earned on account, and a customer is billed, accounts receivable is increased. 21) There is no effect on the statement of cash flows when services are performed on account. Assets and stockholders' equity will increase on the balance sheet. Providing services on account does not affect the cash account; therefore, the statement of cash flows is unaffected. The asset accounts receivable increases as does stockholders' equity (retained earnings). 22) The "matching concept" refers to the process of "matching" the expenses with the revenues that they produce in the appropriate time period. This matching is largely done through the adjusting process. For example, the accrual of salary expense has the effect of matching the correct portion of salary expense to the accounting period in which the employees contributed to producing revenue. Matching means that expenses should be recognized in the same accounting period as the revenues that they helped a business to earn. The matching concept is the foundation of accrual accounting — the recognition of revenues as they are earned and expenses as they are incurred, regardless of when cash is exchanged.

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23) The auditing profession has identified three elements that are typically present when fraud occurs. These three elements are often shown in the form of a triangle. The first of these elements is the availability of opportunity without which fraud could not exist. Therefore, opportunity is at the top of the triangle. The second element recognizes pressure as a key ingredient of misconduct. Pressure can come from a variety of sources. The third element is rationalization. Few individuals think of themselves as evil. They develop rationalizations to justify their misconduct. When working with ethical dilemmas, it is helpful to identify the opportunity, pressure, and rationalization associated with that particular situation. 24) The accountant's role in society requires trust and credibility. Accounting information is worthless if the accountant is not trustworthy. Similarly, tax and consulting advice is useless if it comes from an incompetent person. The importance of ethical conduct is universally recognized across a broad spectrum of accounting organizations. Corporate management is responsible for preparing financial reports, while outside independent accountants (CPAs) audit the reports. The high ethical standards required by the accounting profession state "a certified public accountant assumes an obligation of self-discipline above and beyond requirements of laws and regulations." The AICPA Code of Professional Conduct and the IMA Standards of Ethical Conduct are among ethics regulations governing the accounting profession.

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25) 1.a) This is true. Assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) both increase. 2.b) This is true. Because cash is not affected, cash flows are not affected. 3.c) This is false. The event resulted in an increase in revenue and an increase in accounts receivable. 4.d) This is false. Wheaton would recognize revenue when the services are performed, not when cash is received. 5.e) This is false. Because assets (Accounts Receivable) increase, it is an asset source transaction. 26) 1.a) This is true. The expense is recognized in the period in which the salaries were earned by the employees, in Year 1. 2.b) This is true. The January, Year 2 payment decreases cash flows from operating activities in Year 2. 3.c) This is false. When the payment is made, salaries payable, a liability, is decreased, not increased. 4.d) This is true. Because the expense was recognized in Year 1, the Year 2 statement of changes in stockholders' equity is unaffected. 5.e) This is false. The January, Year 2 payment decreases assets (Cash) and liabilities (Salaries Payable), but not stockholders’ equity. 27) 1.a) This is true. This event reduces assets (Cash) and liabilities (Accounts Payable). 2.b) This is false. This event does not affect the income statement because the expense associated with the accounts payable was previously recognized. 3.c) This is false. This event reduces assets (Cash) and liabilities (Accounts Payable).

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28) 1.a) This is true. An asset exchange transaction involves an increase in one asset and a decrease in another asset. 2.b) This is true. An asset source transaction involves an increase in assets and an increase in liabilities or stockholders’ equity. 3.c) This is true. An asset use transaction involves a decrease in assets and either a decrease in liabilities or stockholders’ equity. Therefore, it cannot result in an increase in stockholders’ equity. 4.d) This is false. Because an asset exchange transaction involves an increase in one asset and a decrease in another, it often affects cash. 5.e) This is true. Some claims exchange transactions, including accruing salaries, involve an increase in a liability and a decrease in stockholders’ equity. 29) 1.a) This is false. Accounts receivable is an asset account. 2.b) This is false. Salaries payable is a liability account on the balance sheet. 3.c) This is true. Interest expense is reported on the income statement. 4.d) This is false. Accounts payable is a liability account on the balance sheet. It represents the amount of cash a company is required to pay in the future. 5.e) This is true. Notes payable is a liability account on the balance sheet. 6.f) This is false. Interest payable is a liability account on the balance sheet.

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30) 1.a) This is false. The AICPA, not FASB, issues a code of professional behavior for CPAs. 2.b) This is true. The PCAOB is a result of the Sarbanes-Oxley Act. 3.c) This is true. The Sarbanes-Oxley Act restricts nonaudit services that audit firms can provide to audit clients. 4.d) This is true. Opportunity, pressure, and rationalization make up the fraud triangle. 5.e) This is false. A $5 million fine and 20-year prison sentence are possible penalties for executives who falsely certify a company's financial statements. 31) 1.a) This is false. Accrued interest expense is recognized as an expense on the income statement even though there has not been a cash payment for the interest. 2.b) This is false. Borrowing money is a financing activity. There will be a cash inflow of $70,000 reported as a financing activity on the statement of cash flows. 3.c) This is true. Accruing interest expense increases the liability account, Interest Payable. 4.d) This is true. Accruing interest expense is a claims exchange transaction. Liabilities increase and stockholders' equity decreases. There is no net effect on total claims. 5.e) This is false. Liabilities and assets increase and stockholders’ equity decreases in Year 1.

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32) 1) AU 2) CE 3) AS 4) AS 5) AU 6) AE 7) AE 1.1) Assets (Cash) decreased, stockholders’ equity (Retained Earnings) decreased 2.2) Liabilities (Salaries Payable) increased, stockholders’ equity (Retained Earnings) decreased 3.3) Assets (Cash) increased, stockholders’ equity (Common Stock) increased 4.4) Assets (Accounts Receivable) increased, stockholders’ equity (Retained Earnings) increased 5.5) Assets (Cash) decreased, liabilities (Salaries Payable) decreased 6.6) Assets (Cash) increased, assets (Accounts Receivable) decreased 7.7) Assets (Land) increased, assets (Cash) decreased 33) 1. IA 2. NA 3. FA 4. OA 5. OA 1.Purchasing and selling long-lived assets is an investing activity 2.Because cash was not collected or paid, the statement of cash flows is not affected 3.Borrowing cash is a financing activity 4.Paying salaries is an operating activity 5.Collecting cash from customers is an operating activity 34) a) Assets

Liabilities

Stockholders' Equity 9,000

9,000

27,500

(13,500)

11,000 (11,000)

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(5,000)

Total

b) Stern Consulting Income Statement For the Year Ended December 31, Year 1 Service revenue $ 27,500 Operating expense (13,500) Net income

$ 14,000

Stern Consulting Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities Cash receipts from revenue

$ 11,000

Cash payments for operating expenses

(13,500)

Net cash flow for operating activities

$ (2,500)

Cash flows for investing activities

Cash flows from financing activities Cash receipt stock issuance

9,000

Cash payment for dividends

(5,000)

Net cash flow from financing activities

4,000

Net increase in cash

1,500

Plus: Beginning cash balance Ending cash balance

Version 1

0 $ 1,500

35) a) $26,500 b) $21,000 c) $8,500 d) Turner Company Balance Sheet As of December 31, Year 1 Assets Cash

$ 21,000

Accounts receivable

5,500

$ 26,500

Liabilities Accounts payable

$ 8,500

Stockholders' equity Common stock

10,000

Retained earnings Total liabilities and stockholders' equity

8,000

18,000 $ 26,500

1.a) Total assets = $10,000 + $38,000 − $21,000 − $500 = $26,500 2.b) Cash on hand at end of Year 1 = $10,000 + $32,500 − $21,000 − $500 = $21,000 3.c) Net income = $38,000 − $29,500 = $8,500 36) 1) Net income = $75,000 − 63,000 − 4,000 = $8,000 2) Maryland Corporation Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities

Version 1

Cash receipts from revenue

$ 68,000

Cash payments for operating expenses

(50,000)

Net cash flow from operating activities

$ 18,000

Cash flows from investing activities

Cash flows from financing activities Cash receipt stock issuance

50,000

Cash payment for dividends

(2,000)

Net cash flow from financing activities

48,000

Net increase in cash

66,000

Plus: Beginning cash balance Ending cash balance

0 $ 66,000

3) Ending retained earnings = Beginning retained earnings of $0 + Net income of $8,000 net income − Dividends of $2,000 = $6,000 37) 1.a) Beginning accounts receivable of $24,000 + Revenues earned on account − Cash collections on account of $55,000 = Ending accounts receivable of $30,000; Revenues earned on account = $61,000 2.b) Beginning accounts payable of $19,000 + Expenses incurred on account of $68,000 − Cash payments made on accounts payable = Ending accounts payable of $15,000; Cash payments made on accounts payable = $72,000

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38) 1.1) Statement of cash flows 2.2) Balance sheet 3.3) Income statement 4.4) Balance sheet 5.5) Statement of cash flows and statement of changes in stockholder's equity 6.6) Income statement and statement of changes in stockholder's equity 7.7) Statement of cash flows and statement of changes in stockholder's equity 8.8) Statement of cash flows 9.9) Balance sheet and statement of changes in stockholder's equity 10.10) Statement of cash flows 39) Event 1) 2)

a. Effect on Statement of Cash Flows 20,000 NA

b. Transaction Type FA

3) 4)

(15,000) NA

5) 6) 7)

35,000 (27,000) (2,000)

OA OA FA

40) a) Event 1) 2)

Assets 40,000

Liabilities

46,500

SH Equity 40,000 46,500

37,500 (32,000)

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(37,500)

(32,000)

39,000 (39,000)

(4,000)

Totals

50,500

(4,000) 5,500

45,000

b) Hylton Consulting Income Statement For the Year Ended December 31, Year 1 Service revenue $ 46,500 Operating expense (37,500) Net income $ 9,000 Hylton Consulting Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities Cash receipts from customers

$ 39,000

Cash payments for operating expenses

(32,000)

Net cash flow from operating activities

$ 7,000

Cash flows from investing activities

Cash flows from financing activities Cash receipt stock issuance

40,000

Cash payment for dividends

(4,000)

Net cash flow from financing activities

36,000

Net increase in cash

43,000

Plus: Beginning cash balance Ending cash balance

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0 $ 43,000

41) a) Total assets = $8,000 + $18,500 − $14,900 − $600 = $11,000 b) Cash balance = $8,000 + $16,200 − $14,900 − $600 = $8,700 c) Net income = $18,500 − $14,900 = $3,600 d) Balance Sheet As of December 31, Year 1 Assets Cash

$ 8,700

Accounts receivable Liabilities

2,300

$ 11,000 $ 0

Stockholders' equity Common stock

8,000

Retained earnings Total liabilities and stockholders' equity

3,000

11,000 $ 11,000

42) Assets Cash 1)

Accounts Receivable

80,000

Stockholders' Cash Equity Flows Common Retained Stock Earnings 20,000 20,000 FA 80,000

36,000

46,000

(30,000)

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Accounts Payable

20,000

Totals

= Liabilities +

36,000

(36,000)

(46,000) (30,000) 34,000

6,000

20,000

44,000

46,000 OA (30,000) OA 36,000

43) 1) BS, 2) BS, 3) SE and CF, 4) IS, 5) BS, 6) IS, 7) BS and SE, 8) IS, 9) CF, 10) SE, 11) SE and CF, 12) BS 44) 1) OA, 2) NA, 3) FA, 4) OA, 5) FA, 6) IA 45) 1) AE, 2) CE, 3) AS, 4) CE, 5) AU, 6) AS, 7) AU, 8) AE, 9) AU, 10) AS 46) 1) AS 2) AS 3) CE 4) AS 5) AU 6) AS 7) AE 8) CE 1.1) Borrowing cash is an asset source transaction that increases cash 2.2) Issuing common stock is an asset source transaction that increases cash 3.3) Accruing interest expense is a claims exchange transaction that increases interest payable and decreases retained earnings 4.4) Providing services for cash is an asset source transaction that increases cash 5.5) Paying creditors is an asset use transaction that decreases cash 6.6) Providing services on account is an asset source transaction that increases accounts receivable 7.7) Collecting on accounts receivable is an asset exchange transaction that increases cash and decreases accounts receivable 8.8) Accruing salary expense is a claims exchange transaction that increases accounts payable and decreases retained earnings

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47) 1.1) $32,000 Service Revenue (from services provided during the year) 2.2) $3,000 salaries expense paid + $2,800 accrued salaries at year end = $5,800 Salaries Expense. 3.3) $25,600 ($32,000 × 0.80) − $14,400 ($24,000 × 0.60) − $3,000 = $8,200 CF from OA 4.4) $32,000 revenue − $24,000 operating expense − $5,800 salaries expense = $2,200 NI 5.5) $0 beginning + $2,200 NI − $1,000 Dividend = $1,200 RE balance? 48) Cash 1. 2.

56,000

16,000

Assets Accounts Receivable 68,000

= Liabilities + Accounts Payable

Stockholders' Equity Common Retained Stock Earnings 68,000

(56,000) 16,000

20,000

(8,000)

Totals

64,000

(20,000) (8,000)

12,000

20,000

16,000

40,000

49) 1.a) $20,000 beginning AR + $100,000 revenue on account − $45,000 cash collected on AR = $75,000 ending AR 2.b) $17,000 beginning AP + $72,000 expenses on account − $20,000 cash paid on AP = $69,000 ending AP 50) Assets

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Liabilities

Stockholders'

Cash

1. 2.

Salaries Interes Notes Payable t Payable Payable

16,00 0 40,00 0

3. 4.

Accounts Receivabl e

Equity Common Retained Stock Earnings 16,00 0

40,00 0 60,00 0

60,000

(8,000 )

(8,000)

20,00 0

(20,000 ) (500)

500

Total 48,00 s 0

60,00 0

20,00 0

500

40,00 0

16,00 0

31,500

51) 1.a) Year 1 Interest expense = Principal of $27,000 × 6% × 10/12 = $1,350 2.b) Net income = $54,000 − ($33,000 + $1,350) = $19,650 52) Assets Cash

1. 2. 3. 4.

25,0 00 20,0 00 80,0 00 (38,0 00)

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Liabiliti Stockholders Reve es ' Equity nue = Note Inter + Com Retained s est mon Earnings Pay Pay Sto ck 25, 000 20,0 00 80,0 80, 00 000 (38,0 00) 1,10 (1,10 0 0)

−

Expen = se

38, 000 1,1 00

80,0 00 (38,0 00) (1,10 0)

Cash Flows

25,000 FA 20,000 FA 80,000 OA (38,00 0) OA NA

(4,00 0) Tota 83,0 ls 00

20, 1,10 000 0

(4,00 0) 25, 36,9 000 00

80, 000

39, 100

40,90 0

(4,000 ) FA 83, 000

Accrued Interest Expense = $20,000 note × 6% interest rate = $1,200 accrued interest per year / 12 months = $100 of interest accrues per month. $100 per month × 11 months (Feb through Dec) = $1,100 accrued interest expense

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CHAPTER 2 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The term "recognition" means to report an economic event in the financial statements. ⊚ true ⊚ false

2) Companies that use accrual accounting recognize revenues and expenses at the time that cash is received or paid, respectively. ⊚ true ⊚ false

3) The term "accrual" describes an earnings event that is recognized before cash is received or paid. ⊚ true ⊚ false

4) A company may recognize a revenue or expense without a corresponding cash collection or payment in the same accounting period. ⊚ true ⊚ false

5) A payment to an employee in settlement of salaries payable decreases an asset and decreases stockholders’ equity. ⊚ true ⊚ false

An increase in an expense may be accompanied by a decrease in a liability. ⊚ true ⊚ false

Accrual accounting usually fails to match expenses with revenues. ⊚ true ⊚ false

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8) The matching concept leads accountants to select the recognition alternative that produces the lowest amount of net income. ⊚ true ⊚ false

9) The governance of a corporation includes the roles and responsibilities of the board of directors, managers, shareholders, and auditor. ⊚ true ⊚ false

10) The ethical standards for certified public accountants only require that such accountants comply with applicable laws and regulations. ⊚ true ⊚ false

11)

Certified public accountants are obligated to act in a way that serves the public interest. ⊚ true ⊚ false

12) The bankruptcies of Enron and WorldCom both indicated the occurrence of major audit failures. ⊚ true ⊚ false

13) The Sarbanes-Oxley Act includes several significant reforms that affect the auditing profession, but it did not reduce an audit firm's ability to provide nonaudit services to its audit clients. ⊚ true ⊚ false

14) The internal controls of a business are designed to reduce the probability of occurrence of fraud.

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⊚ ⊚

true false

15)

Providing services to customers on account is an asset exchange transaction. ⊚ true ⊚ false

16)

The collection of an account receivable is a claims exchange transaction. ⊚ true ⊚ false

17) The cash payment of interest is classified as a financing activity on the statement of cash flows. ⊚ true ⊚ false

18)

Accrued interest expense is an asset use transaction. ⊚ true ⊚ false

19)

Some claims exchange transactions increase liabilities and decrease stockholders’ equity. ⊚ ⊚

true false

20) The primary difference between notes payable and accounts payable is that notes payable generally have longer terms and usually require interest charges. ⊚ true ⊚ false

21)

Issuing a note is an asset use transaction. ⊚ true ⊚ false

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22) The balance in accounts receivable represents the amount of cash the company is required to pay in the future. ⊚ true ⊚ false

23)

Accounts receivable is an asset account on the balance sheet. ⊚ true ⊚ false

24)

Accounts payable is reported on the income statement. ⊚ true ⊚ false

25)

Sales on account decrease the balance in accounts receivable. ⊚ true ⊚ false

26)

Expenses incurred on account increase the accounts receivable balance. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 27) The balance of Accounts Receivable is shown on which of the following financial statements? A) Income statement B) Balance sheet C) Statement of cash flow D) None of these answer choices

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28) Which of the following illustrates how the recognition of revenue earned on account affects the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. + + B.

−

+ +

−

−OA

+OA

A) Option A B) Option B C) Option C D) Option D

29) Pizitz Company experienced a business event that affected its financial statements as indicated below. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income +OA

Which of the following events could have caused these effects on the company’s financial statements? A) Collecting cash from customers as payment of accounts receivable B) Earning cash for providing services to customers C) Paid cash to purchase land D) Purchased supplies on account

30) Stanley Company earns $8,000 of revenue on account in Year 1. Cash collections of receivables amount to $4,500 in Year 1 with the remainder being collected in Year 2. Which of the following shows how the recognition of revenue in Year 1 will affect the company’s accounting equation? Balance Sheet

Version 1

Cash A.

Assets + Accounts Receivable

4,500

= =

Liabilities Accounts Payable

+ +

Stockholders’ Equity Common + Retained stock Earnings 4,500

4,500

4,000

8,000

A) Option A B) Option B C) Option C D) Option D

31) Leece Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income + and +OA −

Which of the following accounting events could have caused these effects on the company’s financial statements? A) Provided consulting services on account B) Provided consulting services for cash C) Collected cash in partial settlement of its account receivable D) The information provided does not represent a completed event.

32)

What happens when a company collects cash from accounts receivable? A) The asset accounts receivable increases. B) Stockholders’ equity increases. C) Liabilities decrease. D) One asset increases and another asset decreases by an equal amount.

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33) Stannous Company earns $10,000 of revenue on account in Year 1. Cash collections of receivables amount to $3,500 in Year 1 with the remainder being collected in Year 2. Which of the following shows how the collection of cash will affect the company’s accounting equation in Year 1?

Assets Cash + Accounts Receivable 3,500 (3,500)

3,500

10,000

Balance Sheet = Liabilities + = Accounts + Payable

Stockholders’ Equity Common + Retained Stock Earnings

3,500

10,000

(4,000)

10,000

A) Option A B) Option B C) Option C D) Option D

34) Frank Company earned $15,000 of cash revenue. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. 15,000 15,000 15,000 OA B. 15,000

15,000

C. 15,000

15,000

15,000 15,000 OA

15,000

15,000 15,000 OA

D. 15,000

Version 1

15,000

A) Option A B) Option B C) Option C D) Option D

35) Jackson Company paid $500 cash for salary expenses. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Income Statement Asset = Liabilitie + Stockholders Revenu − Expens = Net s s ' Equity e e incom e A 500 (500) 500 (500) . B (500) (500) 500 (500) . C (500) (500) . D (500) (500) 500 (500) .

Statement of Cash Flows

(500) OA (500) OA (500 ) IA

A) Option A B) Option B C) Option C D) Option D

36) Perez Company paid a $300 cash dividend. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Income Statement Statement of Cash Flows Asset = Liabilitie + Stockholders Revenu − Expens = Net s s ' Equity e e incom e A. 300 (300) 300 (300) B. (300)

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(300)

300

(300) (300 ) FA

C. (300)

(300)

D. (300)

(300)

(300 ) FA (300) OA

A) Option A B) Option B C) Option C D) Option D

37) Garrison Company acquired $23,000 by issuing common stock. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Assets

Liab.

Income Statement Rev.

A. 23,000

Stk. Equity 23,000

B. 23,000

23,000

− Exp.

Statement of Cash Flows

= Net Inc. 23,000 FA

C. 23,000

23,000

D. 23,000

23,000

23,000 FA 23,000 FA

23,000

23,000 OA

A) Option A B) Option B C) Option C D) Option D

38) Tandem Company borrowed $32,000 of cash from a local bank. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income

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A. 32,000

32,000

B. 32,000

32,000

C. 32,000

32,000

D. 32,000

32,000

32,000 OA 32,000

32,000 32,000 FA

32,000

32,000 FA 32,000 FA

A) Option A B) Option B C) Option C D) Option D

39) Zimmerman Company sold land for $25,000 cash. The original cost of the land was $25,000. Which of the following accurately reflects how this event affects the company's horizontal financial statements model? Balance Sheet Income Statement Statement of Cash Flows Assets = Liabilit + Stockholder Revenue − Expen = Net ies s' Equity se inco me A 25,000 25,000 . IA (25,00 25,000 0) FA B (25,00 (25,000 (25,00 (25,00 . 0) ) 0) 0) IA C 25,000 25,000 15,000 25,000 . FA D 25,000 25,000 25,0 25,000 . 00 IA (25,00 0)

A) Option A B) Option B C) Option C D) Option D

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40) Reynolds Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income + + + + +OA

Which of the following accounting events could have caused these effects on the elements of Reynolds’ statements? A) Paid a cash dividend. B) Earned cash revenue. C) Borrowed money from a bank. D) The information provided does not represent a completed event.

41) Chico Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income + + +FA

Which of the following accounting events could have caused these effects on the elements of Chico’s financial statements? A) Issued common stock B) Earned cash revenue C) Borrowed money from a bank D) Paid a cash dividend

42) Delta Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income

Version 1

−

−OA

Which of the following accounting events could have caused these effects on the elements of Delta’s statements? A) Paid a cash dividend B) Incurred a cash expense C) Borrowed money from a bank D) Earned cash revenue

43) Bledsoe Company acquired $23,000 cash by issuing common stock on January 1, Year 1. During Year 1, Bledsoe earned $9,300 of revenue on account. The company collected $7,600 cash from customers in partial settlement of its accounts receivable and paid $6,200 cash for operating expenses. Based on this information alone, what was the impact on total assets during Year 1? A) Total assets increased by $33,700. B) Total assets increased by $1,400. C) Total assets increased by $26,100. D) Total assets did not change.

44) Bledsoe Company acquired $17,000 cash by issuing common stock on January 1, Year 1. During Year 1, Bledsoe earned $8,500 of revenue on account. The company collected $6,000 cash from customers in partial settlement of its accounts receivable and paid $5,400 cash for operating expenses. Based on this information alone, what was the impact on total assets during Year 1? A) Total assets increased by $20,100. B) Total assets increased by $600. C) Total assets increased by $26,100. D) Total assets did not change.

45) Addison Company experienced an accounting event that affected its financial statements as indicated below:

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Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income + + + +

Which of the following accounting events could have caused these effects on Addison's financial statements? A) Issued common stock B) Earned revenue on account C) Earned cash revenue D) Collected cash from customers in partial settlement of its accounts receivable.

46) In Year 1, Dale Company incurred $4,000 of utility expense on account. Dale paid cash for these expenses in Year 2. Which of the following shows how paying cash for Year 1’s utility expense will affect Dale’s accounting equation in Year 2?

Cash A.

(4,000)

4,000

Assets + Accounts Receivable

C. D.

+ +

Stockholders’ Equity Common + Retained stock Earnings

(4,000) (4,000)

(4,000)

Balance Sheet = Liabilities = Accounts Payable (4,000)

(4,000) (4,000)

A) Option A B) Option B C) Option C D) Option D

47) Which of the following shows how a payment made to settle an accrued expense, such as salaries payable, will affect a company’s financial statements?

Version 1

Balance Sheet Income Statement Assets = Liabilities + Equity Revenue − Expense = Net income a. − − n/a n/a n/a n/a

Statement of Cash Flows −FA

−

n/a

−

n/a

−OA

−

n/a

−IA

A) Option A B) Option B C) Option C D) Option D

48) During Year 1 China Enterprises experienced the following events. (1)Earned $10,000 of revenue on account (2)Incurred $9,000 of expenses on account Based on this information, which of the following describes the combined effects of both events on the amount of total assets, net income and cash flow from operating activities shown on the Year 1 financial statements? Total Assets Net Income A B C D

$ 1,000 $10,000 $10,000 $10,000

$ 1,000 $ 1,000 $ 1,000 $10,000

Net Cash Flow from Operating Activities 0 0 $1,000 $1,000

A) Option A B) Option B C) Option C D) Option D

49) Which of the following correctly describes how accounts receivable will appear on the financial statements?

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A) Asset on the balance sheet B) Expense on the income statement C) Liability on the balance sheet D) Revenue on the income statement

50) Which of the following correctly describes how accounts payable will appear on the financial statements? A) Expense on the income statement B) Revenue on the income statement C) Liability on the balance sheet D) Asset on the balance sheet

51) Greg Company recognized revenue on account. Which of the following financial statements are affected by this accounting event? A) Balance sheet B) Income statement C) Statement of cash flows D) Income statement and the balance sheet

52) Amber Company recognized accrued salary expense. Which of the following financial statements are affected by this accounting event? A) Statement of cash flows B) Income statement C) Balance sheet D) Income statement and the balance sheet

53) Mary Company collected cash from an account receivable. Which of the following financial statements are affected by this accounting event?

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A) Income statement and the statement of cash flows B) Statement of changes in stockholders’ equity C) Balance sheet and the statement of cash flows D) Income statement and the balance sheet

54) Paying cash to settle a salaries payable obligation will affect which section of the statement of cash flows? A) Financing activities B) Operating activities C) Noncash activities D) Investing activities

55) Which of the following choices accurately reflects how the recording of accrued salary expense affects the financial statements of a business? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. + − − + B.

+/−

C. D.

+ +

−

−OA

A) Option A B) Option B C) Option C D) Option D

56) Janzen Company recorded employee salaries earned but not yet paid. Which of the following represents the effect of this transaction on the horizontal financial statements model?

Version 1

Balance Sheet Income Statement Statement of Assets = Liabilities + Stockholders' Revenue − Expense = Net Cash Equity income Flows A. + + + + −OA B. C.

+ −

−

−IA

A) Option A B) Option B C) Option C D) Option D

57) Revenue on account amounted to $6,800. Cash collections of accounts receivable amounted to $4,400. Expenses for the period were $3,500. The company paid dividends of $1,150. What was net income for the period? A) $3,250 B) $900 C) $3,300 D) $2,150

58) Revenue on account amounted to $5,000. Cash collections of accounts receivable amounted to $2,300. Expenses for the period were $2,100. The company paid dividends of $450. What was net income for the period? A) $1,200 B) $2,900 C) $2,850 D) $2,450

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59) ABC Company ended Year 1 with the following account balances: Cash 600, Common Stock 400, and Retained Earnings 200. The following transactions occurred during Year 2: ● Issued common stock for $19,000 cash. ● ABC borrowed an additional $11,000 from Chris Bank. ● ABC earned $9,000 of revenue on account. ● ABC incurred $4,000 of operating expenses on account. ● Cash collections of accounts receivables were $6,000. ● ABC provided additional services to customers for $1,000 cash. ● ABC purchased land for $14,000. ● ABC used $3,000 in cash to make a partial payment on its accounts payable. ● ABC declared and paid a $200 dividend to the stockholders ● On December 31 ABC had accrued salaries of $4,000. What is the amount of net income (loss) reported on the December 31, Year 2 income statement? A) $6,200 B) $5,800 C) $6,000 D) $2,000 E) None of these answer choices is correct

60) ABC Company ended Year 1 with the following account balances: Cash 600, Common Stock 400, and Retained Earnings 200. The following transactions occurred during Year 2: ● Issued common stock for $19,000 cash. ● ABC borrowed an additional $11,000 from Chris Bank. ● ABC earned $9,000 of revenue on account. ● ABC incurred $4,000 of operating expenses on account. ● Cash collections of accounts receivables were $6,000. ● ABC provided additional services to customers for $1,000 cash. ● ABC purchased land for $14,000. ● ABC used $3,000 in cash to make a partial payment on its accounts payable. ● ABC declared and paid a $200 dividend to the stockholders ● On December 31 ABC had accrued salaries of $4,000. What is the net cash flow from operating activities shown on the statement of cash flows for the year ending December 31, Year 2?

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A) $4,000 B) $3,800 C) $6,000 D) None of these answer choices is correct.

61) ABC Company ended Year 1 with the following account balances: Cash 600, Common Stock 400, and Retained Earnings 200. The following transactions occurred during Year 2: ● Issued common stock for $19,000 cash. ● ABC borrowed an additional $11,000 from Chris Bank. ● ABC earned $9,000 of revenue on account. ● ABC incurred $4,000 of operating expenses on account. ● Cash collections of accounts receivables were $6,000. ● ABC provided additional services to customers for $1,000 cash. ● ABC purchased land for $14,000. ● ABC used $3,000 in cash to make a partial payment on its accounts payable. ● ABC declared and paid a $200 dividend to the stockholders ● On December 31 ABC had accrued salaries of $4,000. What is the amount of retained earnings that will be shown on the balance sheet prepared at the end of Year 2? A) $2,000 B) $5,800 C) $6,000 D) $6,200

62)

Recognizing an expense may be accompanied by which of the following? A) An increase in liabilities B) A decrease in liabilities C) A decrease in revenue D) An increase in assets

63)

Which of the following statements is true regarding accrual accounting?

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A) Revenue is recorded only when cash is collected. B) Expenses are recorded when they are incurred. C) Revenue is recorded in the period when it is earned. D) Revenue is recorded in the period when it is earned and expenses are recorded when they are incurred.

64) Mize Company provided $45,500 of services on account, and collected $38,000 from customers during the year. The company also incurred $37,000 of expenses on account, and paid $32,400 against its payables. How do these events impact the elements of the horizontal financial statements model? A) Total assets would increase. B) Total liabilities would increase. C) Total equity would increase. D) All of these answer choices are correct.

65) The following account balances were drawn from the Year 1 financial statements of Grayson Company: Cash Accounts receivable Land

$ 5,600 $ 2,700 $ 9,200

Accounts payable Common stock Retained earnings, January 1 Revenue

$ 1,850 ? $ 3,900

Expenses

$ 7,850

$10,700

What is the balance of the Common Stock account?

A) $11,750 B) $8,900 C) $1,050 D) $11,600

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66) The following account balances were drawn from the Year 1 financial statements of Grayson Company: Cash Accounts receivable Land

$ 8,800 Accounts payable $ 3,000 Common stock $16,000 Retained earnings, January 1 Revenue Expenses

$ 2,500 ? $ 5,400 $19,000 $14,500

What is the balance of the Common Stock account?

A) $15,400 B) $19,900 C) $900 D) $20,800

67) Revenue on account amounted to $4,600. Cash collections of accounts receivable amounted to $4,300. Cash paid for operating expenses was $3,300. The amount of employee salaries accrued at the end of the year was $1,100. What was the net cash flow from operating activities? A) $1,000 B) $1,100 C) $1,300 D) $5,300

68) Revenue on account amounted to $9,000. Cash collections of accounts receivable amounted to $8,100. Cash paid for operating expenses was $7,500. The amount of employee salaries accrued at the end of the year was $900. What was the net cash flow from operating activities?

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A) $900 B) $600 C) $1,500 D) $8,700

69) Warren Enterprises began operations during Year 1. The company had the following events during Year 1: ● The business issued $29,000 of common stock to its stockholders. ● The business purchased land for $21,000 cash. ● Services were provided to customers for $25,000 cash. ● Services were provided to customers for $14,000 on account. ● The company borrowed $25,000 from the bank. ● Operating expenses of $21,000 were incurred and paid in cash. ● Salary expense of $1,700 was accrued. ● A dividend of $13,000 was paid to the stockholders of Warren Enterprises. What is the balance of the Retained Earnings account as of December 31, Year 1? A) $14,000 B) $16,300 C) $39,000 D) $3,300

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70) Warren Enterprises began operations during Year 1. The company had the following events during Year 1: ● The business issued $40,000 of common stock to its stockholders. ● The business purchased land for $24,000 cash. ● Services were provided to customers for $32,000 cash. ● Services were provided to customers for $10,000 on account. ● The company borrowed $32,000 from the bank. ● Operating expenses of $24,000 were incurred and paid in cash. ● Salary expense of $1,600 was accrued. ● A dividend of $8,000 was paid to the stockholders of Warren Enterprises. What is the balance of the Retained Earnings account as of December 31, Year 1? A) $10,000 B) $8,400 C) $16,400 D) $42,000

71) Rushmore Company provided services for $31,500 cash during Year 1. Rushmore incurred $23,000 of operating expenses on account during Year 1, and by the end of the year, $8,500 of that amount had been paid with cash. If these are the only accounting events that affected Rushmore during Year 1, which of the following statements is true? A) The amount of net income shown on the income statement is $8,500. B) The amount of net cash flow from operating activities shown on the statement of cash flows is $17,000. C) The amount of net loss shown on the income statement is $8,500. D) The amount of net income shown on the income statement is $14,500.

72) Rushmore Company provided services for $45,000 cash during Year 1. Rushmore incurred $36,000 of operating expenses on account during Year 1, and by the end of the year, $9,000 of that amount had been paid with cash. If these are the only accounting events that affected Rushmore during Year 1, which of the following statements is true?

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A) The amount of net loss shown on the income statement is $9,000. B) The amount of net income shown on the income statement is $27,000. C) The amount of net income shown on the income statement is $9,000. D) The amount of net cash flow from operating activities shown on the statement of cash flows is $18,000.

73) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $9,600 cash by issuing common stock. 2.Provided $5,900 of services on account. 3.Paid $2,500 cash for operating expenses. 4.Collected $3,700 of cash from customers in partial settlement of its accounts receivable. 5.Paid a $280 cash dividend to stockholders. What is the amount of net income that will be reported on the Year 1 income statement? A) $2,480 B) $2,200 C) $2,760 D) $3,400

74) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $12,000 cash by issuing common stock 2.Provided $4,600 of services on account 3.Paid $3,200 cash for operating expenses 4.Collected $3,800 of cash from customers in partial settlement of its accounts receivable 5.Paid a $200 cash dividend to stockholders What is the amount of net income that will be reported on the Year 1 income statement? A) $1,400 B) $800 C) $1,000 D) $1,200

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75) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $8,800 cash by issuing common stock. 2.Provided $5,100 of services on account. 3.Paid $2,300 cash for operating expenses. 4.Collected $3,300 of cash from customers in partial settlement of its accounts receivable. 5.Paid a $240 cash dividend to stockholders. What is the amount of net cash flows from operating activities that will be reported on the Year 1 statement of cash flows? A) $1,000 B) $2,560 C) $2,800 D) $480

76) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $12,000 cash by issuing common stock 2.Provided $4,600 of services on account 3.Paid $3,200 cash for operating expenses 4.Collected $3,800 of cash from customers in partial settlement of its accounts receivable 5.Paid a $200 cash dividend to stockholders What is the amount of net cash flows from operating activities that will be reported on the Year 1 statement of cash flows? A) $400 B) $600 C) $1,400 D) $1,200

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77) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $8,400 cash by issuing common stock. 2.Provided $4,700 of services on account. 3.Paid $2,200 cash for operating expenses. 4.Collected $3,100 of cash from customers in partial settlement of its accounts receivable. 5.Paid a $220 cash dividend to stockholders. What is the amount of total assets that will be reported on the balance sheet as of December 31, Year 1? A) $9,080 B) $9,300 C) $10,900 D) $10,680

78) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $12,000 cash by issuing common stock 2.Provided $4,600 of services on account 3.Paid $3,200 cash for operating expenses 4.Collected $3,800 of cash from customers in partial settlement of its accounts receivable 5.Paid a $200 cash dividend to stockholders What is the amount of total assets that will be reported on the balance sheet as of December 31, Year 1? A) $12,400 B) $12,600 C) $13,400 D) $13,200

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79) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $7,400 cash by issuing common stock. 2.Provided $3,700 of services on account. 3.Paid $1,950 cash for operating expenses. 4.Collected $2,600 of cash from customers in partial settlement of its accounts receivable. 5.Paid a $170 cash dividend to stockholders. What is the balance of the retained earnings that will be reported on the balance sheet as of December 31, Year 1? A) $8,980 B) $1,580 C) $8,050 D) $1,750

80) Nelson Company experienced the following transactions during Year 1, its first year in operation. 1.Acquired $12,000 cash by issuing common stock 2.Provided $4,600 of services on account 3.Paid $3,200 cash for operating expenses 4.Collected $3,800 of cash from customers in partial settlement of its accounts receivable 5.Paid a $200 cash dividend to stockholders What is the balance of the retained earnings that will be reported on the balance sheet as of December 31, Year 1? A) $1,200 B) $1,000 C) $1,400 D) $13,200

81) On December 31, Year 1, Gaskins Company owed $4,500 in salaries to employees who had worked during December but will not be paid until January, Year 2. If the year-end adjustment is properly recorded on December 31, Year 1, what will be the effect of this accrual on net income and cash flows from operating activities reported for Year 1?

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A) No effect on net income; no effect on cash flow from operating activities B) Decrease in net income; no effect on cash flow from operating activities C) Increase in net income; decrease in cash flow from operating activities D) No effect on net income; decrease in cash flow from operating activities

82)

Which of the following are “matched” under the matching concept? A) Expenses and revenues B) Expenses and liabilities C) Assets and stockholders’ equity D) Assets and liabilities

83) Which of the following financial statements is impacted most significantly by the matching concept? A) Balance sheet B) Income statement C) Statement of changes in stockholders' equity D) Statement of cash flows

84) Which of the following is frequently used to describe the expenses that are matched in the same accounting period in which they are incurred? A) Market expenses B) Matching expenses C) Period costs D) Working costs

85) If retained earnings decreased during the year, and no dividends were paid, which of the following statements must be true?

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A) Expenses for the year exceeded revenues. B) The company did not have enough cash to pay its expenses. C) Total stockholders’ equity decreased D) Liabilities increased during the year.

86)

What is the purpose of the accrual basis of accounting?

A) Recognize revenue when it is collected from customers. B) Match assets with liabilities during the proper accounting period. C) Recognize expenses when cash disbursements are made. D) Recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands.

87)

Which of the following is not an element of the fraud triangle? A) Reliance B) Rationalization C) Opportunity D) Pressure

88)

Which of the following is not a principle of the AICPA Code of Professional Conduct? A) Integrity B) Due Care C) Internal Controls D) Objectivity and Independence

89) Which of the following is not one of the common elements that are typically present when fraud occurs?

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A) The capacity to rationalize B) The existence of pressure leading to an incentive C) The assistance of others D) The presence of an opportunity

90) What is the term used to describe the policies and procedures that are designed to reduce the opportunities for fraud? A) Internal controls B) Asset source transactions C) Accounting standards D) Financial systems

91) What action did the U.S. Congress take because of the audit failures at Enron, WorldCom and other companies? A) Required publicly-traded companies to be audited by a government agency B) Passed the Sarbanes-Oxley Act C) Required companies to begin preparing an additional financial statement D) Passed an amendment to the Securities and Exchange Act

92)

Which of the following is an asset source transaction? A) Issued common stock B) Paid a cash dividend to stockholders C) Collected cash from customers in settlement of accounts receivable D) Accrued salary expense

93)

Which of the following is an asset use transaction?

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A) Purchased land for cash B) Paid cash for salary expense C) Invested cash in an interest earning account D) Accrued salary expense at the end of the period

94)

Which of the following is an asset exchange transaction? A) Issued common stock B) Accrued salary expense at the end of the accounting period C) Collected cash on accounts receivable D) Earned cash revenue for services provided

95) If a company provides services to clients but has not yet collected any cash, how should that transaction be classified? A) Claims exchange transaction B) Asset use transaction C) Asset source transaction D) Asset exchange transaction

96) Which of the following would be included in the "cash flow from operating activities" section of the statement of cash flows? A) Accrual of salary expense at year-end. B) Purchase of land for cash. C) Payments of cash dividends to the owners of the business. D) Cash paid for interest on a note payable.

97) Chester Company began Year 2 with a note payable of $20,000 and interest payable of $800. During the year, the company accrued an additional $400 of interest expense, and paid off the note with interest. On the company’s Year 2 statement of cash flows, cash flows for financing activities related to the note would be:

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A) $1,200 outflow B) $20,000 outflow C) $20,400 outflow D) $21,200 outflow

98) Which of the following describes the effects of a claims exchange transaction on a company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. +OA B.

+OA −

− +FA

A) Option A B) Option B C) Option C D) Option D

99) The Merry Maids provided cleaning services to Orange Company on account. Which of the following would describe the transaction's effect on the Orange Company's financial statements? Balance Sheet Income Statement Assets Liabilities Stockholders' Equity Accounts = Accounts + Common + Retained Revenue − Expense = Net Receivable Payable Stock Earnings income A. + − B.

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−

A) Option A B) Option B C) Option C D) Option D

100) The Merry Maids provided cleaning services to Orange Company on account. Which of the following would describe the transaction's effect on the Merry Maids' financial statements? Balance Sheet Income Statement Assets Liabilities Stockholders' Equity Accounts = Accounts + Common + Retained Revenue − Expense = Net Receivable Payable Stock Earnings income A. + − B.

+ +

−

+ +

−

A) Option A B) Option B C) Option C D) Option D

101) During Year 2, Fancy Foods Incorporated earned $104,000 of revenue on account. The beginning balance in accounts receivable was $26,000, and the ending balance was $4,000. Based solely on this information, what was the amount of cash collected from accounts receivable?

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A) $74,000 B) $82,000 C) $126,000 D) $134,000

102) Fancy Foods Incorporated had an ending balance in accounts payable of $6,000. The company incurred $72,000 of operating expenses on account and paid $90,000 cash to settle accounts payable. Determine the beginning balance in accounts payable. A) $12,000 B) $24,000 C) $96,000 D) $156,000

103) During Year 3, Fancy Foods Incorporated earned $54,000 of revenue on account. The beginning balance in accounts receivable was $5,000, and the ending balance was $10,000. Also, Fancy Foods Incorporated started the year with a beginning balance in accounts payable of $5,000. Fancy Foods’ ending balance in account payable was $4,000. The company incurred $12,000 of operating expenses on account. Determine the amount of cash paid to settle accounts payable. A) $13,000 B) $24,000 C) $96,000 D) $156,000

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Answer Key Test name: Chap 02_2e_Test Bank_MCQs_TF 1) TRUE Recognition means recording revenue or expense, which results in reporting the event in the financial statements. 2) FALSE Accrual basis companies recognize revenue when earned and expense when incurred, regardless of when cash is received or paid. 3) TRUE Accruals involve events such as earning revenue on account and incurring expense on account, in which earnings is affected before cash is received or paid. 4) TRUE Accrual basis companies recognize revenue when earned and expense when incurred, regardless of when cash is received or paid. 5) FALSE The event decreases assets (cash) and decreases liabilities (salaries payable). 6) FALSE An increase in an expense, such as salaries expense, may be accompanied by an increase in a liability, such as salaries payable, but it may not be accompanied by a decrease in a liability. 7) FALSE A primary goal of accrual accounting is to appropriately match expenses with revenues, the matching concept. Appropriately matching expenses with revenues can be difficult even when using accrual accounting. 8) FALSE

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The matching concept does not lead accountants to select the recognition alternative that produces the lowest amount of net income. Instead, it is an accounting principle of recognizing expenses in the same accounting period as the revenues they produce. 9) TRUE All of these stakeholders determine how a company is operated. 10) FALSE The high ethical standards required by the profession state "a certified public accountant assumes an obligation of self-discipline above and beyond requirements of laws and regulations." 11) TRUE The Public Interest Principle of the AICPA Code of Professional Conduct states: “Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism." 12) TRUE The massive surprise bankruptcies ofEnronin late 2001 andWorldComseveral months later suggested major audit failures on the part of the independent auditors. An audit failure means a company’s auditor does not detect, or fails to report, that the company’s financial reports are not in compliance with GAAP. 13) FALSE Prior to the Sarbanes-Oxley Act (SOX), independent auditors often provided nonaudit services, such as installing computer systems, for their audit clients. To reduce the likelihood of conflicts of interest, SOX prohibits all registered public accounting firms from providing audit clients, contemporaneously with the audit, certain nonaudit services, including internal audit outsourcing, financial-information-system design and implementation services, and expert services. 14) TRUE Version 1

Internal controls are policies and procedures that a business implements to reduce opportunities for fraud and to assure that its objectives will be accomplished. 15) FALSE Providing services to customers on account is an asset source transaction that increases the asset accounts receivable. 16) FALSE The collection of an account receivable is an asset exchange transaction. 17) FALSE The cash payment of interest is classified as an operating activity on the statement of cash flows. 18) FALSE Accruing interest expense is a claims exchange transaction. The liability account, Interest Payable, increases and the stockholders’ equity account, Retained Earnings, decreases. Total claims are not affected. 19) TRUE Recognizing accrued expense is a claims exchange transaction. The claims of creditors (liability) increase and the claims of stockholders (stockholders’ equity) decrease. 20) TRUE Notes payable and Accounts payable are both liability accounts. The primary difference between notes payable and accounts payable is that notes payable generally have longer terms and usually require interest charges. 21) FALSE Issuing a note is an asset source transaction. The asset account, Cash, increases and the liability account, Notes Payable, increases. 22) FALSE The balance in accounts receivable represents the amount of cash the company expects to collect in the future. Version 1

23) TRUE Accounts receivable is an asset account on the balance sheet. 24) FALSE Accounts payable is a liability account on the balance sheet. It is not reported on the income statement. 25) FALSE Sales on account increase the balance in accounts receivable. 26) FALSE Expenses incurred on account increase the accounts payable balance not the accounts receivable balance. 27) B Accounts receivable is an asset account on the balance sheet. 28) B Earning revenue on account causes assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) to increase on the balance sheet. On the income statement, the increase in revenue increases net income. The collection of cash will occur in the future. Because cash was not collected or paid, the statement of cash flows is not affected for this event. 29) A Collecting cash from customers as payment of accounts receivable is an asset exchange transaction. Total assets are not affected because there is an increase in one asset account (cash) and a decrease in another asset account (accounts receivable). There is no effect on the income statement. There is a cash inflow from operating activities on the statement of cash flows. 30) C

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Under accrual accounting, revenue should be recognized in the period in which it is earned regardless of whether cash has or has not been collected. The asset account, Accounts Receivable, increases by $8,000 and the stockholders’ equity account, Retained Earnings, increases by $8,000. 31) C The collection of an account receivable is an event that affected the financial statements as indicated because it increased one asset account (Cash) and decreased another asset account (Account Receivable). The amount of total assets is not affected. The company does not recognize revenue when the cash is collected because the revenue was recognized when the service was provided. Therefore, there is no effect on the income statement. It is reported as a cash inflow from operating activities on the statement of cash flows. 32) D When a company collects an account receivable one asset (Cash) increases and another asset (Accounts Receivable) decreases. The amount of total assets is not affected. 33) A When $3,500 cash is collected, the amount of cash collected is removed from the accounts receivable account and recorded in the cash account. Therefore, cash increases by $3,500 and accounts receivable decreases by $3,500. 34) C Earning cash revenue increases assets (Cash) and stockholders' equity (Retained Earnings) on the balance sheet. It increases both revenue and net income on the income statement and is reported as a cash inflow from operating activities on the statement of cash flows. 35) B

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Paying cash for expenses decreases assets (Cash) and decreases stockholders' equity (Retained Earnings) on the balance sheet. It increases expenses which decreases net income on the income statement and is reported as a cash outflow from operating activities on the statement of cash flows. 36) C Paying cash dividends decreases assets (Cash) and decreases stockholders' equity (Retained Earnings) on the balance sheet. It does not affect the income statement but is reported as a cash outflow from financing activities on the statement of cash flows. 37) A Issuing common stock increases assets (Cash) and stockholders' equity (Common Stock). It does not affect the income statement but is reported as a cash inflow from financing activities on the statement of cash flows. 38) D Borrowing cash increases assets (Cash) and increases liabilities (Notes Payable). It does not affect the income statement, but is reported as a cash inflow from financing activities on the statement of cash flows. 39) A Selling land for cash increases one asset (Cash) and decreases another asset (Land). It is an asset exchange transaction and total assets is unchanged. There is no effect on liabilities or stockholders’ equity. It does not affect the income statement but is reported as a cash inflow from investing activities on the statement of cash flows. 40) B

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Earning cash revenue is an event that affected the financial statements as indicated because it increased revenue and net income on the income statement and was reported as a cash inflow from operating activities on the statement of cash flows. Also, this event affected the Balance Sheet by increasing assets (Cash) and stockholders’ equity (Retained Earnings). 41) A Issuing common stock would increase assets (Cash) and increase stockholders' equity (Common Stock). It would not affect net income, but would be reported as a cash inflow from financing activities on the statement of cash flows. 42) B Incurring a cash expense would decrease assets (Cash) and decrease stockholders' equity (Retained Earnings). It would increase expenses and decrease net income, and would be reported as a cash outflow from operating activities on the statement of cash flows. 43) C $23,000 (cash) + $9,300 (accounts receivable) + $7,600 (cash) − $7,600 (accounts receivable) − $6,200 (cash) = $26,100 increase 44) A $17,000 (cash) + $8,500 (accounts receivable) + $6,000 (cash) − $6,000 (accounts receivable) − $5,400 (cash) = $20,100 increase 45) B Earning revenue on account increases assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) on the balance sheet. On the income statement, earning revenue on account increases net income. It does not affect the statement of cash flows. 46) A

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While the expense was incurred and recognized in Year 1, the cash payment occurred in Year 2. The Year 2 cash payment would cause the asset account (cash) and the liability account (accounts payable) to decrease. 47) C When payment is made to settle the obligation for an accrued expense, such as the salaries payable, the asset account (Cash) decreases and the associated liability account (Salaries Payable) decreases. Expenses in the current period are not affected because they were recognized in a previous accounting period. Since the cash outflow was caused by a previous period expense recognition it is classified as an operating activity. 48) B Event (1) increases total assets (accounts receivable), revenues, and net income by $10,000. Event (2) increases total liabilities (accounts payable) and expenses by $9,000, which decreases net income by $9,000. The combined effect of the two events is an increase in total assets of $10,000, an increase in total liabilities of $9,000, and an increase in net income of $1,000 (or $10,000− $9,000). The two events did not affect cash; as a result, there is no effect on net cash flows from operating activities. Assets

Balance Sheet Income Statement = Liabilitie + Stockholders Revenu − Expens = Net s ' Equity e e income

Account Receivabl e 10,000 =

10,000

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Statemen t of Cash Flows

Account Payable +

10,000

9,000

10,000 −

= 10,000

(9,000)

− 9,000 = (9,000 )

1,000

10,000 − 9,000 = 1,000

As indicated by the totals in the horizontal financial statements model, after the accrued revenue and expense has been recognized total assets amount to $10,000, net income is $1,000, and there is no effect on the statement of cash flows. 49) A Accounts receivable appears in the asset section of the balance sheet. 50) C Accounts payable appears in the liabilities section of the balance sheet. 51) D On the balance sheet, recognizing revenue on account will cause an increase in assets (Accounts Receivable) and stockholders’ equity (Retained Earnings). On the income statement, recognition will cause an increase in the revenue account which increases net income. Since cash was not collected or paid, the statement of cash flows is not affected. 52) D On the balance sheet, recognizing accrued salary expense will cause an increase in liabilities (Salaries Payable) and stockholders’ equity (Retained Earnings). On the income statement, the recognition will cause an increase in salaries expense which decreases net income. Since cash was not collected or paid, the statement of cash flows is not affected. 53) C Collecting an account receivable is an asset exchange event. The balance in the cash account will increase and the balance in the accounts receivable account will decrease. Both of these accounts are shown on the balance sheet. Since the revenue was recognized when it was earned, it will not be recognized again when the cash is collected. Therefore, the income statement is not affected. The cash inflow will be shown in the operating section of the statement of cash flows. 54) B Version 1

Since the cash was paid for salaries of employees that operate the business, the cash outflow is classified as an operating activity. 55) C On the balance sheet, accruing salary expense increases liabilities (salaries payable) and decreases stockholders’ equity (retained earnings). On the income statement, it increases expenses which decreases net income. There is no impact on the statement of cash flows. 56) D On the balance sheet, accruing salary expense increases liabilities (Salaries Payable) and decreases stockholders' equity (Retained Earnings). On the income statement, it increases expenses which decrease net income. It does not affect the statement of cash flows. 57) C Net income = Revenue of $6,800 − Expenses of $3,500 = $3,300; dividends decrease retained earnings but do not affect net income. 58) B Net income = Revenue of $5,000 − Expenses of $2,100 = $2,900; dividends decrease retained earnings but do not affect net income. 59) D Revenue is recognized when it is earned and expenses when they are incurred, regardless of when cash changes hands. The issuance of common stock, borrowing, cash collections of accounts receivable, purchase of land, cash payment to partially settle accounts payable, and the payment of dividends do not affect net income. Revenue = $9,000 earned revenue on account + $1,000 provided services for cash = $10,000 Expenses = $4,000 operating expenses + $4,000 accrued salaries = $8,000 Net income = Revenue of $10,000 − Expenses of $8,000 = $2,000 60) A Version 1

Net cash flow from operating activities = Cash collections of accounts receivable of $6,000 + Cash from providing services of $1,000 − Cash payments on accounts payable of $3,000 = $4,000 The issuance of common stock, the borrowing, and the payment of dividends are financing activities. The purchase of land is an investing activity. 61) A Revenue is recognized when it is earned and expenses when they are incurred, regardless of when cash changes hands. The issuance of common stock, borrowing, cash collections of accounts receivable, purchase of land, cash payment to partially settle accounts payable, and the payment of dividends do not affect net income. Revenue = $9,000 earned revenue on account + $1,000 provided services for cash = $10,000 Expenses = $4,000 operating expenses + $4,000 accrued salaries = $8,000 Net income = Revenue of $10,000 − Expenses of $8,000 = $2,000 Ending Retained Earnings = $200 Beginning Retained Earnings− $200 Dividends + $2,000 Net Income = $2,000 62) A Recognizing an expense may be accompanied by an increase in liabilities (i.e. Accounts Payable, Salaries Payable). 63) D Revenue is recognized when earned and expenses are recognized when incurred, regardless of when cash is exchanged. 64) D

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Change in total assets = Increase in accounts receivable because of services provided on account of $45,500 − Decrease in account receivable because of collections on account of $38,000 + Increase in Cash because of Collection on Account receivable of $38,000 − Decrease in Cash because of payments on account of $32,400 = $13,100 increase Change in total liabilities = Increase in accounts payable because of expenses incurred on account $37,000 − Decrease in accounts payable because of payments on account of $32,400 = $4,600 increase Change instockholders’ equity = Increase in retained earnings (revenue) of $45,500 − Decrease in retained earnings (expenses) of $37,000 = $8,500 increase 65) B Assets = Liabilities + Stockholders’ Equity $5,600 + $2,700 + $9,200 = $1,850 + Stockholders’ Equity Stockholders’ Equity = $15,650 Stockholders’ Equity= Common stock + Retained earnings $15,650 = Common Stock + ($3,900 + $10,700 − $7,850) $15,650 = Common Stock + $6,750 Common Stock = $8,900 66) A Assets = Liabilities + Stockholders’ Equity $8,800 + $3,000 + $16,000 = $2,500 + Stockholders’ Equity Stockholders’ Equity = $25,300 Stockholders’ Equity = Common stock + Retained earnings $25,300 = Common Stock + ($5,400 + $19,000 − $14,500) $25,300 = Common Stock + $9,900 Common Stock = $15,400 67) A

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Cash collected on accounts receivable of $4,300 − Cash paid for operating expenses of $3,300 = $1,000. Revenue earned on account and accrued salaries are not cash flow activities. 68) B Cash collected on accounts receivable of $8,100 − Cash paid for operating expenses of $7,500 = $600. Revenue earned on account and accrued salaries are not cash flow activities. 69) D Net income = Revenues of $39,000 − Operating expenses of $22,700 = $16,300 Ending retained earnings = Beginning retained earnings of $0 + Net income of $16,300 − Dividends of $13,000 = $3,300 70) B Net income = Revenues of $42,000− Operating expenses of $25,600 = $16,400 Ending retained earnings = Beginning retained earnings of $0 + Net income of $16,400− Dividends of $8,000 = $8,400 71) A Net income = Revenue of $31,500 −Operating expenses of $23,000 = $8,500 Net cash flow from operating activities = Cash collections of $31,500 − Cash payments for operating expenses of $8,500 = $23,000 72) C Net income = Revenue of $45,000− Operating expenses of $36,000 = $9,000 Net cash flow from operating activities = Cash collections of $45,000− Cash payments for operating expenses of $9,000 = $36,000 73) D Net income = Revenue of $5,900 − Expenses of $2,500 = $3,400 74) A Version 1

Net income = Revenue of $4,600 − Expenses of $3,200 = $1,400 75) A Net cash flow from operating activities = Cash collections of $3,300 −Cash payments for expenses of $2,300 = $1,000 The cash paid for dividends would be reported as a financing activity. 76) B Net cash flow from operating activities = Cash collections of $3,800− Cash payments for expenses of $3,200 = $600 The cash paid for dividends would be reported as a financing activity. 77) D Total assets = Cash of $9,080 (calculated as $8,400 + $3,100 − $2,200 − $220) + Accounts Receivable of $1,600 (calculated as $4,700 − $3,100) = $10,680 78) D Total assets = Cash of $12,400 (calculated as $12,000 + $3,800− $3,200− $200) + Accounts Receivable of $800 (calculated as $4,600− $3,800) = $13,200 79) B Net income: 3,700 − 1,950 = 1,750 Cash: 7,400 + 2,600 − 1,950 − 170 = 7,880 Accounts receivable: 3,700 − 2,600 = 1,100 Assets: 7,880 + 1,100 = 8,980 Ending retained earnings = Beginning retained earnings of $0 + Net income of $1,750 − Dividends of $170 = $1,580 Alternatively: Assets of $8,980 =Liabilities of $0 + Common stock of $7,400 + Retained earnings Retained earnings = $1,580 80) A

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Net income: 4,600 − 3,200 = 1,400 Cash: 12,000 + 3,800 − 3,200 − 200 = 12,400 Accounts receivable: 4,600 − 3,800 = 800 Assets: 12,400 + 800 = 13,200 Ending retained earnings = Beginning retained earnings of $0 + Net income of $1,400 − Dividends of $200 = $1,200 Alternatively: Assets of $13,200 = Liabilities of $0 + Common stock of $12,000 + Retained earnings Retained earnings = $1,200 81) B Recording the adjustment will increase salaries expense, which will reduce net income and it will increase salaries payable, a liability. It will not affect cash flows. 82) A The matching concept refers to the matching of expenses to the revenues that those expenses produce. 83) B The matching concept is an accounting principle of recognizing expenses in the same accounting period as the revenues they produce. Revenues and expenses are reported on the income statement. 84) C When the connection between an expense and the corresponding revenue is vague, accountants commonly match the expense with the period in which it is incurred. Those expenses are frequently called period costs. 85) A If retained earnings decreased and no dividends were paid, the company must have reported a net loss. A net loss would have been the result if expenses for the year exceeded revenues. 86) D Version 1

Recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands, is commonly calledaccrual accounting. 87) A The auditing profession has identified three elements that are typically present when fraud occurs. These three elements are often shown in the form of a triangle. The first of these elements is the availability of opportunity without which fraud could not exist. The second element recognizes pressure as a key ingredient of misconduct. The third element is the rationalization. 88) A 88) C 88) A 88) C The AICPA Code of Professional Conduct includes the following six principles: Responsibilities, Public Interest, Integrity, Objectivity and Independence, Due Care, and Scope and Nature of Services. 89) C The auditing profession has identified three elements that are typically present when fraud occurs: opportunity, pressure, and rationalization. 90) A Internal controls are policies and procedures designed to reduce the opportunities for fraud. 91) B Congress passed the Sarbanes-Oxley Act in 2002 in response to audit failures at Enron and WorldCom, among others. 92) A

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Issuing common stock is an asset source transaction that increases assets (cash) and increases stockholders’ equity (common stock). Paying a cash dividend is an asset use transaction, receiving a payment on accounts receivable is an asset exchange transaction, and accruing salary expense is a claims exchange transaction. 93) B Paid cash for salary expense is an asset use transaction that decreases assets (Cash) and decreases stockholders' equity (Retained Earnings). Purchasing land for cash and investing cash in an interest earning account are asset exchange transactions. Accruing salary expense is a claims exchange transaction. 94) C Collecting cash on accounts receivable is an asset exchange transaction that increases one asset (cash) and decreases another asset (accounts receivable). Issuing common stock is an asset source transaction. Accruing salary expense is a claims exchange transaction. Earning cash revenue is an asset source transaction. 95) C This transaction increases assets (accounts receivable) and increases stockholders’ equity (retained earnings), and is therefore classified as an asset source transaction. 96) D Paying or receiving interest is considered an operating activity. Accruing salary expense is not a cash flow. Paying dividends is a financing activity, and purchasing equipment is an investing activity. 97) B Only the $20,000 principal would be considered an outflow for financing activities. The $1,200 interest paid is considered an operating activity. 98) C Version 1

Recognizing accrued salary expense is a claims exchange transaction. The claims of creditors increase and the claims of stockholders decrease. Total claims remain unchanged. Specifically, the liabilities account, Salaries Payable, increases. The balance in the Salaries Payable account represents the amount of cash the company is required to pay the employee in the future. Recognizing salary expense decreases net income. There is no effect on the statement of cash flows because cash was not paid. 99) C The Merry Maids provided cleaning services to Orange Company on account. From the perspective of Orange, the company has received services but has not paid cash for the services. Orange must record a liability to represent how much money it owes the Merry Maids. On Orange's balance sheet, the liability account, Accounts Payable, will increase and the stockholders' equity account, Retained Earnings, will decrease. On Orange's income statement, expenses will increase and net income will decrease. 100) B The Merry Maids provided services to Orange Company on account. From the perspective of the Merry Maids, it has earned revenue but not been paid for the services. The Merry Maids must record an asset to represent the amount of money it is waiting to receive from Orange Company. On the Merry Maids' balance sheet, the asset account, Accounts Receivable, will increase and the stockholders' equity account, Retained Earnings, will increase. On the Merry Maids' income statement, revenue will increase and net income will increase. 101) C

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Year 2 Changes in Accounts Receivable: Beginning accounts receivable balance + Increases due to sales on account− Decreases due to receivables collections = Ending accounts receivable balance. $26,000 + $104,000− X = $4,000. X= $126,000. 102) B Year 2 Changes in Accounts Payable: Beginning accounts payable balance + Increases due to expenses incurred on account− Decreases due to payment of accounts payable = Ending accounts payable balance. X +$72,000− $90,000 = $6,000. X= $24,000. 103) A Year 2 Changes in Accounts Payable: Beginning accounts payable balance + Increases due to expenses incurred on account− Decreases due to payment of accounts payable = Ending accounts payable balance. $5,000 +$12,000− X= $4,000. X= $13,000.

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CHAPTER 3: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Green Company paid $900 cash to purchase supplies. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

2) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Nickle Company performed a physical count of supplies and determined that the company used $600 of supplies during the year. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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3) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA On February 1, Year 1, Owen Company paid $24,000 cash to lease office space for one year beginning immediately. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

4) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Owen Company recognizes rent expense for the period from February 1, Year 1, to December 31, Year 1. Assume the company paid $24,000 cash to lease the office space for one year on February 1, Year 1. Only record the impact of recognizing rent expense at the end of Year 1. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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5) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Calloway Company collected $750 from a customer for services that Calloway agrees to perform in the future. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

6) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Jennings Company makes an adjusting entry to recognize $500 of previously recorded unearned revenue that it has now been earned by providing services to its client during the period. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

7) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Monica Company paid $41,000 cash to purchase a truck.

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Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

8) Indicate how each event affects the financial statements model. Use the following letters to record your answer in the box shown below each element. You do not need to enter amounts. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Cason Company recorded $2,000 of depreciation expense on a delivery van. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

9) Cornelius Company purchased supplies on account. Would the business event be classified as an asset source, asset use or asset exchange transaction?

10) What effect does being paid cash for services to be provided in the future normally have on the accounting equation?

11)

What is the formula for calculating depreciation expense using the straight-line method?

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12)

What type of assets would a company depreciate?

13)

Depreciation expense is reported on which financial statement?

14) Explain the significance of the return-on-assets ratio. Who (what category or type of financial statement users) would normally be most interested in this ratio, and why?

15) Explain the significance of the return-on-equity ratio. Who (what category or type of financial statement users) would normally be most interested in this ratio, and why?

16) What does the debt-to-assets ratio indicate about the level of a company's debt risk? Who would normally be most interested in this ratio?

17) What is financial leverage? What financial ratio can be increased by using financial leverage?

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 18) Dixon Company collected cash in Year 1 from a customer for services to be performed beginning January, Year 2. Indicate whether each of the following statements about this transaction is true or false. 1.a) Dixon's Year 2 income statement would not be affected by this transaction. 2.b) Dixon's Year 1 statement of cash flows would be affected by this transaction. 3.c) This transaction is an asset exchange transaction. 4.d) The revenue for the services provided will be recorded in Year 2. 5.e) The transaction increases Dixon’s liabilities.

19) Regarding the relationships of revenues and expenses to assets and liabilities, state whether each of the following statements is true or false. 1.a) Recording an increase in a revenue account may be associated with a decrease in assets. 2.b) Recording an increase in a revenue account may be associated with a decrease in liabilities. 3.c) Recording a decrease in assets may be associated with an increase in an expense account. 4.d) A decrease in Supplies will be accompanied by an increase in Supplies Expense.

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20) Regarding the relationships of depreciation expense, book value, and accumulated depreciation, state whether each of the following statements is true or false. 1.a) To determine the book value of a long-term asset, the balance in the accumulated depreciation account must be subtracted from current market value of the asset. 2.b) The amount of accumulated depreciation gets smaller every year that passes. 3.c) The amount of depreciation expense recognized each year is added to the beginning balance of accumulated depreciation account to determine the ending balance of accumulated depreciation account. 4.d) The salvage value is the expected selling value of an asset at the end of its useful life.

21) On November 1, Year 1, Danny Company paid $12,000 cash to rent an office for a year starting immediately. Indicate whether each of the following statements about this transaction is true or false. 1.a) Danny's Year 1 income statement would not be affected by this transaction. 2.b) Danny's Year 1 statement of cash flows would be affected by this transaction. 3.c) This transaction is an asset exchange transaction. 4.d) $12,000 of rent expense will be recorded in Year 2. 5.e) This transaction increases Danny’s liabilities.

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22) Hernandez Company began business operations and experienced the following transactions during Year 1, its first year of operations: 1.1) Issued common stock for $50,000 cash. 2.2) Provided services to customers for $125,000 on account. 3.3) Purchased $2,500 of supplies on account. 4.4) Paid $30,000 cash to rent office space for a 12-month period beginning July 1. 5.5) Collected $115,000 cash from customers. 6.6) Paid cash for $90,000 of operating expenses. 7.7) Adjusted the accounting records to reflect that there was $750 of supplies remaining on hand at year-end. 8.8) Recorded a year-end adjustment to recognize rent expense. Required: 1.a) Record the above transactions on a horizontal statements model, reflecting their effect on the different financial statements. 2.b) Prepare Hernandez Company's income statement, balance sheet and statement of cash flows for the year ended December 31, Year 1.

23) The following transactions apply to Einstein Corporation. 1.1) Issued common stock for $50,000 cash. 2.2) Provided services to customers for $28,000 on account. 3.3) Purchased land for $16,000 cash. 4.4) Purchased $1,500 of supplies on account. 5.5) Paid $12,000 for operating expenses. 6.6) Paid $550 on accounts payable. 7.7) Collected $25,000 cash from customers. 8.8) Accrued $600 of salary expense at year end. 9.9) Paid $2,000 dividends to stockholders. Required: 1.a) Identify the effect on the statement of cash flows for each of the above transactions. 2.b) Classify the above accounting events into one of four types of transactions (asset source, asset use, asset exchange, claims exchange).

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24) The following events occurred during a company's first year of operations, which ended on December 31: 1.a) On April 1, paid $36,000 for to lease office space for one year beginning immediately. 2.b) On February 1, paid $3,000 to purchase supplies; a physical count revealed $1,080 of supplies on hand on December 31. 3.c) On September 1, received $48,000 cash in advance for services to be performed over a six-month period beginning immediately. Required: For each event: 1.1) Show how the events affect each of the company's accounts using the horizontal statements model. In the last column, enter OA, IA, or FA for the type of cash flow activity, if applicable. 2.2) In the row that follows, show how the corresponding adjustment, required as of December 31, affects each of the company's accounts.

25) The following data were taken from the accounting records of Li Company at December 31, Year 2. All adjustments have been recorded. Service revenue Retained earnings Accounts receivable Salaries expense Operating expense Accounts payable Supplies expense Prepaid rent Common stock

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$ 166,000 95,000 26,500 88,000 15,400 22,800 760 4,000 90,000

Supplies Dividends Insurance expense Rent expense Unearned revenue

400 2,400 1,600 20,000 1,530

Required: 1.a) Prepare an income statement for Li Company for Year 2. 2.b) Determine the balance in retained earnings at the end of Year 2.

26) For each of the following transactions, indicate the type by entering AS for asset source transactions, AU for asset use transactions, AE for asset exchange transactions, and CE for claims exchange transactions. 1.1) ________ Paid $2,000 in dividends to its stockholders 2.2) ________ Recorded the accrual of $1,000 in salaries to be paid later 3.3) ________ Paid $1,200 rent for the upcoming year starting immediately 4.4) ________ Earned revenue to be collected next year 5.5) ________ Paid the salaries accrued in #2 above 6.6) ________ Received cash from customers in #4 above 7.7) ________ Purchased supplies on account 8.8) ________ Received $500 from a customer for services to be provided later

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27) Classify each of the following transactions for the purpose of the statement of cash flow as operating activities (OA), investing activities (IA), financing activities (FA), or not reported on the statement of cash flows (NA). 1.1) ________ Sold land 2.2) ________ Received cash for services to be provided in the future 3.3) ________ Borrowed funds from the bank 4.4) ________ Paid rent in advance for the next six months 5.5) ________ Recognized depreciation expense 6.6) ________ Purchased supplies on account

28) Consider the following independent scenarios: 1.a) At January 1, Year 2, the balance in the prepaid insurance account was $480, which related to insurance coverage that expired on March 1, Year 2. On March 1, Year 2, the company paid $3,000 for insurance coverage for one year of insurance coverage that began on that date. What was the amount of insurance expense for Year 2? 2.b) At January 1, Year 2, the balance in the supplies account was $550. At December 31, Year 2, the company counted $400 of supplies on hand. The company reported supplies expense in Year 2 of $3,300. What was the total of supplies purchases during Year 2?

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29) Oregon Company began operations on January 1, Year 1, by issuing $10,000 in common stock to the stockholders. On March 1, Year 1, Oregon received $36,000 cash in advance from a client for services and promised to perform those services for a one-year period beginning April 1, Year 1. During Year 1, services in the amount of $32,000 were provided to customers on account, and 80% of this amount was collected by year-end. During Year 1, operating expenses incurred on account were $24,000, and 60% of this amount was paid by year-end. During the year, Oregon paid $1,200 to purchase supplies. By year-end, $1,080 of the supplies had been used. Dividends to stockholders were $2,000 during the year. During Year 1, Oregon paid salaries of $28,000, and on December 31, Year 1, the company accrued salaries of $2,800. Oregon recorded all appropriate adjusting entries at year end. Required: 1.1) What would Oregon report for service revenue for Year 1? 2.2) What would Oregon report for salaries expense for Year 1? 3.3) What would Oregon report for supplies expense for Year 1? 4.4) What would the amount be for net cash flows from operating activities for Year 1? 5.5) What is the net income for Year 1? 6.6) What would the balance in the retained earnings account be at December 31, Year 1?

30) The following events apply to Bowman's Cleaning Service for Year 1. 1.1) Issued stock for $44,000 cash 2.2) On May 1, paid $27,000 for one year's rent in advance 3.3) Purchased on account $4,500 of supplies to be used in the business 4.4) Performed services of $68,400 and received cash 5.5) At December 31, adjusted the records for the expired rent 6.6) At December 31, an inventory of supplies showed that $660 of supplies were still unused Required: Show how each of these transactions affects the company's accounts. Calculate the year-end total for each account.

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31) Using the form below, record each of the following Year 1 transactions for Mayer Corporation. 1.a) November 1: Received cash from clients for services to be performed over the next six months, $12,000. 2.b) November 1: Paid $1,200 for a 12-month insurance policy. 3.c) December 31: Recorded expiration of two months of the insurance. 4.d) December 31: Earned $4,000 of the amount received from clients in November.

Assets Cash

Supplies

= Prepaid Insurance

Liabilities AP

Unearned Revenue

Stockholders' Equity CS + RE

a. b. c. d.

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32) Pierce Company was founded in Year 1 and engaged in the following transactions: 1.Issued common stock for cash 2.Paid rent in advance for three months at a time 3.Purchased supplies on account 4.Collected cash from a customer for services to be provided over a period of one year 5.Paid a cash dividend to stockholders 6.Purchased a two-year fire insurance policy 7.Provided services to customers on account 8.Collected cash from customers in partial settlement of accounts receivable 9.Paid cash for various operating expenses Required: 1.a) Identify the transactions from the list above that will require adjusting entries at year end. 2.b) Explain why adjusting entries are required before financial statements can be prepared.

33) The effects of transactions occurring during Year 1 and their related year-end adjustments have been recorded below using the accounting equation. Assets Cash

80,000

(20,00 0)

Prepai d Rent

Land

Liabilities AP

+ Stockholders' Equity Unearne CS RE d Revenue 80,00 0

20,000 48,000

32,000

(4,800 )

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48,000 32,000

(32,00 0) 4,800

7) 8)

24,00 0 20,000

(20,00 0)

(4,000 )

10) Total 139,20 s 0

(24,00 0)

16,000

800

24,00 0

(20,00 0) 12,000

(4,000 ) 20,000 80,00 0

40,000

Required: With your knowledge of transaction analysis using an accounting equation: 1.a) Prepare an income statement for Year 1. 2.b) Prepare a statement of cash flows for Year 1.

34) Indicate for each of the following items if the item would be reported on the income statement (IS), statement of changes in stockholders' equity (SE), balance sheet (BS), or statement of cash flows (CF). Some items may appear on more than one statement; if so, identify all applicable statements. 1.1) Salaries payable 2.2) Prepaid insurance 3.3) Dividends paid to stockholders 4.4) Supplies 5.5) Accounts payable 6.6) Depreciation expense 7.7) Retained earnings 8.8) Unearned subscription revenue 9.9) Cash flows from operating activities 10.10) Beginning common stock 11.11) Accumulated depreciation 12.12) Accounts receivable

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35) Tucker Company shows the following transactions for the accounting period ending December 31, Year 1: 1.1) Sold books to customers for $68,000 on account 2.2) Collected $56,000 from customers 3.3) Issued common stock for $16,000 cash 4.4) Prepaid four months' rent for $8,800 on October 1, Year 1 5.5) Purchased supplies for $21,000 cash 6.6) Physical count shows $6,500 of supplies remained on December 31, Year 1 7.7) Recorded adjustment for prepaid rent used Show how the above transactions and year-end adjustments affect the accounting equation. Assets Cash

Accounts Prepaid Supplies Receivable Rent

= Liabilities +

Stockholders' Equity Common Retained Stock Earnings

1) 2) 3) 4) 5) 6) 7) Totals

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36) Determine whether each of the following events are asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE) transactions. ________1) Borrowed $6,000 from creditors ________2) Issued common stock to investors for $8,000 cash ________3) Paid one year's rent in advance ________4) Provided services to customers and collected $35,000 cash ________5) Recognized depreciation expense ________6) Received $3,000 of revenue in advance ________7) Provided services to customers on account, $12,000 ________8) Collected $2,000 from customers in partial settlement of accounts receivable ________9) Recognized accrued salary expense of $2,000 ________10) Adjusted the records for supplies used of $800

37) Thurston Company started its business on January 1, Year 1 by issuing $15,000 of common stock. On January 1, the company purchased equipment for $10,500. The equipment is estimated to have a three-year useful life and a $1,500 salvage value. Customers paid Thurston $54,000 for services performed in Year 1. The company paid $33,000 for operating expenses, and paid a $900 dividend to the stockholders. At year-end, Thurston recognized depreciation expense on the equipment. Required: 1.a) What is the book (carrying) value of the equipment at the end of Year 1? 2.b) What is the net income for Year 1?

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38)

The following events apply to Jason's Lawn Service for Year 1.

1.1) Issued stock for $14,000 cash 2.2) On January 1, paid $12,000 cash for equipment that has an estimated life of five years and a salvage value of $2,000 3.3) On May 1, issued a $3,000, 5% 3-year note to a local bank 4.4) Performed services of $18,400 and received cash 5.5) Paid $15,000 of operating expenses 6.6a) Adjusted the records to recognize expense associated with use of the equipment during Year 1 7.6b) Adjusted the records to recognize interest expense for Year 1 Required: Record the effects of the above events under the appropriate account headings in the accounting formula below. Assets Cash

Book Value of Equipment

Liabilities Notes Payable

Interest Payable

Stockholders' Equity CS RE

1 2 3 4 5 6a 6b Totals

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39) At the end of Year 1, the following information is available for ABC Company and XYZ Company: Statement Data Total Assets Total Liabilities Owners' Equity Net Income

ABC $ 2,000,000 1,200,000 800,000 120,000

XYZ $ 1,600,000 1,200,000 400,000 80,000

Required: 1.a) For each company, calculate the debt-to-assets ratio. (Show your work.) 2.b) For each company, calculate the return-on-equity ratio. (Show your work.) 3.c) For each company, calculate the return-on-assets ratio. 4.d) Identify which company has a greater level of debt risk. 5.e) Explain the meaning of financial leverage. 6.f) Identify which company is using financial leverage more successfully and explain why.

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Answer Key Test name: Chap 03_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D/I NA NA NA NA NA D

Paying cash to purchase supplies decreases one asset account (Cash) and increases another asset account (Supplies). It is an asset exchange transaction. The total amount of assets is not affected. It does not affect the income statement. Even though cash has been paid, expense recognition is deferred until the supplies are used. It will be reported as a cash outflow from operating activities on the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D NA

Recognizing supplies expense is an asset use transaction. Assets (Supplies) decrease and stockholder's equity (Retained Earnings) decreases. The recognition of supplies expense would cause the amount of net income shown on the income statement to decrease. There is no cash payment associated with the use of supplies. Because the expense recognition did not involve the payment of cash, there is no effect on the statement of cash flows. 3) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net

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Statement of Cash

D/I

Equity NA

Income NA

Flows D

The cost of the office space is recognized as an asset. The asset account, Prepaid Rent, increases and the asset account, Cash, decreases. It is an asset exchange transaction. Expense recognition is deferred until Owen Company uses the office space to help generate revenue. Since the expense is deferred, there is no impact on stockholders' equity (Retained Earnings) nor on the income statement. There is a cash outflow from operating activities on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D NA

At the end of Year 1, Owen is required to expense the amount of office space that has been used. Since Owen paid $24,000 on February 1, Year 1, to rent office space for one year, the portion of the lease cost that represents the office use from February 1 to December 31 is 11 months and $22,000. Calculated as $24,000 total rent for one year lease/12 months = $2,000 rent expense per month. $2,000 × 11 months = $22,000. Recognizing rent expense will decrease assets (Prepaid Rent) and stockholders' equity (Retained Earnings). Rent expense will decrease net income. There is no effect on the statement of cash flows at the end of Year 1 because the cash was paid on February 1, Year 1. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

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Collecting a payment in advance from a customer increases assets (Cash) and increases liabilities (Unearned Revenue). It does not affect the income statement. Revenue will not be recognized until the services are provided at a future date. It will be reported as a cash inflow from operating activities on the statement of cash flows. 6) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA D I I NA I NA

The year-end adjustment is a claims exchange transaction. Assets are not affected. On the balance sheet, liabilities (Unearned Revenue) decrease and stockholders' equity (Retained Earnings) increases. On the income statement, revenue and net income increase. The statement of cash flows is not affected. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D/I NA NA NA NA NA D

Purchasing a truck for cash is an asset exchange transaction. One asset (Cash) decreases and another asset (Truck) increases. The purchase does not affect the income statement. Because the asset has a long term useful life the cash outflow is categorized as an investing activity on the statement of cash flows. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D NA

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Recognizing depreciation expense is an asset use transaction. Assets (Book Value of Delivery Van) and stockholders’ equity (Retained Earnings) decrease. It increases expenses and decreases net income. It does not affect cash flows. 9) Purchasing supplies on account is an asset source transaction. The asset account, Supplies, increases and the liability account, Accounts Payable, increases. 10) When a company is paid cash for services to be provided in the future, it is considered unearned revenue. The asset account, Cash, increases and the liability account, Unearned Revenue increases. There is no effect on stockholders' equity. The cash inflow is reported on the statement of cash flows as an operating activity. 11) (Asset Cost − Salvage value) / Useful life = Depreciation expense 12) A company depreciates long-term assets that it plans to use over several years. 13) Income Statement 14) The return-on-assets ratio measures the relationship between the level of income and the size of the investment. The stockholders would normally be interested in this ratio to assess how effectively a company is using its assets to generate income. Investors would prefer a company to have a higher return-on-assets ratio. 15) The return-on-equity ratio measures the relationship between net income and stockholders' equity. The stockholders would normally be most interested in this ratio because it measures how well the company is using the stockholders’ investment to earn income.

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16) The relationship between total debt and total assets can be measured by the debt-to-assets ratio. With a high debt-to-assets ratio, a company experiences a great degree of debt risk. A company with a high debt-to-assets ratio may be forced into bankruptcy if it is unable to meet the required payments on its outstanding debt. The company's creditors would likely be most interested in this ratio. 17) Financial leverage is the use of borrowed money to increase return on stockholders' investment. If a company can borrow money at 8% and invest it at 10%, it can increase its return-on-equity ratio. 18) 1.a) This is false. Because work will not begin until Year 2, the revenue is recognized in Year 2. 2.b) This is true. Only the Year 1 statement of cash flows is affected because no cash is received in Year 2. 3.c) This is false. Collecting a cash advance is an asset source transaction that increases assets (Cash) and increases liabilities (Unearned Revenue). 4.d) This is true. Revenue will be recognized only when services are performed, beginning in Year 2. 5.e) This is true. The transaction increases unearned revenue, a liability.

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19) 1.a) This is false. An increase in a revenue account is usually associated with an increase in assets, such as cash or accounts receivable. 2.b) This is true. Recording an increase in revenue may be associated with a decrease in liabilities, as in the case of earning revenue from a prepaid contract (Unearned Revenue). 3.c) This is true. Recording a decrease in assets (such as Prepaid Rent or Prepaid Insurance, or Supplies) may be associated with an increase in expenses. 4.d) This is true. Supplies expense is increased when supplies are used, or decreased. 20) 1.a) This is false. To determine the book value of a long-term asset, the balance in the accumulated depreciation account must be subtracted from the cost of the asset. 2.b) This is false. Accumulated depreciation gets larger every year that passes. 3.c) This is true. The amount of depreciation expense recognized each year is added to the beginning balance of the accumulated depreciation account to determine the ending balance of accumulated depreciation account. 4.d) This is true. The salvage value is the expected selling value of an asset at the end of its useful life.

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21) 1.a) This is false. Because Danny Company will have rented the building for two months at the end of Year 1. The Year 1 income statement will recognize $2,000 of rent expense. $12,000 for one year of rent/ 12 months = $1,000 rent expense per month. 2.b) This is true. The Year 1 statement of cash flows is affected because $12,000 of cash is paid in Year 1 for rent. No cash is paid in Year 2. 3.c) This is true. Prepaying for rent is an asset exchange transaction that decreases assets (Cash) and increases assets (Prepaid Rent). Total assets are not affected. 4.d) This is false. The company will record the remaining ten months of rent expense in year 2 which will be $10,000. Rent expense in Year 2 is calculated as $1,000 rent expense per month × 10 months = $10,000. 5.e) This is false. The transaction increases the asset account, Prepaid Rent, and decreases the asset account, Cash. 22) a) = Liabil + Stockhol Reve − Expe = NI CF ities ders' nue nse Equity Supp Prepa AP CS + RE lies id Rent 50, 50,0 F 000 00 A 125 125 125, ,00 ,00 000 0 0 2,5 2,50 00 0 30, (30, O 000 000) A 115, O 000 A

Assets

Cash

1. 50, 000 2.

125, 000

3. 4. (30, 000) 5. 115 ,00 0

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(115 ,000 )

6. (9,0 00) 7.

(1,7 50)

8. Tot als

45, 000

10,0 00

750

(15, 000) 15, 000

2,50 0

(90, 000) (1,7 50) (15, 000) 50, 18, 125 000 250 ,00 0

90,0 00 1,75 0 15,0 00 106, 750

(90, (90, O 000) 000) A (1,7 50) (15, 000) 18,2 45,0 50 00

b) Hernandez Company Income Statement For the Year Ended December 31, Year 1 Service revenue $ 125,000 Operating expenses (90,000) Rent expense (15,000) Supplies expense (1,750) Net income

$ 18,250 Hernandez Company Balance Sheet As of December 31, Year 1

Assets Cash

$ 45,000

Accounts receivable

10,000

Supplies

750

Prepaid rent

15,000

$ 70,750

Liabilities Accounts payable

$ 2,500

Stockholders’ equity Common stock

$ 50,000

Retained earnings Total liabilities and stockholders' equity

18,250

68,250 $ 70,750

Hernandez Company

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Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities Cash receipts from revenue

$ 115,000

Cash payments for rent

(30,000)

Cash payments for operating expenses

(90,000)

Net cash flow from operating activities

$ (5,000)

Cash flows for investing activities

Cash flows from financing activities Cash receipts from issuing common stock

50,000

Net increase in cash

45,000

Plus: Beginning cash balance

Ending cash balance

$ 45,000

23) a)

Event 1) 2)

Cash Flow 50,000 FA NA

Transaction Asset source Asset source

3) 4)

(16,000) IA NA

Asset exchange Asset source

5) 6) 7) 8)

(12,000) OA (550) OA 25,000 OA NA

Asset use Asset use Asset source Claims exchange

(2,000) FA

Asset use

24) Assets

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= Liabili + Stockhold Reven − Expen = ties ers' ue se

Cash Suppl Prepai ies d Rent a (36,0 ) 00)

Unearne d Revenue

36,00 0 (27,0 00)

b (3,00 3,000 ) 0) (1,92 0) c 48,00 ) 0

Equity C + RE S (36,0 O 00) A (27,0 00)

27,00 0

(27,0 00) (3,00 O 0) A

(1,92 0)

1,920

48,000 (32,000 )

48,00 O 0 A 32,00 32,0 0 00

32,00 0

1.a) Payment of $36,000 ÷ Time period of 12 months = $3,000 per month; April through December = 9 months; $3,000 per month × 9 months = Expense of $27,000 2.b) Purchase of $3,000 − Amount of hand of $1,080 = Amount used of $1,920 3.c) Receipt of $48,000 ÷ Time period of 6 months = $8,000 per month; September through December = 4 months; $8,000 per month × 4 months = $32,000 25) a) Li Company Income Statement For the Year Ended December 31, Year 2 Service revenue Salaries expense

88,000

Operating expense

15,400

Insurance expense

1,600

Rent expense

20,000

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$ 166,000

Supplies expense Net Income

760

125,760 $ 40,240

b) Beginning retained earnings Add: Net income Less: Dividends Ending retained earnings

$ 95,000 40,240 (2,400) $ 132,840

26) 1) AU 2) CE 3) AE 4) AS 5) AU 6) AE 7) AS 8) AS 1.1) Assets (cash) decreased, Equity (retained earnings from dividends) decreased 2.2) Liabilities (salaries payable) increased, Equity (retained earnings from salaries expense) decreased 3.3) Assets (Cash) decreased, Assets (Prepaid Rent) increased 4.4) Assets (Accounts Receivable) increased, Stockholders’ equity (Retained Earnings) increased 5.5) Assets (Cash) decreased, Liabilities (Salaries Payable) decreased 6.6) Assets (Cash) increased, Assets (Accounts Receivable) decreased 7.7) Assets (Supplies) increased, Liabilities (Accounts Payable) increased 8.8) Assets (Cash) increased, Liabilities (Unearned Revenue) increased

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27) 1) IA 2) OA 3) FA 4) OA 5) NA 6) NA 1.1) Purchasing and selling long-lived assets is an investing activity 2.2) Received cash for services to be provided in the future is an operating activity 3.3) Borrowing cash is a financing activity 4.4) Paying rent, including paying in advance, is an operating activity 5.5) Recognized depreciation expense does not affect cash flows 6.6) Making purchases on account does not affect cash flows 28) 1.a) $2,980 2.b) $3,150 1.a) Monthly insurance expense beginning March 1 = Payment of $3,000 ÷ 12 months = $250 per month; Year 2 Insurance expense = Insurance expense relating to January and February of $480 + Insurance expense for March through December of $250 per month × 10 months = $480 + $2,500 = $2,980 2.b) Beginning supplies of $550 + Supplies purchased − Supplies expense = Ending balance of supplies; $400 + Supplies purchased − $3,300 = $400; Supplies purchased = $3,150

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29) 1.1) $59,000 2.2) $30,800 3.3) $1,080 4.4) $18,000 5.5) $3,120 6.6) $1,120 1.1) Monthly revenue relating to cash received in advance = Receipt of $36,000 ÷ 12 months = $3,000 per month Related revenue earned during Year 1 = $3,000 per month × 9 months (April through December) = $27,000 Year 1 Service revenue = Revenue earned on account of $32,000 + Revenue earned relating to cash received in advance of $27,000 = $59,000 2.2) Salaries expense = Salaries incurred and paid during the year of $28,000 + Accrued salaries at year-end of $2,800 = $30,800 3.3) Supplies expense = Supplies used during the year of $1,080 4.4) Net cash flows from operating activities = Cash collections on accounts receivable of $25,600 (calculated as $32,000 × 80%) + Cash received in advance of $36,000 − Cash payment for operating expenses of $14,400 (calculated as $24,000 × 60%) − Cash paid for supplies of $1,200 − Salaries incurred and paid during the year of $28,000 = $18,000 5.5) Net income = Revenue of $59,000 (from part 1) − Operating expenses of $24,000 − Salaries expense of $30,800 − Supplies expense of $1,080 = $3,120 6.6) Ending retained earnings = Beginning retained of $0 + Net income of $3,120 − Dividends of $2,000 = $1,120 30) Assets

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= Liabilities + Stockholders' Equity

Cash 1)

Supplies

44,000

27,000 4,500

4,500

68,400

(18,000)

44,000

2) (27,000)

Prepaid Rent

(18,000)

(3,840)

31) Assets Cash a.

12,000

(1,200)

c. d.

Supplies

= Prepaid Insurance

Liabilities AP

Unearned Revenue 12,000

Stockholders' Equity CS + RE

1,200 (200)

(200) (4,000)

4,000

32) 1.a) Adjusting entries are required for transactions 2, 3, 4, and 6. 2.b) Adjusting entries are required at the end of an accounting period to properly match expenses with revenues. Transactions that involve deferrals and accruals often require adjusting entries to bring account balances up to date. 33) a) Income Statement For the Year Ended December 31, Year 1 Service revenue $ 68,000 Operating expense (24,000) Insurance expense (4,000) Net income

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$ 40,000

b) Statement of Cash Flows For the Year Ended December 31, Year 1 Cash flows from operating activities Cash receipts from revenue

$ 64,000

Cash payment for insurance

(4,800)

Net cash flow from operating activities

$ 59,200

Cash flows from investing activities Cash receipt from sale of land Cash payment for land

20,000 (20,000)

Net cash flow from investing activities

Cash flows from financing activities Cash receipt stock issuance

80,000

Net cash flow from financing activities

80,000

Net increase in cash

1,39,200

Plus: Beginning cash balance

Ending cash balance

$ 1,39,200

34) 1) BS, 2) BS, 3) SE and CF, 4) BS, 5) BS, 6) IS, 7) BS and SE, 8) BS, 9) CF, 10) SE, 11) BS, 12) BS 35) Assets Cash 1) 2)

Accounts Prepaid Supplies Receivable Rent 68,000

= Liabilitie + s

Stockholders' Equity Common Retained Stock Earnings 68,000

56,000 (56,000 )

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16,000

(8,800)

(21,000 )

16,00 0 8,800 21,000

(14,500 )

7) Total s

42,200

12,000

(6,600 ) 2,200

6,500

(14,500 ) (6,600) -

16,00 0

46,900

36) 1) AS 2) AS 3) AE 4) AS 5) AU 6) AS 7) AS 8) AE 9) CE 10) AU 1.1) Borrowing cash is an asset source transaction that increases cash 2.2) Issuing common stock is an asset source transaction that increases cash 3.3) Paying rent in advance is an asset exchange transaction that increases prepaid rent and decreases cash 4.4) Providing services for cash is an asset source transaction that increases cash 5.5) Recognizing depreciation expense is an asset use transaction that decreases the book value of the asset and decreases stockholders' equity (retained earnings) 6.6) Receiving an advance payment is an asset source transaction that increases cash 7.7) Providing services on account is an asset source transaction that increases accounts receivable 8.8) Collecting on accounts receivable is an asset exchange transaction that increases cash and decreases accounts receivable 9.9) Accruing salary expense is a claims exchange transaction that increases accounts payable and decreases retained earnings 10.10) Recognizing supplies expense is an asset use transaction that decreases supplies

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37) 1.a) $7,500 2.b) $18,000 1.a) Year 1 Depreciation expense = (Cost of $10,500 − Salvage value of $1,500) ÷ Useful life of 3 years = $3,000; Book value = Cost of $10,500 − Accumulated depreciation of $3,000 = $7,500 2.b) Net income = $54,000 − ($33,000 + $3,000) = $18,000 38)

1 2 3 4 5

Assets = Liabilities + Stockholders' Equity Cash Book Value Notes Interes CS RE of Payable t Equipment Payable 14,000 14,00 0 (12,000 12,000 ) 3,000 3,00 0 18,400 18,400 (15,000 )

(15,000 ) (2,000)

(2,000 )

6b Total $ 8,400 s

100 $ 10,000

$ 3,00 0

$ 100

(100) $ 14,00 0

$ 1,300

1.6a) Depreciation expense = (Cost of $12,000 − Salvage value of $2,000) ÷ Useful life of five years = $2,000 2.6b) Interest expense = Principal of $3,000 × 5% × 8/12 = $100

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39) 1.a) Debt-to-assets ratio = Total debt ÷ Total assets: ABC = $1,200,000 ÷ $2,000,000 = 0.60 XYZ = $1,200,000 ÷ $1,600,000 = 0.75 2.b) Return-on-equity ratio = Net income ÷ Total stockholders' equity: ABC = $120,000 ÷ $800,000 = 0.15 XYZ = $80,000 ÷ $400,000 = 0.20 3.c) Return-on-assets ratio = Net income ÷ Total assets: ABC = $120,000 ÷ $2,000,000 = 0.06 XYZ = $80,000 ÷ $1,600,000 = 0.05 4.d) XYZ Company has the higher level of financial risk because 75% of its assets are financed by creditors. For ABC, 60% of the assets are financed by creditors. 5.e) Financial leverage is the practice of using borrowed money to increase the return on stockholders' investment. 6.f) XYZ Company is using financial leverage more favorably because it has a higher return-on-equity ratio. XYZ's return-on-equity is 20%, whereas ABC's return-on-equity ratio is 15%.

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CHAPTER 3 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Companies that use accrual accounting recognize revenues and expenses at the time that cash is received or paid, respectively. ⊚ true ⊚ false

2) A company may recognize a revenue or expense without a corresponding cash collection or payment in the same accounting period. ⊚ true ⊚ false

Purchasing supplies for cash is an asset exchange transaction. ⊚ true ⊚ false

An increase in revenue may be accompanied by a decrease in a liability. ⊚ true ⊚ false

Unearned revenue is reported on the income statement by subtracting it from revenue. ⊚ true ⊚ false

Asset use transactions always involve the payment of cash. ⊚ true ⊚ false

7) An adjusting entry that decreases unearned revenue and increases service revenue is a claims exchange transaction. ⊚ true ⊚ false

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Sometimes the recognition of revenue is accompanied by an increase in liabilities. ⊚ true ⊚ false

Recognition of depreciation expense is an asset use transaction. ⊚ true ⊚ false

10) Recognition of depreciation expense on equipment decreases the accumulated depreciation on the equipment. ⊚ true ⊚ false

11) When a company purchases a depreciable asset, it must estimate the asset's useful life and salvage value. ⊚ true ⊚ false

12)

A cost may be recorded as an expense or as an asset purchase. ⊚ true ⊚ false

13) The carrying value of an asset is the expected selling price of an asset at the end of its useful life. ⊚ true ⊚ false

14)

Accumulated depreciation is reported on the income statement. ⊚ true ⊚ false

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15) Purchasing a truck for $50,000 cash with a four-year useful life and $6,000 salvage value is an example of a deferred expense. ⊚ true ⊚ false

16) Calculating the debt-to-assets ratio measures how efficiently a company is using its assets in the normal scope of business. ⊚ true ⊚ false

17)

A high debt-to-asset ratio may indicate that a company has a high level of debt risk. ⊚ true ⊚ false

18) The financial statement ratio that may be of greatest interest to a company's stockholders is the amount of its return-on-assets ratio. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 19) Account Number (1) (2) (3) (4) (5) (6) (7) (8)

Account Title Cash Service Revenue Accounts Receivable Salaries Expense Dividends Common Stock Salaries Payable Retained Earnings

Which of the following is a true statement? (Note: A statement may be true even if it does not identify all accounts that appear on that particular financial statement.)

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A) Account numbers 2, 4, and 5 will appear on the income statement. B) Account numbers 1, 3, and 8 will appear on the balance sheet. C) Account numbers 2, 5, and 8 will appear on the statement of cash flows. D) Account numbers 4, 5, and 6 will appear on the statement of changes in stockholders’ equity.

20) During Bruce Company’s first year of operations, the company purchased $4,100 of supplies. At year-end, a physical count of the supplies on hand revealed that $1,725 of unused supplies were available for future use. How will the related adjusting entry affect the company’s financial statements? A) Expenses will increase and assets will decrease by $2,375. B) Assets and expenses will both increase by $1,725. C) Expenses and assetswill both increase by $2,375. D) The related adjusting entry has no effect on net income or the accounting equation.

21) During Bruce Company’s first year of operations, the company purchased $2,300 of supplies. At year-end, a physical count of the supplies on hand revealed that $825 of unused supplies were available for future use. How will the related adjusting entry affect the company’s financial statements? A) Expenses will increase and assets will decrease by $1,475. B) Assets and expenses will both increase by $825. C) Expenses and assets will both increase by $1,475. D) The related adjusting entry has no effect on net income or the accounting equation.

22)

Recognizing an expense may be accompanied by which of the following? A) A decrease in liabilities B) An increase in assets C) A decrease in revenue D) A decrease in assets

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23)

Which of the following statements is true regarding accrual accounting?

24)

Recognition of revenue may be accompanied by which of the following? A) A decrease in a liability B) An increase in a liability C) An increase in an asset D) An increase in an asset or a decrease in a liability

25)

Which of the following events would require a year-end adjusting entry? A) Purchasing supplies for cash during the year. B) Purchasing land for cash during the year. C) Providing services on account during the year. D) Each of these events would require a year-end adjusting entry.

26) Which of the following shows how purchasing supplies for cash will affect a company’s financial statements at the date of purchase? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + − n/a n/a n/a n/a n/a −IA B.

n/a

−

n/a

−

n/a

−

−OA

+ −

n/a

−OA

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A) Option A B) Option B C) Option C D) Option D

27) Which of the following shows how the year-end adjustment to recognize supplies expense will affect a company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + − n/a n/a n/a n/a n/a n/a B.

−

n/a

−

n/a

−

n/a

+ −

n/a

−OA

−

n/a

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

28) How does the adjusting entry to recognize the portion of the unearned revenue that a company earned during the accounting period affect the financial statements? A) An increase in assets and a decrease in liabilities. B) An increase in liabilities and a decrease instockholders’ equity. C) A decrease in liabilities and an increase instockholders’ equity. D) A decrease in assets and a decrease in liabilities.

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29) On December 1, Year 1, Jack’s Snow Removal Company received $6,000 of cash in advance from a customer and promised to provide services for that customer during the months of December, January, and February. How will the Year 1 year-end adjustment to recognize the partial expiration of the contract impact the financial statements? A) Total assets will increase by $2,000. B) Stockholders’ Equity will increase by $2,000. C) Total liabilities will increase by $2,000. D) Total assets will increase by $2,000 and stockholders’ equity will increase by $2,000.

30) On January 1, Year 2, the Supplies account of Sheldon Company had a balance of $1,200. During the year, the company purchased $3,400 of supplies on account and made partial payments totaling $3,000 on those accounts. On December 31, Year 2, Sheldon determined that there were $1,400 of supplies on hand. Which of the following would be reported on Sheldon’s Year 2 financial statements? A) $1,600 of supplies; $200 of supplies expense B) $1,400 of supplies; $2,000 of supplies expense C) $1,400 of supplies; $3,200 of supplies expense D) $1,600 of supplies; $3,400 of supplies expense

31) On October 1, Year 1, Jason Company paid $7,200 to lease office space for one year beginning immediately. What is the amount of rent expense that will be reported on the Year 1 income statement and what is the cash outflow for rent that would be reported on the Year 1 statement of cash flows? A) $7,200; $7,200 B) $1,800; $1,800 C) $1,800; $7,200 D) $1,200; $7,200

32) Which of the following shows how paying cash to lease office space for one year affects the company’s financial statements? Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income A. + − n/a n/a n/a + −

of Cash Flows −OA

−

n/a

−

n/a

−

n/a

+ −

n/a

−OA

−

n/a

−OA

A) Option A B) Option B C) Option C D) Option D

33) On October 1, Year 1 Allen Company paid $24,000 cash to lease office space for one year beginning immediately. How would the adjustment on December 31, Year 1 to recognize rent expense affect the company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (6,000) n/a (6,000) n/a 6,000 (6,000) n/a B. (6,000)

6,000

n/a

6,000

(6,000)

−OA

C. (2,000)

n/a

(2,000)

n/a

2,000

(2,000)

n/a

D. (4,000)

(4,000)

n/a

4,000

(4,000)

−OA

A) Option A B) Option B C) Option C D) Option D

34) When a revenue or an expense event is recognized after cash has been exchanged it is referred to as

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A) an accrual B) a deferral C) either an accrual or deferral D) neither of these terms describe this event

35)

How wouldan advance payment for rent be classified? A) Asset source transaction B) Asset use transaction C) Asset exchange transaction D) Claims exchange transaction

36)

Which of the following accounts would not appear on a balance sheet? A) Service Revenue B) Supplies C) Unearned Revenue D) Prepaid Rent

37) Which of the following would cause net income on the accrual basis to be different from (either higher or lower than) "cash provided by operating activities" on the statement of cash flows? A) Purchased land for cash B) Purchased supplies for cash C) Paid rent expense D) Paid dividends to stockholder

38) Duluth Company collected a $6,000 cash advance from a customer on November 1, Year 1 for services to be provided over a six-month period beginning on that date. If the year-end adjustment is properly recorded, what will be the effect of the adjusting entry on Duluth's Year 1 financial statements?

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A) Increase assets and decrease liabilities B) Increase assets and increase revenues C) Decrease liabilities and increase revenues D) No effect

39) On September 1, Year 1, Gomez Company collected $9,000 in advance from a customer for services to be provided over a one-year period beginning on that date. How much revenue would Gomez Company report related to this contract on its income statement for the year ended December 31, Year 1? How much would the company report as net cash flows from operating activities for Year 1? A) $3,000; $3,000 B) $9,000; $9,000 C) $3,000; $9,000 D) $0; $9,000

40) Which of the following shows how receiving cash for services that will be performed in the future affects the company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + − n/a n/a + n/a + +OA B.

n/a

+OA

+ −

n/a

+OA

A) Option A B) Option B C) Option C D) Option D

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41) Allen Company received $12,000 cash from Gerry Corporation for cleaning services that Allen agrees to perform over a one year period beginning on June 1, Year 1. How would the adjustment on December 31, Year 1 to recognize the portion of the revenue that Allen earned during Year 1 affect Allen company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. n/a (7,000) 7,000 7,000 n/a 7,000 n/a B.

n/a

(7,000)

7,000

n/a

C. 12,000

12,000

n/a

12,000

n/a

12,000

12,000 OA

(6,000)

6,000

n/a

6,000

n/a

A) Option A B) Option B C) Option C D) Option D

42)

What is the purpose of the accrual basis of accounting?

43)

Which of the following is an asset use transaction? A) Purchased land for cash B) Recorded rent expense at the end of the period C) Borrowed cash from the bank D) Accrued salary expense at the end of the period

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44)

Which of the following is a claims exchange transaction?

A) Recognized revenue earned on a contract where the cash had been collected at an earlier date B) Issued common stock C) Provided services on account D) Purchased land for cash

45) Joseph Company purchased a delivery van on January 1, Year 1 for $35,000. The van is estimated to have a 5-year useful life and a $5,000 salvage value. How much expense should Joseph recognize in Year 1 related to the use of the van? A) $6,000 B) $7,000 C) $30,000 D) $5,000

46)

Which of the following events involves a deferral?

A) Recording interest that has been earned but not received. B) Recording revenue that has been earned but not yet collected in cash. C) Recording supplies that have been purchased with cash but not yet used. D) Recording salaries owed to employees at the end of the year that will be paid during the following year.

47) The entry to recognize depreciation expense incurred on equipment involves which of the following? A) A decrease in assets B) An increase in liabilities C) An increase in assets D) A decrease in liabilities

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48) The following accounts and balances were obtained from the records of Barnes Company: Cash Accounts receivable Equipment Accumulated depreciation Accounts payable Common stock

$ 4,500 $ 2,700 $10,000 $ 3,200 $ 2,800 $ 6,000

Based on this information alone the amount of Barnes's retained earnings is: A) $11,600. B) $17,200. C) $5,200. D) None of these answers is correct.

49) On January 1, Year 1, Marino Moving Company paid $68,000 cash to purchase a truck. The truck was expected to have a four-year useful life and a $4,000 salvage value. If Marino uses the straight-line method, which of the following shows how the adjusting entry to recognize depreciation expense at the end of Year 3 will affect the Company’s financial statements? A) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows Cas + Book = h Valu e of Truc k NA NA NA 16,000 NA 16,000 (16,000 NA )

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Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholder Revenu − Expens = Net Cash s s’ Equity e e Income Flows Cas + Book = h Value of Truck NA (16,000 NA (16,000) NA 16,000 (16,000 NA ) )

C) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows Cas + Book = h Valu e of Truc k NA NA NA 48,000 NA 48,000 (48,000 NA )

D) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows Cas + Book = h Valu e of Truc k NA NA NA 16,000 NA 16,000 (16,000 (16,000) ) OA

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50) On January 1, Year 1, Marino Moving Company paid $35,000 cash to purchase a truck. The truck was expected to have a four-year useful life and a $3,000 salvage value. If Marino uses the straight-line method, which of the following shows how the adjusting entry to recognize depreciation expense at the end of Year 3 will affect the Company’s financial statements? A) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows Cas + Book = h Value of Truck NA (8,000 NA (8,000) NA 8,000 (8,000 NA ) )

Assets Cas + Book h Value of Truck NA (24,000 )

Balance Sheet Income Statement Statemen t of Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows =

(8,000)

8,000

(8,000 )

C) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholder Revenu − Expens = Net Cash s s’ Equity e e Income Flows Cas + Book = h Value of Truck NA (24,000 NA 24,000 NA 24,000 (24,000 NA

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)

D) Balance Sheet Income Statement Statemen t of Assets Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows Cas + Book = h Value of Truck NA (8,000 NA 8,000 NA 8,000 (8,000 (8,000) ) ) OA

51) Consider how each of the transactions listed below affect net income reported on the income statement and the net cash flows from operating activities reported on the statement of cash flows. Which transaction(s) would affect the income statement in a different period from the statement of cash flows? A) Recognized depreciation expense on equipment. B) Incurred operating expenses on account. C) Paid interest that was accrued in a prior year. D) All of these answer choices would affect the income statement in a different period from the statement of cash flows.

52) On January 1, Year 1, Alabama Company purchased a machine for $26,000. The machine has an estimated useful life of 4 years and an estimated salvage value of $6,000. What is the book value of the machine reported on Alabama's balance sheet as of December 31, Year 1? A) $26,000 B) $19,500 C) $21,000 D) $15,000

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53) On May 1, Year 2, Cole Company paid $12,000 cash for supplies. The Year 2 adjusting entry to recognize the amount of supplies used during Year 2 A) increases the amount of supplies expense recognized in Year 2. B) decreases the amount of liabilities shown on the Year 2 balance sheet. C) increases the amount of liabilities shown on the Year 2 balance sheet. D) decreases the amount of supplies expense recognized in Year 2.

54)

When a company purchases supplies on account A) Cash flow from financing activities decreases B) Total assets decrease C) Expenses increase D) Liabilities increase

55) Hawk Company purchased $800 of supplies on account. Which of the following shows how this purchase will affect Hawk’s balance sheet?

Assets Cash Supplies A.

800

(800)

Balance Sheet Liabilities + Accounts Payable 800

Stockholders' Equity Common Retained Stock Earnings

(800)

800 800

(800)

A) Option A B) Option B C) Option C D) Option D

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56) Knoll Company started Year 2 with a $1,000 balance in its Cash account, a $200 balance in its Supplies account and a $1,200 balance in its common stock account. During Year 2, the company experienced the following events: 1.(1) Paid $600 cash to purchase supplies. 2.(2) Physical count revealed $50 of supplies on hand at the end of Year 2. Based on this information the amount of supplies expense reported on the Year 2 income statement is A) $600 B) $750 C) $800 D) $850

57) Chester Company started Year 2 with a $2,000 balance in its Cash account, a $500 balance in its Supplies account, and a $2,500 balance in its Common Stock account. During Year 2, the company experienced the following events: 1.(1) Paid $1,400 cash to purchase supplies. 2.(2) Physical count revealed $300 of supplies on hand at the end of Year 2. Based on this information, which of the following shows how the year-end adjusting entry required to recognize supplies expense would affect Chester’s account balances?

Assets Cash Supplies A.

(1,600)

1,600

(1,400)

Balance Sheet Liabilities + Accounts Payable

Stockholders' Equity Common Retained Stock Earnings (1,600)

1,600

1,400 (1,400)

(1,400)

A) Option A B) Option B C) Option C D) Option D

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58) Pizitz Company experienced a business event that affected its financial statements as indicated below. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA −OA

Which of the following events could have caused these effects? A) Paid cash to reduce supplies payable B) Recognized supplies expense C) Paid cash to purchase supplies D) Purchased supplies on account

59) Which of the following shows how paying cash to purchase supplies will affect a company’s financial statements? A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income +/− NA NA NA NA NA −OA

B) Balance Sheet Income Statement Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Cash Flows Equity Income +/− NA NA NA NA NA NA

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C) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA NA NA −OA

D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA + − NA

60) Which of the following shows how adjusting the accounts to recognize supplies expense will affect a company’s financial statements? A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − − NA NA + − NA

B) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA + − −OA

C) Version 1

Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA + − NA

D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA + − +OA

61)

A deferral exists when a company pays cash A) at the same time the associated expense is recognized. B) after recognizing the associated expense. C) before recognizing the associated expense. D) None of these answer choices are correct.

62)

Which of the following statements is false?

A) Prepaid insurance is a liability reported on the balance sheet. B) Prepaid insurance indicates that a company has already paid cash for insurance coverage that protects the company for some future time period. C) Prepaid insurance is a deferred expense. D) Prepaid insurance represents a future economic benefit.

63) Bates Company paid $1,600 cash for the right to use office space during the coming year. Which of the following shows how this event would affect Bates’ balance sheet?

Assets

Version 1

Balance Sheet Liabilities +

Stockholders' Equity

Cash

Prepaid Rent 1,600

(1,600)

1,600

A. B.

Accounts Payable 1,600

Common Stock

Retained Earnings

1,600

(1,600)

A) Option A B) Option B C) Option C D) Option D

64) Which of the following shows how paying cash to lease an office building for the upcoming year affects a company’s financial statements? A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income +/− NA NA NA NA NA −OA

B) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income +/− NA NA NA + − −OA

C) Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income − NA − NA NA NA

of Cash Flows −OA

D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA −IA

65) On August 1, Year 1, Lace Company paid $2,400 cash for an insurance policy that would provide protection for a one-year term. Which of the following shows how the required adjustment on December 31, Year 1, will affect Lace Company’s balance sheet?

Balance Sheet Assets = Liabilities + Cash Prepaid Rent Accounts Payable (2,400) 2,400

(800)

2,400

(1,000)

Stockholders' Equity Common Retained Stock Earnings

(800) 2,400 (1,000)

A) Option A B) Option B C) Option C D) Option D

66) On October 1, Year 1, Wilson Company paid cash for an insurance policy that would provide protection for a one-year term. Which of the following shows how the required adjusting entry on December 31, Year 1 will affect Wilson’s financial statements? Version 1

A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA + − −OA

B) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA + − NA

C) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − NA NA NA −OA

D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

67) On March 1, Year 1, Presco Enterprises paid $1,200 cash for an insurance policy that would provide protection for a one-year term. The company’s fiscal year ends on December 31. Based on this information, the amount of insurance expense appearing on the Year 1 income statement would be Version 1

A) $200 B) $500 C) $1,000 D) $1,200

68) On November 1, Year 1, Falloch, Incorporated paid $3,600 cash for a contract allowing the company to use office space for one year. The company’s fiscal year ends on December 31. Based on this information, the amount of cash flow from operating activities appearing on the Year 1 statement of cash flows would be A) $2,100 B) $3,000 C) $3,300 D) $3,600

69) On June 1, Year 1, Maverick Company paid $1,200 cash for an insurance policy that would protect the company for one year. The company’s fiscal year ends on December 31. Based on this information, the amount of insurance expense and the cash flow from operating activities shown on the Year 1 financial statements would be A) Insurance Expense

Cash Flow

500

1,200

Insurance Expense

Cash Flow

700

1,200

Insurance Expense

Cash Flow

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1,200

Insurance Expense

Cash Flow

700

500

70)

A deferral exists when a company receives cash A) after recognizing the associated revenue. B) at the same time the associated revenue is recognized. C) before recognizing the associated revenue. D) either before or after recognizing the associated revenue.

71) Langley Incorporated accepted a $24,000 retainer for which the company agreed to provide services in the future. Recognizing this event would A) defer the recognition of revenue. B) increase the balance in the company’s cash account. C) cause the company’s liabilities to increase. D) All of the answers are correct.

72) Amelia Consulting Services collected $12,000 cash for services to be provided in the future. Which of the following shows how recognizing the cash receipt will affect the company's balance sheet? Assets Cash Prepaid Rent A. B.

12,000

Version 1

Balance Sheet Liabilities + Unearned Revenue 12,000

Stockholders' Equity Common Retained Stock Earnings (12,000)

12,000

12,000 (12,000)

12,000

A) Option A B) Option B C) Option C D) Option D

73) Which of the following shows how the event “collected cash for services to be rendered in the future” affects a company’s financial statements? A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income + NA + NA NA NA +OA

B) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income + + NA NA NA NA +OA

C) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income + + NA NA + − +OA

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D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income + + NA NA NA NA NA

74) On September 1, Year 1, Zelda Company collected $120,000 cash for services to be provided for one year beginning immediately. The company's fiscal year ends on December 31. Based on this information, the amount of revenue appearing on the Year 1 income statement would be A) $30,000 B) $40,000 C) $80,000 D) $120,000

75) On October 1, Year 1, Gomez Company collected $13,200 in advance from a customer for services to be provided over a one-year period beginning on that date. How much revenue would Gomez Company report related to this contract on its income statement for the year ended December 31, Year 1? How much would the company report as net cash flows from operating activities for Year 1? A) $3,300; $3,300 B) $13,200; $13,200 C) $3,300; $13,200 D) $0; $13,200

76) On October 1, Year 1, Gomez Company collected $24,000 in advance from a customer for services to be provided over a one-year period beginning on that date. How much revenue would Gomez Company report related to this contract on its income statement for the year ended December 31, Year 1? How much would the company report as net cash flows from operating activities for Year 1?

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A) $6,000; $6,000 B) $24,000; $24,000 C) $6,000; $24,000 D) $0; $24,000

77) On June 1, Year 1, Jack Associates collected $48,000 cash for consulting services to be provided for one year beginning immediately. Based on this information, which of the following shows how the required adjustment on December 31, Year 1, would affect Jack's balance sheet? Assets Cash Prepaid Rent A.

Balance Sheet Liabilities + Unearned Revenue (28,000)

Stockholders' Equity Common Retained Stock Earnings 28,000

20,000

(20,000)

20,000

28,000

(28,000)

A) Option A B) Option B C) Option C D) Option D

78) On February 1, Year 1, Cora Company collected $60,000 cash for consulting services to be provided for one year beginning immediately. The company's fiscal year ends on December 31. Based on this information, the amount of unearned revenue appearing on the December 31, Year 2 balance sheet would be A) $60,000 B) $55,000 C) $5,000 D) zero

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79) Which of the following shows how the adjusting entry to recognize services provided to a client who paid for the services prior to the work being performed? A) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − NA − + NA + NA

B) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income + + NA + NA + +IA

C) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA − + + NA + NA

D) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA − + + NA + +OA

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80) On August 1, Year 1, Carson Company collected $84,000 for services to be provided for one year beginning immediately. The company's fiscal year ends on December 31. Based on this information, the amount of service revenue and the cash flow from operating activities shown on the Year 1 financial statements would be A) Service Revenue

Cash Flow

35,000

84,000

Service Revenue

Cash Flow

42,000

84,000

Service Revenue

Cash Flow

35,000

Service Revenue

Cash Flow

84,000

49,000

81) Foster Company’s December 31, Year 1, balance sheet showed $2,700 cash, $1,000 common stock, and $1,700 retained earnings. The company experienced the following event during Year 2. On October 1, collected $12,000 in advance for an agreement to provide office space for one year beginning immediately. Based on this information alone,

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A) the Year 3 income statement would show $9,000 of rent revenue. B) the Year 3 balance sheet would show $9,000 of rent revenue. C) the Year 2 income statement would show $3,000 of unearned rent revenue. D) the Year 2 balance sheet would show $3,000 of unearned rent revenue.

82) Hans Company’s December 31, Year 1, balance sheet showed $800 cash, $500 supplies, $400 accounts payable, $300 common stock, and $600 retained earnings. The company experienced the following events during year 2. 1.(1) Purchased $1,000 of supplies on account 2.(2) Earned $2,000 cash revenue 3.(3) Paid $1,200 cash to reduce accounts payable created in Event 1 above 4.(4) Physical count revealed $300 of supplies on hand at the end of Year 2 Based on this information, the company would report A) a $200 balance in the accounts payable account on the Year 2 balance sheet. B) a $800 net cash inflow from operating activities on the Year 2 statement of cash flows. C) a $1,200 supplies expense on the Year 2 income statement. D) All of the answers are correct.

83) Betsy Company’s December 31, Year 1, balance sheet showed $1,900 cash, $500 accounts payable, $400 common stock and $1,000 retained earnings. The company experienced the following events during Year 2. 1.(1) On April 1, Year 2 the company paid $2,400 cash to rent office space for the coming year starting immediately 2.(2) Earned $3,600 cash revenue 3.(3) Paid a $200 cash dividend Based on this information, the company would report A) a $1,200 net cash inflow from operating activities on the Year 2 statement of cash flows. B) a $2,600 balance in retained earnings on the Year 2 balance sheet. C) a $600 balance in a prepaid rent account on the Year 2 balance sheet. D) All of the answers are correct.

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84) Tammy Company paid cash to purchase a long-term operational asset. The cost of the asset will be expensed (depreciated) A) on the day it is purchased. B) at the end of its useful life. C) over the useful life of the asset. D) when the asset is sold.

85) On January 1, Year 1, Martin Mowing Company paid $64,000 to purchase a truck. The truck was expected to have a six-year useful life and a $4,000 salvage value. If Margin uses the straight-line method, the amount of depreciation expense recognized on the Year 2 income statement is A) $10,000 B) $20,000 C) $21,333 D) $30,000

86) On January 1, Year 1 Marrow Moving Company paid $35,000 to purchase a truck. The truck was expected to have a four-year useful life and an $8,000 salvage value. If Marrow uses the straight-line method, the amount of accumulated depreciation shown on the Year 2 balance sheet is A) $7,000 B) $13,500 C) $17,500 D) $35,000

87) On January 1, Year 1, Melon Moving Company paid $55,000 to purchase a truck. The truck was expected to have a four-year useful life and a $5,000 salvage value. If Melon uses the straight-line method, the amount of book value shown on the Year 2 balance sheet is

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A) $42,500 B) $30,000 C) $25,000 D) $12,500

88) On January 1, Year 1, Melon Moving Company paid $60,000 to purchase a truck. The truck was expected to have a five-year useful life and a $5,000 salvage value. If Melon uses the straight-line method, the amount of book value shown on the Year 4 balance sheet is A) $27,000 B) $16,000 C) $5,000 D) zero

89) At the end of Year 1, the following information is available for Grumpy, Happy, and Doc Companies.

Total Assets Total Liabilities Stockholders' Equity Net Income

Grumpy

Happy

Doc

$2,000,000 1,400,000 600,000 118,000

$2,000,000 800,000 1,200,000 190,000

$3,000,000 1,800,000 1,200,000 150,000

Which company has the highest level of debt risk? A) Grumpy B) Happy C) Doc D) They all have equal debt risk.

90) At the end of Year 1, the following information is available for Grumpy, Happy, and Doc Companies.

Version 1

Total Assets Total Liabilities Stockholders' Equity Net Income

Grumpy

Happy

Doc

$2,000,000 1,400,000 600,000 118,000

$2,000,000 800,000 1,200,000 190,000

$3,000,000 1,800,000 1,200,000 150,000

Which company is the most profitable from the stockholders' perspective? A) Grumpy B) Happy C) Doc D) Cannot be determined

91) At the end of Year 1, the following information is available for Grumpy, Happy, and Doc Companies.

Total Assets Total Liabilities Stockholders' Equity Net Income

Grumpy

Happy

Doc

$2,000,000 1,400,000 600,000 118,000

$2,000,000 800,000 1,200,000 190,000

$3,000,000 1,800,000 1,200,000 150,000

Which company has the highest return-on-assets ratio? A) Grumpy B) Happy C) Doc D) They all have equal return-on-assets ratios.

92) Which of the following ratios would be most useful in evaluating a company's performance from the owners' perspective?

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A) Return-on-assets ratio B) Debt-to-assets ratio C) Return-on-equity ratio D) Either the debt-to-assets ratio or the return-on-equity ratio

93) Wichita, Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

$218,000

Expenses

175,520

Net Income

$ 42,480

Current Assets

$ 59,000

Long-term Assets

177,000

Total Assets

$236,000

Current Liabilities

$ 38,000

Long-term Liabilities

89,000

Total Liabilities Common Stock Retained Earnings

127,000 $ 49,000 60,000

Total Equity

109,000

Total Liabilities and Equity

$236,000

What is the company’s return-on-assets ratio?

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A) 46% B) 33% C) 18% D) 9%

94) Wichita, Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

$200,000

Expenses

180,000

Net Income

$ 20,000

Current Assets

$ 50,000

Long-term Assets

150,000

Total Assets

$200,000

Current Liabilities

$ 20,000

Long-term Liabilities

80,000

Total Liabilities Common Stock Retained Earnings

100,000 $ 40,000 60,000

Total Equity

100,000

Total Liabilities and Equity

$200,000

What is the company’s return-on-assets ratio? A) 5% B) 10% C) 20% D) 50%

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95) Wichita,Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

$ 202,000

Expenses

177,520

Net Income

$ 24,480

Current Assets

$ 51,000

Long-term Assets

153,000

Total Assets

$ 204,000

Current Liabilities

$ 22,000

Long-term Liabilities

81,000

Total Liabilities Common Stock Retained Earnings

103,000 $ 41,000 60,000

Total Equity

101,000

Total Liabilities and Equity

$204,000

What is the company’s return-on-equity ratio? A) 50% B) 6% C) 12% D) 24%

96) Wichita, Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

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$200,000

Expenses

180,000

Net Income

$ 20,000

Current Assets

$ 50,000

Long-term Assets

150,000

Total Assets

$200,000

Current Liabilities

$ 20,000

Long-term Liabilities

80,000

Total Liabilities Common Stock Retained Earnings

100,000 $ 40,000 60,000

Total Equity

100,000

Total Liabilities and Equity

$200,000

What is the company’s return-on-equity ratio? A) 5% B) 10% C) 20% D) 50%

97) Wichita, Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

$206,000

Expenses

189,040

Net Income Current Assets

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$ 16,960 $ 53,000

Long-term Assets

159,000

Total Assets

$212,000

Current Liabilities

$ 26,000

Long-term Liabilities

83,000

Total Liabilities Common Stock Retained Earnings

109,000 $ 43,000 60,000

Total Equity

103,000

Total Liabilities and Equity

$212,000

What is the company’s debt-to-assets ratio? A) 8% B) 51% C) 45% D) 4%

98) Wichita, Incorporated reported the following amounts on its financial statements prepared as of the end of the current accounting period: Revenues

$200,000

Expenses

180,000

Net Income

$ 20,000

Current Assets

$ 50,000

Long-term Assets

150,000

Total Assets

$200,000

Current Liabilities

$ 20,000

Long-term Liabilities

80,000

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Total Liabilities Common Stock Retained Earnings

100,000 $ 40,000 60,000

Total Equity

100,000

Total Liabilities and Equity

$200,000

What is the company’s debt-to-assets ratio? A) 5% B) 10% C) 45% D) 50%

99) Chestnut,Incorporated reported the following balances on its balance sheet at December 31, Year 1:

Total Assets

$264,000

Total Liabilities

$ 86,000

Common Stock

83,000

Retained Earnings

95,000

Total Equity

178,000

Total Liabilities and Equity

$264,000

On January 1, Year 2, Chestnut purchased equipment for $57,000 on account. What is the company’s debt-to-assets ratio immediately after the purchase of the equipment? (Round your answer to 2 decimal places.)

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A) 0.33 B) 0.45 C) 0.35 D) 0.44

100) Chestnut, Incorporated reported the following balances on its balance sheet at December 31, Year 1: Total Assets

$ 460,000

Total Liabilities

$ 170,000

Common Stock

160,000

Retained Earnings

130,000

Total Equity Total Liabilities and Equity

290,000 $ 460,000

On January 1, Year 2, Chestnut purchased equipment for $40,000 on account. What is the company’s debt-to-assets ratio immediately after the purchase of the equipment? A) 0.42 B) 0.46 C) 0.37 D) 0.34

101)

Which of the following transactions would increase a company's return-on-assets ratio? A) Received cash from customers for goods sold to them on account last month. B) Borrowed cash from a local bank. C) Incurred expenses on account. D) Paid cash to settle accounts payable.

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Answer Key Test name: Chap 03_2e_Test Bank_MCQs_TF 1) FALSE Accrual basis companies recognize revenue when earned and expense when incurred, regardless of when cash is received or paid. 2) TRUE Accrual basis companies recognize revenue when earned and expense when incurred, regardless of when cash is received or paid. 3) TRUE The event decreases assets (Cash) and increases assets (Supplies). There is no net effect on total assets. 4) TRUE In the case of unearned revenue, when the revenue is actually earned (i.e. services are provided) revenue will increase (which increases retained earnings) and the liability account, unearned revenue, will decrease. 5) FALSE Unearned revenue is a liability account on the balance sheet. It is not reported on the income statement. 6) FALSE Asset use transactions can also involve a decrease in another asset account, such as supplies or prepaid rent. 7) TRUE Unearned revenue, a liability, decreases and service revenue increases the equity account retained earnings, making this a claims exchange transaction. 8) FALSE

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Recognition of revenue increases equity, which cannot be accompanied by an increase in liabilities. It could, however, be accompanied by a decrease in liabilities as in a claims exchange transaction. 9) TRUE Recognition of depreciation expense is an asset use transaction that decreases assets (Book Value of Asset) and decreases stockholders’ equity (Retained Earnings). 10) FALSE The accumulated depreciation increases (accumulates) each time depreciation expense is recognized. 11) TRUE It is necessary to estimate an asset's useful life and salvage value in order to calculate depreciation expense associated with the use of that asset. 12) TRUE

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A cost is incurred when a company pays cash or incurs a liability as a result of its operating or investing activities. For example, a company may pay cash or increase its salaries payable to compensate its employees who have completed work for the company. In this case, the company would recognize an expense because it has already used the labor provided by the employees. In other words, there is no future benefit associated with the cost because the benefit was obtained in the past when the work was done. Alternatively, a company could pay cash to purchase supplies that it plans to use in the future. Under this circumstance, a benefit will occur in the future when the supplies are used in the process of producing revenue. As a result, the company would record the cost as the purchase of an asset. In summary, when a company incurs a cost that has no future benefit it recognizes an expense. When a company incurs a cost that has a future benefit it records the purchase of an asset. Note carefully, that in accounting terms, a cost and an expense do not mean the same thing. 13) FALSE The salvage value of an asset is the expected selling price of an asset at the end of its useful life. The carrying value (book value) of an asset is the difference between the cost of the asset and the balance in that asset’s accumulated depreciation account. 14) FALSE Accumulated depreciation is a contra-asset account that is reported on the Balance Sheet, not on the Income Statement. 15) TRUE

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The expense will be deferred until the truck is used instead of being recognized as soon as the cash payment is made. Assuming the company uses the straight-line depreciation method, it would calculate the depreciation expense as ($50,000 − $6,000)/4-year life = $11,000 depreciation expense. The company would recognize $11,000 depreciation expense in Year 1, Year 2, Year 3, and Year 4. 16) FALSE This is false. The debt-to-assets ratio measures the level of debt risk in a business. 17) TRUE This is true. Debt is inherently risky because, unlike stockholders’ equity, it must be repaid. 18) FALSE This is false. Stockholders are interested in the earnings that their investment is generating, so the return-on-equity ratio, rather than the return-on-assets ratio, would be of greatest interest to them. 19) B A balance sheet reports assets, liabilities, and stockholders’ equity as of a selected date (usually the end of an accounting period). Cash and accounts receivable are asset accounts. Retained earnings is a stockholders' equity account. 20) A The company used $2,375 ($4,100 − $1,725) of supplies during its first year of operations. The adjusting entry to recognize supplies expense will decrease stockholders’ equity (Retained Earnings) and decrease assets (Supplies) by $2,375. It will increase expenses and decrease net income. 21) A

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The company used $1,475 ($2,300 − $825) of supplies during its first year of operations. The adjusting entry to recognize supplies expense will decrease stockholders’ equity (Retained Earnings) and decrease assets (Supplies) by $1,475. It will increase expenses and decrease net income. 22) D Recognizing an expense may be accompanied by a decrease in assets (i.e. Cash, Prepaid Rent orPrepaid Insurance) or an in increase in liabilities (i.e. Accounts Payable, Salaries Payable). 23) D Revenue is recognized when earned and expenses are recognized when incurred, regardless of when cash is exchanged. 24) D Recognizing revenue may be accompanied by either an increase in assets (Cash or Accounts Receivable) or a decrease in liabilities (Unearned Revenue). 25) A Purchasing supplies requires a year-end adjusting entry to recognize the expense associated with the amount of supplies used during the year. Purchasing land for cash does not require an adjusting entry and providing services on account does not require an adjusting entry at the end of the accounting period. 26) D Purchasing supplies for cash decreases the asset account (Cash) and increases the asset account (Supplies). Expenses in the current period are not affected because the expense will not be recognized until the supplies are used. There is a cash outflow that is classified as an operating activity. 27) B

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Recognizing supplies expense is an asset use transaction. On the balance sheet, the asset account (Supplies) and the stockholders’ equity account (Retained Earnings) decrease. The recognition of supplies expense would cause the amount of net income shown on the income statement to decrease. There is no effect on the statement of cash flows. 28) C Recognizing the portion of the unearned revenue that a company earned during the accounting period involves a decrease in liabilities (Unearned Revenue) and an increase in stockholders’ equity (Retained Earnings). 29) B The year-end adjustment to recognize one month’s work on the threemonth contract results in a $2,000 decrease in liabilities (Unearned Revenue) and a $2,000 increase in stockholders’ equity (Retained Earnings). 30) C Supplies = Amount on hand at end of year of $1,400 Supplies expense = Beginning balance of Supplies account of $1,200 + Supplies purchased of $3,400 − Ending balance of Supplies account of $1,400 = $3,200 31) C Monthly rent expense = Payment of $7,200 ÷ 12 months = $600 per month Rent expense (on the income statement) = $600 per month × 3 months = $1,800. The $7,200 paymentfor rent is the cash outflow from operating activities that will be reported on the statement of cash flows. 32) C

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Purchasing prepaid rent is an asset exchange transaction. The asset account Cash decreases and the asset account Prepaid Rent increases. Expense recognition is deferred until the office space is used. Because the cash outflow was incurred to operate the business, it is classified as an operating activity on the statement of cash flows. 33) A At the end of Year 1, Allen Company is required to expense the amount of office space that has been used. Allen Company paid $24,000 on October 1, Year 1 to rent office space for one year. The portion of the lease cost that represents using office space from October 1 through December 31 is computed as follows: $24,000 Cost of annual lease / 12 months = $2,000 Cost per month $2,000 Cost per month × 3 months used = $6,000 Rent expense The expense recognition is an asset use transaction. On the balance sheet, assets (Prepaid Rent) and stockholders’ equity (Retained Earnings) decrease. The expense recognition reduces the amount of net income shown on the income statement. The statement of cash flows is not affected. 34) B A deferral occurs when a company postpones, delays or otherwise puts off the recognition of a revenue or an expense. The revenue or expense event is recognized after cash has been exchanged. 35) C Paying cash for rent in advance increases one asset (Prepaid Rent) and decreases another asset (Cash). Therefore, it is classified as an asset exchange transaction. 36) A

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Service Revenue is an income statement account and, as such, it does not appear on the balance sheet. Unearned Revenue, despite having the word “revenue” in its title, is a liability account that appears on the balance sheet. Supplies and prepaid rent are both assets that appear on the balance sheet. 37) B Purchasing supplies for cash is a cash outflow from operating activities, but will not be reported as an expense until the supplies are used. Purchasing land is a cash outflow from investing activities and does not affect net income. Paying rent expense causes equal decreases in net income and cash flows from operating activities. Paying dividends to stockholders is a cash outflow from financing activities and does not affect net income. 38) C The adjusting entry to recognize revenue earned on the contract will decrease liabilities (Unearned Revenue) and increase stockholders’ equity (Retained Earnings). On the income statement, it will increase revenues and net income. 39) C Monthly revenue = Receipt of $9,000 ÷ 12 months = $750 per month Revenue (on the income statement) = $750 per month × 4 months (September through December) = $3,000 The company will recognize the $9,000 received as a cash inflow from operating activities in Year 1. 40) D

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The cash receipt related to unearned revenue is an asset source transaction. The asset account Cash increases and the liability account Unearned Revenue increases. Collecting the cash has no effect on the income statement. The revenue will be reported on the income statement after the company performs the services. It is classified as a cash inflow from operating activities. 41) A The $12,000 requires Allen to provide cleaning services from June 1, Year 1 to May 31, Year 2. By December 31, Year 1, Allen has earned 7 months (June 1 through December 31) of revenue related to this contract. Allen will recognize the amount of revenue earned by recording an adjustment to the accounting records at the end of the accounting period. The adjustment for revenue earned in Year 1 is computed as follows: $12,000 Cost of annual cleaning services / 12 months = $1,000 Cleaning revenue earned per month $1,000 × 7 months = $7,000 Cleaning revenue to be recognized in Year 1 The year-end adjustment moves $7,000 from the liability Unearned Revenue to the Cleaning Revenue account. This adjustment is a claims exchange event. Assets are not affected. On the balance sheet, liabilities (Unearned Revenue) decreases and stockholders’ equity (Retained Earnings) increases. On the income statement, revenue and net income increase. Cash flow is not affected by the adjustment. 42) D Recognizing revenue when it is earned and expenses when they are incurred, regardless of when cash changes hands, is commonly calledaccrual accounting. 43) B

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Recording rent expense at the end of the period is an asset use transaction that decreases assets (Prepaid Rent) and decreases stockholders’ equity (Retained Earnings). Purchasing land for cash is an asset exchange transaction. Borrowing cash from a bank is an asset source transaction. Accruing salary expense is a claims exchange transaction. 44) A Recognizing revenue earned on a contract where the cash had been collected at an earlier date is a claims exchange transaction that decreases liabilities (Unearned Revenue) and increases stockholders’ equity (Retained Earnings). Purchasing land for cash is an asset exchange transaction. Issuing common stock is an asset source transaction. Providing services on account is an asset source transaction. 45) A Depreciation expense = (Cost of $35,000 − Salvage value of $5,000) ÷ Useful life of five years = $6,000 46) C Recording the purchase of supplies constitutes a deferral because it involves the payment of cash before an expense (in this case, supplies expense) is recognized. 47) A Recognizing depreciation expense involves a decrease in assets (Book Value of Equipment) and a decrease in stockholders’ equity (Retained Earnings). 48) C

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Assets = $4,500 + $2,700 + $10,000 − $3,200 = $14,000 Assets of $14,000 = Liabilities of $2,800 + Stockholders’ Equity Stockholders’ Equity = $11,200 Stockholders’ Equity = Common stock of $6,000 + Retained earnings $11,200 = $6,000 + Retained earnings Retained Earnings = $5,200 49) B Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($68,000 Cost − $4,000 Salvage) ÷ 4 Year life = $16,000 On the balance sheet, assets (Book Value of Truck) and stockholders’ equity (Retained Earnings) decrease by $16,000. The recognition of depreciation will be shown as an expense on the income statement which will decrease net income. There is no impact on the statement of cash flows because the associated cash outflow would have been recognized previously when the truck was purchased. 50) A

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Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($35,000 Cost − $3,000 Salvage) ÷ 4 Year life = $8,000 The adjusting entry to recognize depreciation expense will cause the book value of the truck to decrease by $8,000, which decreases total assets and retained earnings. The recognition of depreciation will be shown as an expense on the income statement which will decrease net income. There is no impact on the statement of cash flows because the associated cash outflow would have been recognized previously when the truck was purchased. 51) D Recognizing depreciation expense reduces net income but does not affect cash flows from operating activities. Incurring operating expenses on account also reduces netincome but does not affect cash flows from operating activities. Paying interest that was accrued in a prior year will reduce cash flows from operating activities but will not affect net income. 52) C Accumulated depreciation at end of Year 1 = (Cost of $26,000 − Salvage value of $6,000) ÷ 4 years = $5,000 Book value = Cost of $26,000 cost − Accumulated depreciation of $5,000 = $21,000 53) A The adjusting entry at the end of year 2 to recognize supplies expense causes assets (Supplies) to decrease and stockholders’ equity (Retained Earnings) to decrease. Supplies expense decreases net income. 54) D

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Purchasing on account means that the buyer does not pay cash at the time of purchase. Instead the buyer incurs an obligation (Accounts Payable) to pay cash in the future. When supplies are purchased on account, assets (Supplies) and liabilities (Accounts Payable) increase. The cash flow associated with the purchase of supplies is an operating activity not a financing activity. 55) A Purchasing on account means that the buyer does not pay cash at the time of purchase. Instead the buyer incurs an obligation (Accounts Payable) to pay cash in the future. When supplies are purchased on account, assets (Supplies) and liabilities (Accounts Payable) increase. 56) B Since the Company started the accounting period with $200 of supplies and then purchased an additional $600 of supplies during the accounting period, there was a total amount of $800 ($200 + $600) of supplies that were available to be used during the accounting period. Since there were only $50 of supplies on hand at the end of the accounting period, $750 ($800 − $50) had to have been used. Assets, in this case supplies, used in the process of producing revenue are called expenses. 57) A The amount of supplies available for use is $1,900 ($500 beginning balance in the Supplies account plus the $1,400 amount of supplies purchased). Given that there was $300 of supplies on hand at the end of the accounting period, $1,600 ($1,900 available − $300 ending balance) of supplies must have been used during the period. The amount of supplies used would be recorded as an expense. On the balance sheet, the use of supplies will decrease assets (Supplies) by $1,600 and stockholders’ equity (Retained Earnings) by $1,600. 58) C

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Paying cash to purchase supplies is an asset exchange transaction. One asset (Cash) decreases and another asset (Supplies) increases. The income statement is not affected at the time supplies are purchased. Instead, the income statement will be affected at the time the amount of supplies used is determined at the end of the accounting period. Since cash was paid to purchase the supplies, there will be a cash outflow from operating activities shown on the statement of cash flows. 59) A Paying cash to purchase supplies is an asset exchange transaction. One asset (Cash) decreases and another asset (Supplies) increases. The income statement is not affected at the time supplies are purchased. Instead, the income statement will be affected at the time the amount of supplies used is determined at the end of the accounting period. Since cash was paid to purchase the supplies, there will be a cash outflow from operating activities shown on the statement of cash flows. 60) C Recognizing supplies expense at the end of the accounting period is an asset use transaction. On the balance sheet, assets (Cash) decreases and stockholders' equity (Retained Earnings) decreases. On the income statement, supplies expense increases and net income decreases. There is no effect on the statement of cash flows. The effect on cash flow occurs at the time the company pays for the supplies not when the supplies are expensed. 61) C

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Companies use deferrals to recognize expenses in the period they are incurred regardless of when cash is paid. For example, a company could pay $1,200 for the right to use office space in the future. In this case, the company would defer the expense recognition by recording the cost (cash payment) in an asset account. Then the expense would be recognized later in the period in which the office space is used to generate revenue. In summary, a deferred expense occurs when a company pays cash before recognizing the associated expense. 62) A Prepaid insurance is an asset account (not a liability account) that appears on the balance sheet. 63) B Paying cash to purchase the right to use office space in the future is an asset exchange event. One asset account (Cash) decreases and another asset account (Prepaid Rent) increases. The recognition of rent expense is deferred until a future date when the office space is used in the process of generating revenue. 64) A Paying cash to lease an office building that will be used in the future is an asset exchange transaction. One asset account (Cash) decreases and another asset account (Prepaid Rent) increases. The income statement is not affected. The cash outflow is shown in the operating activities section of the statement of cash flows. 65) D Cost per month = $2,400 total ÷ 12 months = $200 per month As of December 31, Year 1: Amount used = $200 per month × 5 months = $1,000 insurance expense The expense recognition is an asset use transaction. On the balance sheet, assets (Prepaid Insurance) decrease and stockholders’ equity (Retained Earnings) decreases. Version 1

66) B The adjusting entry to recognize the use of insurance coverage is an asset use transaction. On the balance sheet, assets (Prepaid Insurance) decrease and stockholders’ equity (Retained Earnings) decreases. The expense recognition decreases the amount of net income. The cash flow occurred at the time the insurance was purchased. There is no cashflow effect at the time the expense is recognized on December 31, Year 1. 67) C Cost per month = $1,200 total ÷ 12 months = $100 per month As of December 31, Year 1: Amount used = $100 per month × 10 months = $1,000 insurance expense Future benefit = $100 per month × 2 months = $200 prepaid insurance 68) D The cash outflow is not affected by how much of the office space has or has not been used. Since $3,600 cash was paid in Year 1, there would be a $3,600 cash outflow from operating activities shown on the Year 1 statement of cash flows. There would be zero cash flow shown on the Year 2 statement of cash flows. 69) B Cost per month = $1,200 total ÷ 12 months = $100 per month As of December 31, Year 1: Amount used = $100 per month × 7 months = $700 insurance expense Future benefit = $100 per month × 5 months = $500 prepaid insurance Since all of the cash was paid in Year 1, the total $1,200 cash outflow would be shown on the Year 1 statement of cash flows. Zero would be shown in Year 2. 70) C

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Note that revenues as well as expenses can be deferred. A deferral occurs whenever a company receives or pays cash but defers (delays) the recognition of the related revenue or expense. Recall that revenue cannot be recognized before the work has been done. This is true even if the company has already received the cash for the work that will be done in the future. In this case the company would receive the cash but defer the recognition of revenue until it has completed the work. 71) D Collecting cash for services to be provided in the future is an asset source transaction. The asset account (Cash) and the liability account (Unearned Revenue) increase. The unearned revenue account shows the company’s obligation to perform services in the future. Revenue recognition is deferred until the services are actually performed. 72) B Collecting cash for services to be provided in the future is an asset source transaction. The asset account (Cash) and the liability account (Unearned Revenue) increase. The retained earnings account is not affected because the revenue recognition is deferred. 73) B Collecting cash for services to be rendered in the future is an asset source transaction. The asset account (Cash) increases and the liability account (Unearned Revenue) increases. Since the revenue recognition is deferred (delayed), there is no effect on the income statement. A cash inflow from operating activities is shown on the statement of cash flows. 74) B

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Revenue earned per month = $120,000 total ÷ 12 months = $10,000 per month As of December 31, Year 1: Amount earned = $10,000 per month × 4 months = $40,000 service revenue Future obligation = $10,000 per month × 8 months = $80,000 unearned revenue 75) C Monthly revenue = Receipt of $13,200 ÷ 12 months = $1,100 per month Revenue (on the income statement) = $1,100 per month × 3 months (October through December) = $3,300 The company will recognize the $13,200 received as a cash inflow from operating activities in Year 1. 76) C Monthly revenue = Receipt of $24,000 ÷ 12 months = $2,000 per month Revenue (on the income statement) = $2,000 per month× 3 months (October through December) = $6,000 The company will recognize the $24,000 received as a cash inflow from operating activities in Year 1. 77) A Revenue earned per month = $48,000 total ÷ 12 months = $4,000 per month As of December 31, Year 1: Amount earned = $4,000 per month × 7 months = $28,000 service revenue Recognizing deferred revenue is a claims exchange transaction. On the balance sheet, liabilities (Unearned Revenue) and stockholders’ equity (Retained Earnings) decrease by $28,000. 78) D Version 1

Revenue earned per month = $60,000 total ÷ 12 months = $5,000 per month As of December 31, Year 1: Amount earned = $5,000 per month × 11 months = $55,000 service revenue Future obligation = $5,000 per month × 1 month = $5,000 unearned revenue As of December 31, Year 2: Amount earned = $5,000 per month × 1 months = $5,000 service revenue All of the revenue has been earned by the end of Year 2 so the amount of unearned revenue is zero on December 31, Year 2. 79) C When a company collects cash for services before they are provided, the company recognizes an obligation to provide the services in the future (Unearned Revenue). When the company settles its obligation by providing services, the liability account (Unearned Revenue) decreases and stockholders’ equity (Retained Earnings) increases. This is a claims exchange transaction. On the income statement, the increase in revenue causes net income to increase. There is no effect on the statement of cash flows because the cash flow was previously recognized at the time the cash was collected from the client. 80) A

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Revenue earned per month = $84,000 total ÷ 12 months = $7,000 per month As of December 31, Year 1: Amount earned = $7,000 per month × 5 months = $35,000 service revenue All of the cash was collected in Year 1. The cash inflow from operating activities on the December 31, Year 1 statement of cash flows would be $84,000. 81) A Earnings per month = $12,000 total ÷ 12 months = $1,000 per month As of December 31, Year 2: Amount earned = $1,000 per month × 3 months = $3,000 earned revenue Future obligation = $1,000 per month × 9 months = $9,000 unearned revenue The $3,000 earned revenue is shown on the Year 2 income statement and the $9,000 remaining balance in the unearned revenue account is shown on the Year 2 balance sheet. As of December 31, Year 3: Amount earned = $1,000 per month × 9 = $9,000 earned revenue Since all of the revenue has been earned by December 31, Year 3, the balance in the unearned revenue account on the Year 3 balance sheet is zero. 82) D

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Amount of supplies expense: $500 beginning balance in supplies + $1,000 supplies purchased = $1,500 supplies available for use; $1,500 supplies available for use − $300 ending balance of supplies = $1,200 supplies expense shown on the Year 2 income statement. Amount of accounts payable balance: $400 beginning balance + $1,000 increase due to purchase of supplies − $1,200 payment to reduce accounts payable = $200 ending balance of accounts payable shown on the Year 2 balance sheet. $2,000 cash revenue − $1,200 cash payment to reduce accounts payable = $800 Net cash inflow from operating activities on Year 2 statement of cash flows. 83) D Cost per month for rent = $2,400 total ÷ 12 months = $200 per month As of December 31, Year 2: Amount used = $200 per month × 9 months = $1,800 rent expense for Year 2 income statement. Amount unused = $200 per month × 3 months = $600 prepaid rent for Year 2 balance sheet. Net cash flow from operating activities: $3,600 cash inflow from customers (revenue) − $2,400 cash outflow for rent = $1,200 net cash inflow. Ending retained earnings balance: $1,000 beginning balance in retained earnings + $3,600 revenue − $1,800 rent expense − $200 cash dividend = $2,600 ending retained earnings balance on the Year 2 balance sheet. 84) C Purchasing a long-term asset is a deferral event. The cost of the purchase is placed in an asset account on the day of purchase. As the asset is used, a portion of its cost will be expensed. Accordingly, the expense recognition is spread over the useful life of the asset. Since the company pays the cash before it recognizes the expense, the purchase is a deferral. 85) A Version 1

Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($64,000 Cost − $4,000 Salvage) ÷ 6 Year life = $10,000 Straight-line depreciation recognizes the same amount of expense for each year of useful life. In this case, $10,000 will be recognized in Year 1, Year 2, Year 3, Year 4, Year 5, and Year 6. 86) B Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($35,000 Cost − $8,000 Salvage) ÷ 4 Year life = $6,750 The accumulated depreciation account is a contra asset account. As its name implies, the balance accumulates each year. In this case, the ending balance in the accumulated depreciation account will be $6,750 in Year 1, $13,500 in Year 2, $20,250 in Year 3, and $27,000 in Year 4. 87) B Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($55,000 Cost − $5,000 Salvage) ÷ 4 Year life = $12,500 The book value is the amount of the cost of the asset minus the accumulated depreciation. At the end of Year 2, the book value is $30,000 ($55,000 Cost − $25,000 Accumulated depreciation). 88) B

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Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($60,000 Cost − $5,000 Salvage) ÷ 5 Year life = $11,000 The book value is the amount of the cost of the asset minus the accumulated depreciation. At the end of Year 4, the book value is $16,000 ($60,000 Cost − $44,000 Accumulated depreciation). 89) A The debt-to-assets ratio measures the level of debt risk. Debt-to-assets ratio = Total debt ÷ Total assets Grumpy: $1,400,000 ÷ $2,000,000 = 70% Happy: $800,000 ÷ $2,000,000 = 40% Doc: $1,800,000 ÷ $3,000,000 = 60% Grumpy has the highest debt-to-assets ratio. 90) A The return-on-equity ratio measures profitability from the owners’ perspective. Return-on-equity ratio = Net income ÷ Stockholders’ equity Grumpy: $118,000 ÷ $600,000 = 20% (rounded) Happy: $190,000 ÷ $1,200,000 = 16% (rounded) Doc: $150,000 ÷ $1,200,000 = 13% (rounded) Grumpy has the highest return-on-equity ratio. 91) B Return-on-assets ratio = Net income ÷ Total assets Grumpy: $118,000 ÷ $2,000,000 = 6% (rounded) Happy: $190,000 ÷ $2,000,000 = 10% (rounded) Doc: $150,000 ÷ $3,000,000 = 5% (rounded) Happy has the highest return-on-assets ratio. 92) C

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Because owners are interested in the performance of their investment in a company, the return-on-equity ratio is most useful to them in measuring the company’s performance. 93) C Return-on-assets ratio = Net income ÷ Total assets Return-on-assets ratio = $42,480÷ $236,000 = 18% 94) B Return-on-assets ratio = Net income ÷ Total assets Return-on-assets ratio = $20,000 ÷ $200,000 = 10% 95) D Return-on-equity ratio = Net income ÷ Total equity Return-on-equity ratio = $24,480 ÷ $101,000 = 24% 96) C Return-on-equity ratio = Net income ÷ Total equity Return-on-equity ratio = $20,000 ÷ $100,000 = 20% 97) B Debt-to-assets ratio = Total debt ÷ Total assets Debt-to-assets ratio = $109,000 ÷ $212,000 = 51% 98) D Debt-to-assets ratio = Total debt ÷ Total assets Debt-to-assets ratio = $100,000 ÷ $200,000 = 50% 99) B This transaction increases equipment, an asset, and accounts payable, a liability. Debt-to-assets ratio = Total debt ÷ Total assets Debt-to-assets ratio = ($86,000 + $57,000) ÷ ($264,000 + $57,000) = 0.45 100) A

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This transaction increases equipment, an asset, and accounts payable, a liability. Debt-to-assets ratio = Total debt ÷ Total assets Debt-to-assets ratio = ($170,000 + $40,000) ÷ ($460,000 + $40,000) = 0.42 101) D Return-on-assets ratio = Net income ÷ Total assets Increasing net income (the numerator) and/or decreasing total assets (the denominator) increases the company’s return-on-assets ratio. Paying cash to settle accounts payable decreases assets, but has no effect on net income; this transaction increases the return-on-assets ratio.

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CHAPTER 4: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company purchased $10,000 of merchandise inventory on account from Jacobs Company Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

2) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company paid $100 cash to a freight company for delivering inventory that Wetzel had purchased from Jacobs Company with freight terms FOB shipping point. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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3) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company sold merchandise to a customer for $950 on account. Wetzel's cost of the merchandise was $600. (Consider the effects of both parts of this event.) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

4) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company paid $40 of freight cost to have merchandise shipped to one of its customers under terms FOB destination. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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5) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA A customer returned goods to Wetzel Company that had been purchased for $60 on account. The goods had originally cost Wetzel $35. Wetzel credited the customer's account for the return. (Consider the effects of both parts of this event.) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

6) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company returned some defective merchandise it had previously purchased on account from a supplier, Jacobs Company. Jacobs Company agreed to credit Wetzel's account. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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7) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company sold merchandise to a customer for $1,400 cash. The merchandise had originally cost Wetzel $850. (Consider the effects of both parts of this event.) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

8) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA On April 1, Year 1, Wetzel Company paid a supplier, Jacobs Company, the amount owed on account related to a purchase of inventory on account with terms of 2/10, net/30. The inventory was purchased on March 1, Year 1. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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9) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA After a physical count of its inventory, Wetzel Company discovered that $400 of inventory is missing. Show how the adjustment for inventory shrinkage would affect Wetzel Company's statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

10) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company discovered that a recent shipment of merchandise it had purchased was not of the same quality it had expected. The supplier agreed to grant Wetzel an allowance of $250. Wetzel had not yet paid the amount owed on the shipment to the supplier. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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11) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company recorded a cash discount on goods recently purchased on account. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

12) Indicate how each event affects the elements of financial statements. Use the following letters to record your answer in the box shown below each element. You do not need to enter dollar amounts. If an event increases one account and decreases another account equally within the same element (such as an asset exchange event), record I/D. If an event has no impact on the element, record NA. Increase = I Decrease = D Not Affected = NA Wetzel Company granted a $70 allowance to a customer who was not totally satisfied with the quality of goods received. The customer did not return the goods and had not yet paid for them. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

13) Give three examples of a period cost. At what time are period costs recognized as expenses?

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14) Give an example of a product cost. At what time are product costs recognized as expenses? What is the name of the expense account?

15)

Explain the major difference between a merchandising business and a service business.

16) How are the elements of the financial statements affected when merchandise inventory is purchased on account? (Assume a perpetual inventory system is in use.)

17)

If goods are shipped FOB destination, who is responsible for the freight costs?

18) Xavier Company sold goods with the terms 2/15, n/30. What do these payment terms mean?

19) If the buyer is to pay the transportation cost of delivering merchandise, were the goods shipped FOB destination or FOB shipping point?

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20) On June 1, merchandise subject to terms 2/10, n/30 was sold on account to a customer for $26,500. On June 3, the customer returns $5,800 of that merchandise. a) What is the amount of cash collected by the seller if the payment is made by the customer on June 8? b) What is the amount of cash collected by the seller if payment is made by the customer on June 21?

21) Why are cash discounts given, who benefits by these discounts, and what are the benefits of those discounts?

22) Suppose that merchandise is sold on account. The buyer has not yet paid the invoice because the buyer is dissatisfied with the quality of the merchandise. The seller grants an allowance to the buyer who then agrees to keep goods instead of returning them. What is the effect of granting the allowance on the financial statements of: a) The seller? b) The buyer?

23) Explain the difference between "transportation-in" and "transportation-out." Also, indicate whether each is a product cost or period cost, and in which account the costs are recorded.

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24)

How do gains and losses differ from revenues and expenses? How are they similar?

25) What type of financial statement matches sales revenue items with related expense items and distinguishes between recurring operating items and nonoperating items such as gains and losses?

26) If a company uses the perpetual inventory system, when would it normally discover that merchandise inventory has been lost or stolen?

27) What is a common size income statement? Explain how a common size income statement is useful to financial statement users.

28) Explain the computation and the meaning of each of the following: a. Gross margin percentage b. Return on sales

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29) Discuss the major differences between a perpetual inventory system and a periodic inventory system.

30) Indicate how accounting for lost and stolen merchandise differs between firms using a perpetual inventory system and those using a periodic inventory system. Which system provides the best way to account for such losses and why?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 31) Indicate whether each of the following statements is true or false. 1.________ a) A merchandising company generates revenue primarily by selling goods to customers. 2.________ b) The supply of goods accumulated to deliver when sales are made is called Supplies. 3.________ c) Retail companies are firms that sell goods to other businesses. 4.________ d) Product costs include all costs associated with the sale of products. 5.________ e) Walmart is an example of a wholesale company.

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32) Indicate whether each of the following statements is true or false. (Assume a perpetual inventory system) 1.________ a) Purchasing merchandise inventory for cash is recorded as an expense. 2.________ b) Merchandise inventory is expensed in the period it is sold. 3.________ c) Merchandise inventory is an account appearing on the balance sheet. 4.________ d) Cost of goods available for sale is allocated between cost of goods sold and selling expenses. 5.________ e) Cost of goods sold is a part of administrative and selling expenses.

33) Indicate whether each of the following statements is true or false. (Assume a perpetual inventory system.) 1.________ a) Transportation-out cost is a part of selling and administrative costs. 2.________ b) When transportation-out cost is incurred, the balance in the inventory account increases. 3.________ c) When transportation-in cost is incurred, the balance in the inventory account increases. 4.________ d) When the transportation-out cost is incurred, the balance in the cost of goods sold account increases. 5.________ e. Transportation-in cost is a part of selling and administrative costs.

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34) Indicate whether each of the following statements is true or false. (Assume a perpetual inventory system.) 1.________ a) The freight terms FOB shipping point increase the cost of inventory to the buyer. 2.________ b) The term FOB means that goods are shipped free of charge to buyer and seller. 3.________ c) FOB shipping point means that the purchaser's responsibility ends at freight point. 4.________ d) FOB destination means that the seller's responsibility ends at destination. 5.________ e) When goods are sold FOB shipping point, the seller will record transportationout costs.

35) Indicate whether each of the following statements is true or false. 1.________ a) A cash discount is extended to reward the buyer for purchasing large quantities of goods. 2.________ b) A purchase discount refers to a cash discount as seen from the seller's viewpoint. 3.________ c) A sales discount refers to a cash discount as seen from the buyer's view. 4.________ d) In a perpetual inventory system, a sales discount is recorded as a reduction of sales revenue. 5.________ e) In a perpetual inventory system, a purchase discount is recorded as a reduction of merchandise inventory.

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36) Indicate whether each of the following statements is true or false. 1.________ a) A multistep income statement separates product from period costs. 2.________ b) A single-step income statement shows the computation of gross margin. 3.________ c) Interest is normally shown as a separate item on the multistep income statement. 4.________ d) The treatment of interest on the multistep income statement is consistent with the treatment of interest on the statement of cash flows. 5.________ e) Gains and losses are included in operating income on a multistep income statement.

37) Indicate whether each of the following statements is true or false. (Assume a perpetual inventory system.) 1.________ a) In a perpetual inventory system, an employee theft is discovered immediately. 2.________ b) No adjustment is required for inventory losses under a perpetual inventory system. 3.________ c) Inventory shrinkage is calculated as the difference between the beginning and ending balances in the merchandise inventory account. 4.________ d) In a perpetual inventory system, adjustments for lost, damaged or stolen merchandise are recorded as expenses. 5.________ e) Recording inventory losses due to employee theft or shoplifting has a negative effect on the statement of cash flows.

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38) Indicate whether each of the following statements is true or false. 1.________ a) A common size income statement facilitates comparison between two or more companies of different size and in the same industry. 2.________ b) A common size income statement is prepared by dividing the various amounts reported on the income statement by the amount of total assets. 3.________ c) A common size income statement is helpful in comparing the results of operation in different time periods. 4.________ d) The gross margin percentage is computed by dividing gross margin by net income. 5.________ e) Return on sales is computed by dividing net income by net sales.

39) Patty's Pet Shop experienced the following business events during its first year of operation: 1.1) Borrowed $50,000 from the bank. 2.2) Purchased merchandise on account, $44,000, terms 1/10, n/30. 3.3) Paid for the merchandise purchased within the discount period. 4.4) Sold merchandise on account for $51,000. The inventory sold had a cost of $28,000. 5.5) Collected $41,500 on the merchandise sold on account. 6.6) Paid operating expense of $17,000. 7.7) Recognized accrued interest expense of $2,000. Required: 1.a) What is the balance of the cash account at the end of Year 1? 2.b) What are total assets at the end of Year 1? 3.c) What is gross margin for Year 1? 4.d) What is operating income for Year 1? 5.e) What is net income for Year 1? 6.f) What are total liabilities at the end of Year 1? 7.g) What is total retained earnings at the end of Year 1?

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40) Outdoor World experienced the following business events during its first year of operation. The company uses a perpetual inventory system. 1.1) Purchased merchandise on account for $170,000. 2.2) Sold inventory costing $124,000 for $208,000 on account. 3.3) Paid transportation-out cost of $7,000 on goods sold. 4.4) Paid operating expenses of $55,200. 5.5) Sold land for $45,400 that had cost $50,000. 6.6) A count of the inventory revealed that there was $45,800 of inventory on hand at the end of Year 1. Required: 1.What was Outdoor World's net income for Year 1? 2.What was the gross margin and the gross margin percent for Year 1? 3.What amount of inventory will be reported on the balance sheet for December 31, Year 1? 4.Prepare a multistep income statement for Year 1.

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41) Mattress Warehouse experienced the following business events during December, its first month of operation. The company uses the perpetual inventory system. 1.1. Issued common stock for cash. 2.2. Borrowed money from the Star City Bank issuing a note payable. 3.3. Purchased inventory on account, terms 2/10, n/30, FOB shipping point. 4.4. Returned part of the merchandise purchased in event #3. 5.5. Paid freight costs on merchandise purchased in event #3. 6.6. Sold merchandise for cash. 7.(a) Recognized cash revenue from sale of merchandise. 8.(b) Recognize cost of goods sold. 9.7. Paid freight costs to deliver goods sold in event #6. 10.8. Recorded the discount allowed in event #3. 11.9. Recorded the payment for goods purchased in event #3. 12.10. Accrued interest on the note payable issued in event #2. (The note is not due for several months.) Required: Complete the financial statements model shown below. Identify each event as asset source (AS), asset use (AU), asset exchange (AX), or claims exchange (CX). Also explain how each event affects the financial statements by placing a "+" for increase, "−" for decrease, "+−" for increase and decrease, or "NA" for not affected under each of the components of the following statements model. Also, indicate in the cash flow column if the event would be recorded as an operating activity (OA), an investing activity (IA) or a financing activity (FA). The first event is recorded as an example. Event Event Assets Liabilities Stockholders’ Revenue Expense Net Cash Number Type Equity Income Flow 1 AS + NA + NA NA NA +FA 2 3 4 5 6(a) 6(b) 7 8

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9 10

42) Jackson Medical Supply experienced the following events during June. The company uses the perpetual inventory system. 1.1. Issued common stock for cash. 2.2. Purchased inventory on account, terms 2/10, n/30, FOB shipping point. 3.3. Paid the freight charges on the purchase in event #2. 4.4. Sold merchandise to a customer on account, terms 2/10, n/30, FOB destination. 5.(a) Recognized revenue from sale of merchandise. 6.(b) Recognize cost of goods sold. 7.5. Paid the freight charges on goods sold in event #4. 8.6. Customer returned some of the merchandise sold in event #4. 9.(a) Recognized the sales return. 10.(b) Recognize the cost of the goods as a return to the inventory account. 11.7. Recorded discount granted to the customer in event #4. 12.8. Recorded payment received from the customer in event #4. 13.9. Recorded discount received on purchase in event #2. 14.10. Recorded payment of amount due on purchase in event #2. Required: Complete the financial statements model shown below. Identify each event as asset source (AS), asset use (AU), asset exchange (AX), or claims exchange (CX). Also explain how each event affects the financial statements by placing a "+" for increase, "−"for decrease, "+−" for increase and decrease, or "NA" for not affected under each of the components of the following statements model. Also, indicate in the cash column if the event would be recorded as an operating activity (OA), an investing activity (IA) or a financing activity (FA). The first event is recorded as an example. Event Even Asset Liabilitie Stockholders Revenu Expens Net Statemen Numbe t s s ’ Equity e e Incom t of r Type e Cash Flows 1 AS + NA + NA NA NA +FA

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2 3 4(a) 4(b) 5 6(a) 6(b) 7 8 9 10

43) The following events apply to Deb's Dance Wholesalers. 1.1) Sold merchandise to a customer. The goods were shipped FOB destination, with a freight cost of $50. 2.2) Purchased merchandise with freight cost of $75, shipped with the terms FOB shipping point. 3.3) Sold merchandise to a customer with freight cost of $40, shipped FOB shipping point. Required: 1.a) What is the total amount of freight that will be paid by Deb's Dance Wholesalers? 2.b) What is the amount of the expense that will be recorded with regards to freight costs paid by Deb's Dance Wholesalers?

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44) On April 6, Year 1, Gringotts Company purchased $140,000 of merchandise inventory. Terms of the purchase included a discount of 3/20, n/30 and the freight terms were FOB destination. Freight costs amounted to $4,600. Gringotts paid the account payable on April 24. Gringotts sold all inventory for $189,500. Required: What is the amount of gross margin that will be shown on the income statement?

45) The following is a partial list of account balances for Fisherman's Supply at December 31, Year 1. Cash Accounts receivable Inventory Supplies Land Accounts payable Common stock Retained earnings Sales Cost of goods sold Salaries expense Utilities expense Other operating expense Gain on sale of land

87,450 24,800 197,450 3,600 134,800 47,500 300,000 78,250 490,350 399,250 36,250 9,500 30,000 7,000

Required: 1. Prepare a multistep income statement.

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46) The current year income statements for the Alpha Company and the Omega Company appear below: Alpha Company Net sales Cost of goods sold Operating expense

$ 1,050,000 475,000 367,500

Omega Company $ 260,000 107,500 73,000

Required: 1.Prepare common size income statements for the Alpha Company and the Omega Company. 2.What is the gross margin percentage for each company? 3.What is the net income percentage for each company? 4.Briefly comment on the pricing policies of each company as well as the ability to control expenses. Disregarding the difference in size, which company appears to be doing a better job?

47) The current year income statements of two competitors, Green Company and Black Company, are as follows: Green Company Net sales Cost of goods sold Gross margin Operating expenses: Selling expense Administrative expense Total operating expense Net Income

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Black Company

$ 6,200 3,880 2,320

$ 3,440 2,030 1,410

1,220 875 2,095 $ 225

660 505 1,165 $ 245 20

Required: 1.1) What is the gross margin percentage for each company? 2.2) What is the net income percentage for each company? 3.3) Which company is selling their products for lower prices (at a lower markup)?

48) At the beginning of the year, Superior Sales had $7,500 of merchandise inventory. During the year, the company purchased $72,000 of inventory. At the end of the year, a count of the inventory revealed that the business had $11,640 of inventory on hand. Superior uses the periodic inventory system. Required: 1.a) What is cost of goods sold for the year? 2.b) What is the amount of goods available for sale? 3.c) What is the amount of inventory that will be shown on the year-end balance sheet?

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49) During April, Bloom Garden Supply Company experienced the following business events. The company uses the periodic inventory system. 1.1) April 4 Purchased $10,000 of merchandise on account, terms 1/10, n/30, FOB shipping point. 2.2) April 5 Paid shipping cost of $1,100 on the April 4 purchase. 3.3) April 6 Returned $1,200 of the merchandise purchased on April 4. 4.4) April 7 Sold merchandise for $5,800 on account, terms 2/10, n/30, FOB Destination. 5.5) April 7 Paid the shipping cost of $350 on the previous sale. 6.6) April 10 Recorded the discount and paid the amount due from the purchase of merchandise on April 4. 7.7) April 28 Sold merchandise for $7,200 cash. Required: a) Bloom's beginning inventory balance for April was $35,000. A physical count of inventory on April 30 revealed $33,600 of merchandise on hand. Calculate Bloom's cost of goods available for sale and cost of goods sold for April.

50) Indicate whether each of the following statements is true or false. 1.a) The perpetual inventory system recognizes inventory transactions as they occur. 2.b) The periodic inventory system recognizes sales revenue at the end of the accounting period. 3.c) A physical count of inventory at the end of each accounting period is necessary for the periodic inventory system, as well as for the perpetual inventory system. 4.d) A periodic inventory system requires more detailed record keeping than a perpetual inventory system. 5.e) With a periodic inventory system, cost of goods sold is not determined until the end of the accounting period.

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51) Indicate whether each of the following statements is true or false. (Assume a periodic inventory system) 1.a) If the balance in ending inventory is overstated, net income will be understated. 2.b) If the balance in ending inventory is understated, retained earnings will be understated. 3.c) If the balance in ending inventory is overstated, selling and administrative expenses will not be affected. 4.d) If the balance in ending inventory is overstated, cost of goods sold will be overstated. 5.e) If the balance in ending inventory is overstated, assets will be overstated.

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Answer Key Test name: Chap 04_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA NA

The purchase of inventory on account increases assets (Merchandise Inventory) and liabilities (Accounts Payable). Because product costs are expensed when inventory is sold, not when the goods are purchased, the event does not affect net income. Because the purchase was made on account, this transaction does not affect the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA NA

Because incurring transportation-in costs is necessary to obtain inventory, these costs are added to the inventory account. The freight cost increases one asset account (Merchandise Inventory) and decreases another asset account (Cash). Net income is not affected by this transaction because transportation-in costs are not expensed when they are incurred. Instead, they are expensed as part of cost of goods sold when the inventory is sold. However, the cash paid for transportation-in costs is reported as an outflow in the operating activities section of the statement of cash flows. 3) Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I I I

of Cash Flows NA

Recording the sale increases assets (Accounts Receivable) and increases stockholders' equity (Retained Earnings) by $950. Sales revenue and net income increase by the same amount. Recording the cost of the merchandise sold decreases assets (Merchandise Inventory) and decreases stockholders' equity (Retained Earnings) by $600. The expense (Cost of Goods Sold) increases and net income decreases by that same amount. The net effect on assets and stockholders' equity is an increase to each of $350 (or $950 − $600). The transaction does not affect the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D D

The cost of shipping goods to customers is an expense called transportation-out. This transaction decreases assets (Cash) and stockholders' equity (Retained Earnings). It increases expenses (transportation-out), which decreases net income. It is reported as a cash outflow from operating activities. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D D D D NA

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The sales return decreases assets (Accounts Receivable) and stockholders' equity (Retained Earnings) by $60. Sales revenue and net income decrease by the same amount. Because the company got the inventory back, the sales return increases assets (Merchandise Inventory) and stockholders' equity (Retained Earnings) by $35. The expense (Cost of Goods Sold) decreases and net income increases by that same amount. The net effect is a decrease to assets and stockholders' equity of $25 (or $60 − $35). Cash flow is not affected. 6) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D NA NA NA NA NA

The purchase return decreases assets (Merchandise Inventory) and decreases liabilities (Accounts Payable). Because product costs are expensed when inventory is sold, not when the goods are purchased, the event does not affect net income. There is no impact on the statement of cash flows. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I NA I I I I I

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Recording the sale increases assets (Cash) and increases stockholders' equity (Retained Earnings) by $1,400. Sales revenue and net income increase by the same amount. Recording the cost of the merchandise sold decreases assets (Merchandise Inventory) and decreases stockholders' equity (Retained Earnings) by $850. The expense (Cost of Goods Sold) increases and net income decreases by that same amount. The net effect on assets and stockholders' equity is an increase to each of $550 (or $1,400 − $850). The transaction is reported as a $1,400 cash inflow from operating activities. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D NA NA NA NA D

Since payment was not made within the 10-day discount period, no discount is available. The payment on account decreases assets (Cash) and decreases liabilities (Accounts Payable) by the amount of the invoice. There is no effect on the income statement. It is reported as a cash outflow from operating activities. 9) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D NA

The adjustment to write off the inventory shrinkage decreases assets (Merchandise Inventory) and stockholders' equity (Retained Earnings). The write-off increases expenses and decreases net income. It does not affect the statement of cash flows. 10) Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

of Cash Flows NA

Although no inventory was physically returned, the cost of the inventory on hand decreased. Therefore, the purchase allowance decreases assets (Merchandise Inventory) and decreases liabilities (Accounts Payable) by $250. Because product costs are expensed when inventory is sold, not when the goods are purchased, the event does not affect net income. It does not affect the statement of cash flows. 11) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D NA NA NA NA NA

A purchase discount reduces the cost of the inventory and the associated account payable on the balance sheet. A purchase discount does not directly affect the income statement or the statement of cash flows. 12) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D D NA D NA

Granting a sales allowance to a customer decreases assets (Accounts Receivable) and decreases stockholders' equity (Retained Earnings). It also decreases revenue and net income. It does not affect the statement of cash flows.

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13) Examples of period costs include selling and administrative costs such as advertising, administrative salaries, sales commissions, and insurance. (Notes to instructor: Only three are required. Transportationout is another example of a period cost.) Period costs are usually recognized as expenses in the period in which they are incurred. 14) Payment of transportation-in, storage costs, and the cost of the merchandise itself are product costs. They are recognized at the time the merchandise inventory is sold. The expense account is called Cost of Goods Sold. 15) A merchandising business generates revenue by selling goods to customers while a service business generates revenue by providing services to its customers. 16) Assets increase (Inventory) and liabilities increase (Accounts Payable). 17) If goods are delivered FOB destination, the seller is responsible. If goods are delivered FOB shipping point, the buyer is responsible for the freight cost. 18) These terms mean the seller will allow a 2 percent cash discount if the purchaser pays cash within 15 days from the date of purchase. The amount not paid within the first 15 days is due at the end of 30 days from the date of purchase. 19) FOB shipping point The terms FOB shipping point and FOB destination identify whether the buyer or the seller is responsible for freight costs. If goods are delivered FOB shipping point, the buyer is responsible for the freight cost. If goods are delivered FOB destination, the seller is responsible.

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20) a) $20,286 Cash collected if payment is made on June 8 (within the discount period) = ($26,500 − $5,800) × 0.98 = $20,286 b) $20,700 Cash collected if payment is made on June 21 (after the discount period had ended) = $26,500 − $5,800 = $20,700 21) To encourage buyers to pay promptly, sellers sometimes offer cash discounts. Both the buyer and seller will benefit. The buyer benefits by paying a lower price for the goods. The seller benefits by collecting cash sooner. 22) a) Assets decrease (Accounts Receivable) and stockholders' equity (Retained Earnings) decreases. Revenue and net income decrease. There is no effect on the statement of cash flows. b) Assets (Inventory) decrease and liabilities (Accounts Payable) decrease. There is no effect on the statement of cash flows. 23) Transportation-in is the freight cost on goods purchased under the terms FOB shipping point. It is a product cost and is recorded in the merchandise inventory account. Transportation-out is the freight cost on goods sold to customers under the terms FOB destination. It is a period cost and is recorded in the transportation-out account. Transportation-out is reported on the income statement as an operating expense in the section below gross margin.

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24) Gains and losses result from peripheral activities that are not likely to recur, such as the sale of land for more or less than its historic cost. As such, they are presented separately from revenues and expenses on a multistep income statement, below operating income. They are similar in that they all appear on the income statement. Gains are similar to revenues in that they increase net income. Losses are similar to expenses in that they decrease net income. 25) Multistep income statement 26) It would normally discover that merchandise has been lost or stolen when taking a physical inventory count of the merchandise, and comparing that count to the inventory balance in the ledger account. 27) Common size statements express items on financial statements as percentages. For example, on the income statement, cost of goods sold, gross margin, operating expenses, and net income are calculated as a percentage of net sales. Percentages help the user of financial statements to compare statements over time and to compare one company with another company. 28) a. The gross margin percentage is computed by dividing gross margin by net sales. This measurement provides information about the firm's pricing strategy. b. The return on sales is computed by dividing net income by net sales. This measurement helps the user determine how efficiently the firm is controlling its costs and expenses. The return on sales can be explained as the number of pennies earned on each sales dollar.

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29) The perpetual system derives its name from the fact that the balance in the inventory account is adjusted perpetually. The balances of the inventory account as well as cost of goods sold are determined at the point of sale. In the periodic system, inventory balances are only determined by a physical count, and the cost of goods sold is computed at the end of the period. 30) In both systems, such losses are not known immediately. In the perpetual system, losses are often discovered only when comparing a physical inventory count with the current balance of the inventory account. An adjustment is then made reducing the inventory balance and recording an increase in the cost of goods sold (expense) account. Under a periodic system, losses are not really "discovered" but rather are included in the computation of cost of goods sold after the physical inventory is taken. Periodic systems do not separate the cost of lost, damaged or stolen merchandise from the cost of goods sold. 31) a) T b) F c) F d) F e) F 1.a) This is true. Merchandising companies primarily sell goods to customers, both retail and wholesale. 2.b) This is false. Merchandise inventory is the account used for accumulating supplies of goods for resale. 3.c) This is false. Retail companies are firms that primarily sell goods to the public, not to other businesses. 4.d) This is false. Costs associated with selling products include cost of goods sold (product costs) and selling expenses (period costs). 5.e) This is false. Retail companies sell goods to the final consumer; wholesale companies sell goods to other merchandising companies. Walmart is an example of a retail company.

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32) (a) F (b) T (c) T (d) F (e) F 1.a) This is false. The purchase of merchandise inventory is recorded as an asset exchange transaction. 2.b) This is true. Merchandise inventory is expensed when it is sold and is reported on the income statement as cost of goods sold. 3.c) This is true. Merchandise inventory is an asset account that is reported on the balance sheet. 4.d) This is false. Cost of goods available for sale is made up of cost of goods sold and ending merchandise inventory, not selling expenses. 5.e) This is false. Cost of goods sold is an expense separate from selling and administrative expenses. 33) a) T b) F c) T d) F e) F 1.a) This is true. Transportation-out is a selling and administrative expense, or period cost. 2.b) This is false. Transportation-out is a selling and administrative expense that does not affect the inventory account. 3.c) This is true. Transportation-in increases the merchandise inventory account. 4.d) This is false. Transportation-out does not affect cost of goods sold. It is a selling and administrative expense. 5.e) This is false. Transportation-in is a product cost that is added to inventory and included in cost of goods sold.

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34) a) T b) F c) F d) T e) F 1.a) This is true. FOB shipping point means that the buyer pays freight costs, which are added to the merchandise inventory account. 2.b) This is false. FOB means Free on Board and indicates the point at which ownership of goods transfers from the seller to the buyer. 3.c) This is false. FOB shipping point means that the purchaser's responsibility begins, not ends, at the shipping point. 4.d) This is true. FOB destination means that the seller's responsibility ends at the destination point. 5.e) This is false. When goods are sent FOB shipping point, the shipper does not record anything for freight costs. 35) a) F b) F c) F (d) T (e) T 1.a) This is false. Cash discounts are extended by the seller to encourage early payment of a receivable. 2.b) This is false. Cash discounts are purchase discounts from the perspective of the buyer, not the seller. 3.c) This is false. Cash discounts are sales discounts from the perspective of the seller, not the buyer. 4.d) This is true. Sales discounts are recorded as a reduction to accounts receivable and a reduction to sales revenue. 5.e) This is true. A purchase discount reduces the cost of the inventory and the associated account payable on the balance sheet.

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36) a) T b) F c) T d) F e) F 1.a) This is true. On a multistep income statement, cost of goods sold (product cost) is shown separately from operating expenses (period cost). 2.b) This is false. A single-step income statement does not show gross margin. 3.c) This is true. Interest is normally shown below operating income on a multistep income statement. 4.d) This is false. Interest is separate from operating expenses on the multistep income statement yet is a cash flow from operating activities on the statement of cash flows. 5.e) This is false. Gains and losses are shown below operating income on a multistep income statement. 37) a) F b) F c) F d) T e) F 1.a) This is false. In a perpetual inventory system, theft is not detected until a physical count is taken. 2.b) This is false. An adjustment to write-down inventory is necessary to recognize inventory losses in a perpetual system. 3.c) This is false. Inventory shrinkage is calculated as the difference between book inventory and physical inventory. 4.d) This is true. Adjustments for losses due to shrinkage are recorded as expenses, typically cost of goods sold. 5.e) This is false. Inventory losses have no impact on the statement of cash flows.

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38) a) T b) F c) T d) F e) T 1.a) This is true. Common size income statements are helpful in comparing companies of different size in the same industry. 2.b) This is false. A common size income statement is prepared by dividing elements by sales, not total assets. 3.c) This is true. Common size income statements are helpful in comparing different time periods. 4.d) This is false. Gross margin percentage is calculated as gross margin divided by sales. 5.e) This is true. Return on sales is computed by dividing net income by net sales.

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39) a) $30,940 b) $56,000 c) $23,000 d) $6,000 e) $4,000 f) $52,000 g) $4,000 Refer to account balances set forth below: 1.a) Ending balance of cash = $30,940 2.b) Total assets = Cash of $30,940 + Accounts receivable of $9,500 + Inventory of $15,560 = $56,000 3.c) Gross margin = Net sales of $51,000 − Cost of goods sold of $28,000 = $23,000 4.d) Operating income = Sales of $51,000 − Cost of goods sold of $28,000 − Operating expenses of $17,000 = $6,000 5.e) Net income = Operating income of $6,000 (see part d) − Interest expense of $2,000 = $4,000 6.f) Total liabilities = Accounts payable of $2,000 + Notes payable of $50,000 = $52,000 7.g) Ending retained earnings = Net income of $4,000

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40) a) Inventory shrinkage = $170,000 − $124,000 − $45,800 = $200 Cost of goods sold = Cost of goods sold + Write-off of inventory shrinkage Cost of goods sold = $124,000 + $200 = $124,200 Loss on the sale of the land = $45,400 − $50,000 = $4,600 Net income = Sales − Cost of goods sold − Operating expenses − Transportation-out +/− Nonoperating items (here, the loss on the sale of the land) Net income = $208,000 − $124,200 − $55,200 − $7,000 − $4,600 = $17,000 b) Gross margin = Net sales − Cost of goods sold Gross margin = $208,000 − $124,200 = $83,800 Gross margin percentage = $83,800 ÷ $208,000 = 40.29% c) Outdoor World must make an adjustment to write off the inventory shrinkage so that the balance on the Inventory account reported on the financial statements agrees with the amount of inventory on hand at the end of the year. The write off will decrease both assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by $200. After the write off, inventory will be reported on the balance sheet at $45,800 ($46,000 −$200). d) Outdoor World Income Statement For the World Ended December 31, Year 1 Sales Revenue Cost of goods sold Gross margin

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$ 208,000 124,200 83,800

Operating expenses: Operating expense

$ 55,200

Transportation-out Operating income

7,000

62,200 21,600

Nonoperating items Loss on sale of land Net Income

(4,600) $ 17,000

41) Event Event Assets Liabilities Stockholders’ Revenue Expense Net Cash Number Type Equity Income Flow 1 AS + NA + NA NA NA +FA 2 AS + + NA NA NA NA +FA 3 AS + + NA NA NA NA NA 4 AU − − NA NA NA NA NA 5 AX +− NA NA NA NA NA −OA 6(a) AS + NA + + NA + +OA 6(b) AU − NA − NA + − NA 7 AU − NA − NA + − −OA 8 AU − − NA NA NA NA NA 9 AU − − NA NA NA NA −OA 10 CX NA + − NA + − NA

42) Event Even Asset Liabilitie Stockholders Revenu Expens Net Statemen Numbe t s s ’ Equity e e Incom t of r Type e Cash Flows 1 AS + NA + NA NA NA +FA 2 AS + NA NA NA NA NA NA 3 Ax +− NA NA NA NA NA −OA 4(a) As + NA + + NA + NA 4(b) AU − NA − NA + − NA 5 AU − NA − NA + − −OA 6(a) AU − NA − − NA − NA 6(b) AS + NA + NA − + NA 7 AU − NA − − NA − NA

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8 9 10

CX AU AU

+− − −

NA − +

NA NA NA

+OA NA −OA

43) a) Freight paid by Deb's Dance Wholesalers = $50 (event 1) + $75 (event 2) = $125 b) Expense (transportation-out) = $50 (event 1) When goods are delivered FOB shipping point, the buyer is responsible for the freight cost. When goods are delivered FOB destination, the seller is responsible for the freight costs. Event 1) – As seller of goods shipped FOB destination, Deb's is responsible for the freight cost. Event 2) – As purchaser of goods shipped FOB shipping point, Deb's is responsible for the freight cost. Event 3) – As seller of goods shipped FOB shipping point, Deb's is not responsible for the freight costs. 44) Purchase discount = List price of purchase × discount percentage Purchase discount = $140,000 × 0.03 = $4,200 Cost of goods sold = List price of purchase − Purchase discount + Transportation-in Cost of goods sold = $140,000 − $4,200 + $0* = $135,800 Gross margin = Net sales − Cost of goods sold Gross margin = $189,500 − $135,800 = $53,700 * FOB destination indicates that the seller (rather than the Gringotts) pays the freight costs. 45) Fisherman's Supply Income Statement For the World Ended December 31, Year 1 Sales revenue

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$ 490,350

Cost of goods sold

399,250

Gross margin

91,100

Operating expenses: Salaries expense

$ 36,250

Utilities expense

9,500

Other operating expense Operating income

30,000

75,750 15,350

Gain on sale of land

7,000

Net Income

$ 22,350

46) 1. Net sales Cost of goods sold Gross margin Operating expense Net Income

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Alpha Company

Percent

Omega Company

Percent

$ 1,050,000 475,000 575,000 367,500 $ 207,500

100.0% 45.2% 54.8% 35.0% 19.8%

$ 260,000 107,500 152,500 73,000 $ 79,500

100.0% 41.3% 58.7% 28.1% 30.6%

2. Gross margin percentage = Gross margin ÷ Net sales: Alpha Company 54.8% Omega Company 58.7% 3. Net income percentage = Net income ÷ Net sales: Alpha Company 19.8% Omega Company 30.6% 4. The markup percentage is higher for the Omega Company. Omega is able to either charge relatively higher prices or is able to find a very advantageous supply source (or both). The percent of operating expenses is lower for the Omega Company which means that it is doing a good job in managing its expenses. The above information, plus the fact that net income is 30.6 cents per sales dollar, would indicate that Omega is operating in a more efficient and productive manner. 47) 1) Gross margin percentage = Gross margin ÷ Net sales: Green Company = 37.4% ($2,320 ÷ $6,200) Black Company = 41.0% ($1,410 ÷ $3,440) 2) Net income percentage = Net income ÷ Net sales: Green Company = 3.6% ($225 ÷ $6,200) Black Company = 7.1% ($245 ÷ $3,440) 3) Green Company is selling its products at a lower markup: its gross profit percentage is 37.4%, compared to 41.0% for Black Company.

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48) a) $67,860 b) $79,500 c) $11,640 Beginning inventory Purchases b) Goods available for sale c) Less: Ending inventory a) Cost of goods sold

$ 7,500 72,000 79,500 (11,640) $ 67,860

49) a) Cost of goods available for sale: $44,812 a) Purchase discount = (Purchase of $10,000 − Return of $1,200) × 1% = $88 Cash payment = Balance in accounts payable of ($10,000 − $1,200 − $88) = $8,712 Cost of goods sold: $11,212 Beginning inventory balance Add: Purchases Add: Transportation-in Less: Purchase returns and allowances Less: Purchase discounts Cost of goods available for sale Less: Ending inventory balance Cost of goods sold

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$ 35,000 10,000 1,100 (1,200) (88) 44,812 (33,600) $ 11,212

50) 1.a) This is true. Perpetual systems continually adjust the inventory account as transactions occur. 2.b) This is false. Periodic systems record sales revenue as it occurs but does not update the inventory account for each sale. 3.c) This is true. Physical counts are necessary for both systems. 4.d) This is false. Periodic systems require less detailed record keeping than perpetual systems. 5.e) This is true. Cost of goods sold is not determined until a physical count is completed in a periodic system. 51) 1.a) This is false. If ending inventory is overstated, net income will be overstated. 2.b) This is true. If ending inventory is understated, cost of goods sold will be overstated, which will cause net income to be understated and retained earnings to be understated. 3.c) This is true. If ending inventory is overstated, cost of goods sold will be understated, which has no effect on selling and administrative expenses. 4.d) This is false. If ending inventory is overstated, cost of goods sold will be understated. 5.e) This is true. If ending inventory is overstated, assets will also be overstated since inventory is an asset.

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CHAPTER 4 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Wholesale companies sell goods primarily to other businesses. ⊚ true ⊚ false

Merchandising businesses include retail companies and manufacturing companies. ⊚ true ⊚ false

Costs of selling inventory are product costs. ⊚ true ⊚ false

4) The beginning inventory plus cost of goods sold equals the cost of goods available for sale during the period. ⊚ true ⊚ false

Costs charged to the Merchandise Inventory account are product costs. ⊚ true ⊚ false

6) Like product costs, selling and administrative costs cannot be recognized as an expense until inventory has been sold. ⊚ true ⊚ false

7) Gross margin is equal to the amount of change (increase or decrease) in Merchandise Inventory during a period. ⊚ true ⊚ false

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8) A perpetual inventory system updates the Merchandise Inventory account for all purchases of inventory, as well as returns of inventory to suppliers. ⊚ true ⊚ false

9) With a perpetual inventory system, the cost of merchandise inventory is recognized as an expense at the time of purchase. ⊚ true ⊚ false

10) With a perpetual inventory system, assets and stockholders’ equity increase by the amount of the gross margin when inventory is sold. (Consider the effects of both parts of this event.) ⊚ true ⊚ false

11) In a perpetual inventory system, a purchase allowance is treated as a decrease in expenses by the company that purchased the goods. ⊚ true ⊚ false

12) A company that purchases merchandise treats a cash discount as a reduction to the cost of merchandise inventory. ⊚ true ⊚ false

13) Melbourne Company purchased merchandise with a list price of $3,300. The credit terms were 2/10, n/30. Assuming that Melbourne paid for the merchandise during the discount period, the cost of goods sold for this transaction would be $2,970. ⊚ true ⊚ false

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14)

Net income is not affected by a purchase of merchandise. ⊚ true ⊚ false

15)

The term FOB shipping point indicates that the seller is responsible forfreight costs. ⊚ ⊚

true false

16) A company using a perpetual inventory system treats transportation-out as an operating expense. ⊚ true ⊚ false

17)

Gains and losses are recorded for increases and decreases in the market value of land. ⊚ true ⊚ false

18)

A multistep income statement shows sales revenue, cost of goods sold, and gross margin. ⊚ true ⊚ false

19) A multistep income statement separates routine operating results from peripheral or nonoperating items. ⊚ true ⊚ false

20) For a company that uses the perpetual inventory system, a physical count of the inventory can reveal the amount of inventory shrinkage the company has experienced. ⊚ true ⊚ false

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21) The write-off to record the amount of inventory shrinkage affects both the balance sheet and the income statement. ⊚ true ⊚ false

22)

Net sales is calculated by subtracting cost of goods sold from sales revenue. ⊚ true ⊚ false

23)

Sales discounts affect net sales, but purchase discounts do not. ⊚ true ⊚ false

24) Common size financial statements are prepared by converting dollar amounts to percentages. ⊚ true ⊚ false

25) A common size income statement is prepared by dividing all amounts on the statement by net income. ⊚ true ⊚ false

26)

Sales discounts do not affect a company's gross margin percentage. ⊚ true ⊚ false

27) The return on sales ratio indicates the amount of each sales dollar that is left over after covering the cost of goods sold. ⊚ true ⊚ false

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28) If a company uses the periodic inventory system, it records inventory purchases in the Purchases account at the time of purchase. ⊚ true ⊚ false

29) With a periodic inventory system, the cost of goods sold is recorded at the time of a sale of merchandise. ⊚ true ⊚ false

30) A company's amount of cost of goods sold reported on the income statement will be the same with a periodic inventory system as it would be with a perpetual system. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 31) Which of the following items is not a product cost?

A) Freight cost on goods delivered FOB destination to customers. B) Cost of merchandise purchased for resale. C) Transportation cost on merchandise purchased from suppliers. D) All of these answer choices are product costs.

32)

Which of the following would be considered as primarily a merchandising business? A) West Consulting B) Martin's Supermarket C) Sandridge and Associates Law Offices D) KPM Accounting and Tax Service

33)

Which of the following would not be considered as primarily a merchandising business?

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A) Abercrombie and Fitch B) Sam's Clubs C) Amazon D) Regal Cinemas

34) What is the term used to describe a firm that primarily sells merchandise to other businesses? A) Wholesale firm B) Service firm C) Retail firm D) Consulting firm

35) Star Company recognizes sales revenue from selling inventory for $2,000 cash. Note that Star is only recording the sales revenue part of the transaction and not the cost of goods sold. Star uses the perpetual inventory system. Which of the following answers reflects the effect of the sales revenue on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 2,000 − 2,000 2,000 n/a 2,000 2,000OA B. (2,000)

−

(2,000)

2,000

n/a

C. 2,000

2,000

n/a

2,000

n/a

2,000

2,000OA

D. (2,000)

n/a

(2,000)

n/a

2,000

(2,000) (2,000)OA

A) Option A B) Option B C) Option C D) Option D

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36) Star Company recognized $500 of cost of goods sold. Note that Star is only recording the cost of goods sold part of the transaction and not the sales revenue. Star uses the perpetual inventory system. Which of the following answers reflects the effect of recognizing the cost of goods sold on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 500 − 500 n/a 500 (500) n/a B. (500)

−

(500)

n/a

500

(500)

n/a

C. (500)

(500)

n/a

500

(500)

500 OA

(500)

n/a

D. (500)

A) Option A B) Option B C) Option C D) Option D

37)

Which of the following is considered a product cost? A) Utility expense for the current month. B) Salaries paid to the employees of a merchandiser. C) Transportation cost on goods received from suppliers. D) Transportation cost on goods shipped to customers.

38)

Which of the following is considered a period cost? A) Transportation cost on goods received from suppliers. B) Advertising expense for the current month. C) Cost of merchandise purchased. D) None of these answer choices are considered a period cost.

39)

When are product costs matched directly with sales revenue?

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A) In the period immediately following the purchase. B) In the period immediately following the sale. C) When the merchandise is purchased. D) When the merchandise is sold.

40)

When a merchandising company pays cash to purchase inventory A) the amount of total assets increases. B) the amount of total assets remains the same. C) the amount of expenses increases. D) the amount of total asset decreases.

41)

What type of account is the Cost of Goods Sold account? A) Liability B) Asset C) Contra asset D) Expense

42)

When a merchandising company sells inventory, it will A) recognize only an expense. B) recognize only revenue. C) recognize revenue and expense. D) not recognize revenue or expense.

43)

Gross margin is reported on a A) single step income statement. B) multistep income statement. C) single step balance sheet. D) multistep balance sheet.

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44)

Which of the following statements about period costs is true? A) Most period costs are expensed in the period the costs are incurred. B) Period costs are expensed when the products associated with these costs are sold. C) Period costs are usually recorded as assets. D) Period costs do not adhere to the matching concept.

45) Llewelyn Company paid the balance due on an account payable. Llewelyn uses the perpetual inventory system. Which of the following reflects the effect of the payment on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. − − n/a n/a n/a n/a −OA B.

−

n/a

−OA

+/−

n/a

−IA

+/−

n/a

−IA

A) Option A B) Option B C) Option C D) Option D

46) A company using the perpetual inventory system paid $250 cash to have goods delivered from one of its suppliers. How would the payment of $250 for transportation-in be classified? A) An asset source transaction B) An asset use transaction C) An asset exchange transaction D) A claims exchange transaction

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47)

Edgar Corporation purchased merchandise inventory for $4,000 cash. This transaction is A) an asset source transaction. B) an asset exchange transaction. C) an asset use transaction. D) a claims exchange transaction.

48) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $12,600 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $2,100 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $19,200 cash. What effect will the return of merchandise to the supplier in event (2) have on Darlington’s financial statements? A) Assets and stockholders’ equity decrease by $2,100. B) Assets and liabilities decrease by $2,058. C) Assets and liabilities decrease by $2,100. D) None. It is an asset exchange transaction.

49) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $12,500 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $1,200 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $18,800 cash. What effect will the return of merchandise to the supplier in event (2) have on Darlington’s financial statements? A) Assets and stockholders’ equity decrease by $1,176. B) Assets and liabilities decrease by $1,176. C) Assets and liabilities decrease by $1,200. D) None. It is an asset exchange transaction.

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50) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $13,300 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $2,800 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $20,600 cash. What is the gross margin that results from these four transactions? A) $10,310 B) $10,366 C) $7,300 D) $7,154

51) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $12,500 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $1,200 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $18,800 cash. What is the gross margin that results from these four transactions? A) $5,100 B) $7,726 C) $6,550 D) $11,074

52) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $12,200 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $1,700 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $18,400 cash. What is the net cash flow from operating activities as a result of the four transactions?

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A) $8,110 B) $8,144 C) $6,076 D) $6,200

53) Darlington Company entered into the following business events during its first month of operations. The company uses the perpetual inventory system. 1.1) The company purchased $12,500 of merchandise on account under terms 2/10, n/30. 2.2) The company returned $1,200 of merchandise to the supplier before payment was made. 3.3) The liability was paid within the discount period. 4.4) All of the merchandise purchased was sold for $18,800 cash. What is the net cash flow from operating activities as a result of the four transactions? A) $5,100 B) $7,726 C) $6,550 D) $11,074

54) Galaxy Company sold merchandise costing $3,700 for $6,400 cash. The merchandise was later returned by the customer for a refund. The company uses the perpetual inventory system. What effect will the sales return have on the financial statements? (Consider the effects of both parts of this event.) A) Total assets decrease by $6,400 and total stockholders’ equity decreases by $3,700. B) Total assets and total stockholders’ equity decrease by $2,700. C) Total assets and total stockholders’ equity decrease by $6,400. D) Total assets and total stockholders’ equity increase by $2,700.

55) Galaxy Company sold merchandise costing $1,700 for $2,600 cash. The merchandise was later returned by the customer for a refund. The company uses the perpetual inventory system. What effect will the sales return have on the financial statements?(Consider the effects of both parts of this event.)

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A) Total assets and total stockholders’ equity decrease by $900. B) Total assets decrease by $2,600 and total stockholders’ equity decreases by $1,700. C) Total assets and total stockholders’ equity decrease by $2,600. D) Total assets and total stockholders’ equity increase by $900.

56) A company purchased inventory on account. If the perpetual inventory system is used, which of the following choices accurately reflects how the purchase affects the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + n/a n/a + − n/a B.

+/−

n/a

−OA

n/a

−OA

A) Option A B) Option B C) Option C D) Option D

57) Kenyon Company experienced a transaction that had the following effect on the financial statements: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − − n/a n/a n/a n/a n/a

Which of the following business events would result in this effect on the financial statements?

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A) Paid for merchandise that had been purchased on account. B) A loss on land that was sold for cash. C) Return by a customer of a sale that was made on account. D) Return to a supplier of merchandise purchased on account.

58) James Company experienced the following events during its first accounting period: 1.(1) Purchased $10,000 of inventory on account. 2.(2) Returned $100 of inventory purchased in Event 1. 3.(3) Sold the inventory for $12,000 cash. Based on this information, which of the following shows how the recognition of the return will affect the Company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. n/a n/a n/a n/a n/a n/a 100 OA B. (100)

(100)

n/a

C. (100)

(100)

n/a

100

(100)

n/a

D. (100)

(100)

n/a

(100) OA

A) Option A B) Option B C) Option C D) Option D

59)

James Company experienced the following events during its accounting period:

1.(1) Purchased $10,000 of inventory on account. 2.(2) Returned $2,000 of inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. Immediately after the three events have been recognized, the balance in the Inventory account is

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A) $2,000 B) $8,000 C) $10,000 D) Zero

60) James Company experienced the following events during its first accounting period: 1.(1) Purchased $10,000 of inventory for cash. 2.(2) Returned $200 of the inventory purchased in Event 1. Inventory was returned for cash. Based on this information, which of the following shows how the recognition of the return will affect the Company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (200) (200) n/a n/a n/a n/a n/a B. (200)

(200)

n/a

200

(200)

n/a

C. (200)

(200)

n/a

(200) OA

D. (200)

200

n/a

200 OA

A) Option A B) Option B C) Option C D) Option D

61)

James Company experienced the following events during its accounting period:

1.(1) Purchased $10,000 of inventory on account. 2.(2) Returned $2,000 of inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. 4.(4) Sold inventory purchased in Event 1 for $10,000 to customers on account. At the end of the first accounting period what would be reported on the Income Statement for net income?

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A) $2,000 B) $8,000 C) $10,000 D) Zero

62) James Company experienced the following events during its accounting period: 1.(1) Purchased $10,000 of inventory on account. 2.(2) Returned $2,000 of the inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. 4.(4) Sold inventory purchased in Event 1 for $10,000 to customers on account. At the end of the first accounting period what would be reported for Net Operating Cash Flow on the Statement of Cash Flows? A) $2,000 B) ($8,000) C) ($10,000) D) Zero

63) James Company experienced the following events during its first accounting period: 1.(1) Purchased $10,000 of inventory on account under terms 1/10 n/30. 2.(2) Returned $2,000 of the inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. Based on this information, which of the following shows how the recognition of the cash discount (Event 1) will affect the Company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (100) (100) n/a n/a n/a n/a n/a B. (80)

(80)

n/a

C. (100)

(100)

n/a

(100) OA

D. (40)

(40)

n/a

(40)

n/a

Version 1

A) Option A B) Option B C) Option C D) Option D

64)

James Company experienced the following events during its first accounting period:

1.(1) Purchased $10,000 of inventory on account under terms 1/10 n/30. 2.(2) Returned $2,000 of the inventory purchased in Event 1 3.(3) Paid the remaining balance in account payable within the discount period for the inventory purchased in Event 1 Immediately after the three events have been recognized, the balance in the inventory account is A) $7,920 B) $8,000 C) $10,000 D) Zero

65) James Company experienced the following events during its first accounting period: 1.(1) Purchased $10,000 of inventory on account under terms 1/10 n/30. 2.(2) Returned $2,000 of the inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. Based on this information, which of the following shows how paying off the account payable (Event 3) will affect the Company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (8,000) (8,000) n/a n/a n/a n/a (8,000) OA B. (7,900) (7,900) n/a n/a 7,900 (7,900) (7,900) OA C. (8,000) (8,000) n/a n/a 8,000 (8,000) (8,000) OA D. (7,920) (7,920) n/a n/a n/a n/a (7,920) OA

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A) Option A B) Option B C) Option C D) Option D

66) James Company experienced the following events during its first accounting period. 1.(1) Purchased $10,000 of inventory on account under terms 1/10 n/30. 2.(2) Returned $2,000 of the inventory purchased in Event 1. 3.(3) Paid the remaining balance in account payable for the inventory purchased in Event 1. If the Company pays the account payable after the discount period has expired, how much cash will be required to settle the liability? A) $7,920 B) $8,000 C) $10,000 D) Zero

67) Taylor Company purchased $9,000 of inventory under terms FOB shipping point. Freight cost amounted to $300. The cost of inventory and freight were paid with cash. Which of the following shows how the recognition of this purchase, including freight costs if applicable, will affect Taylor’s financial statements? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cash + Invento = Accounts + Commo + Retain Revenu − Expen = Net ry Payable n ed e se Incom Stock Earnin e gs A (9,00 9,000 n/a n/a n/a n/a n/a n/a n/a . 0) B (9,30 9,300 n/a n/a (9,300 n/a 9,300 (9,30 n/a . 0) ) 0) C (9,30 9,300 n/a n/a n/a n/a n/a n/a (9,300) . 0) OA D (9,30 9,300 n/a n/a (300) n/a 300 (300) (9,300) . 0) OA

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A) Option A B) Option B C) Option C D) Option D

68) Taha Company purchased $9,000 of inventory under terms FOB destination. Freight cost amounted to $300. The cost of inventory and freight were paid with cash. Which of the following shows how the recognition of this purchase, including freight costs if applicable, will affect Taha’s financial statements? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cash + Invento = Accounts + Commo + Retain Revenu − Expen = Net ry Payable n ed e se Incom Stock Earnin e gs A (9,30 9,300 n/a n/a (9,300 n/a 9,300 (9,30 n/a . 0) ) 0) B (9,30 9,300 n/a n/a n/a n/a n/a n/a (9,300) . 0) OA C (9,00 9,000 n/a n/a (300) n/a 300 (300) (9,300) . 0) OA D (9,00 9,000 n/a n/a n/a n/a n/a n/a (9,300) . 0) OA

A) Option A B) Option B C) Option C D) Option D

69) At the end of its Year 1 accounting period, Voss Company had a $35,000 balance in its inventory account. Even so, when the company took a physical count of the inventory, it found only $34,300 of inventory on hand. Which of the following shows how recognizing the inventory shrinkage will affect the Company’s financial statements?

Assets

Version 1

Balance Sheet = Liabiliti + Stockholders’

Income Statement

Statemen t of

es Equity Cash Flows Cas + Inventor = Accounts + Commo + Retaine Revenu − Expens = Net h y Payable n d e e Incom Stock Earning e s A n/a (700) n/a n/a (700) n/a 700 (700) (700) OA . B n/a (700) n/a n/a (700) n/a n/a n/a n/a . C n/a 700 n/a n/a 700 700 n/a 700 n/a . D n/a (700) n/a n/a (700) n/a 700 (700) n/a .

A) Option A B) Option B C) Option C D) Option D

70) On April 1, Snell Company sold on account merchandise with a list price of $50,000. Payment terms were 3/10/n30. The receivable was collected from the customer on April 8. Considering only the collection of cash from the receivable, what effect will the transaction have on the company’s statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (1,500) n/a (1,500) (1,500) n/a (1,500) 48,500 OA B. (1,500)

n/a

(1,500)

n/a

(1,500)

n/a

C. (1,500)

n/a

(1,500)

n/a

1,500

(1,500) 1,500 OA

D. 48,500

n/a

48,500

n/a

48,500 48,500 OA

A) Option A B) Option B C) Option C D) Option D

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71) Anchor Company sold merchandise with a cost of $560 to a customer for $890 on account. Due to an error, neither part of the related two-part transaction was recorded in the accounting records. What effect will the failure to make the necessary entries have on the company's financial statements? A) Total assets and total stockholders’ equity will be overstated. B) Total assets will be overstated and total stockholders’ equity will be understated. C) Total assets and total stockholders’ equity will be understated. D) The financial statements will not be affected.

72) A company using the perpetual inventory system paid cash for freight costs to purchase merchandise. Which of the following reflects the effects of this event on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. − n/a − n/a n/a n/a −OA B.

+/−

n/a

−OA

+/−

n/a

+/−

n/a

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

73) A company using the perpetual inventory system paid cash for a transportation-in cost. Which of the following choices reflects the effects of this event on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

Version 1

−

n/a

−

n/a

−OA

+/−

n/a

+/−

n/a

−

n/a

−

−OA

+/−

n/a

−OA

A) Option A B) Option B C) Option C D) Option D

74) A company’s chart of accounts includes, in part, the following account numbers and corresponding account titles: Account Number (1) (2) (3) (4) (5) (6) (7) (8) (9)

Account Title Cash Merchandise inventory Cost of goods sold Transportation-out Dividends Common stock Selling expense Loss on the sale of land Sales

Which accounts would appear on the income statement? A) Account numbers 3, 4, 7, 8, and 9 B) Account numbers 3, 4, 5, 7, and 9 C) Account numbers 2, 3, 7, 8, and 9 D) Account numbers 3, 5, 7, and 8

75) A company’s chart of accounts includes, in part, the following account numbers and corresponding account titles:

Version 1

Account Number (1) (2) (3) (4) (5) (6) (7) (8) (9)

Account Title Cash Merchandise inventory Cost of goods sold Transportation-out Dividends Common stock Selling expense Loss on the sale of land Sales

Which accounts would appear on the balance sheet? A) Account numbers 1, 2, 4, and 5 B) Account numbers 1, 3, 7, and 8 C) Account numbers 1, 2, and 6 D) Account numbers 3, 4, 8, and 9

76) A company’s chart of accounts includes, in part, the following account numbers and corresponding account titles: Account Number (1) (2) (3) (4) (5) (6) (7) (8) (9)

Account Title Cash Merchandise inventory Cost of goods sold Transportation-out Dividends Common stock Selling expense Loss on the sale of land Sales

Which accounts would affect gross margin? A) Account numbers 2 and 9 B) Account numbers 3 and 9 C) Account numbers 3, 4, 7, and 9 D) Account numbers 3, 7, 8, and 9

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77) A company’s chart of accounts includes, in part, the following account numbers and corresponding account titles: Account Number (1) (2) (3) (4) (5) (6) (7) (8) (9)

Account Title Cash Merchandise inventory Cost of goods sold Transportation-out Dividends Common stock Selling expense Loss on the sale of land Sales

Which accounts would affect operating income? A) Account numbers 2, 4, and 9 B) Account numbers 3, 5, 7, and 9 C) Account numbers 3, 4, 7, and 9 D) Account numbers 3, 4, 7, 8, and 9

78) When using a perpetual inventory system, which of the following events is an asset use transaction? A) Paid cash to purchase inventory B) Paid cash for transportation-out costs C) Purchased inventory on account D) Paid cash for transportation-in costs

79) What is the effect of recording the purchase of inventory on account under the perpetual inventory system?

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A) Total assets increase B) Total liabilities increase C) Total assets are unaffected D) Total assets and total liabilities increase

80) Middleton Company uses the perpetual inventory system. The company purchased an item of inventory for $155 and sold the item to a customer for $280. How will the sale affect the company's Inventory account? A) The inventory account will decrease by $280. B) The inventory account will decrease by $155. C) The inventory account will decrease by $125. D) There is no effect on the inventory account.

81) Middleton Company uses the perpetual inventory system. The company purchased an item of inventory for $130 and sold the item to a customer for $200. How will the sale affect the company's Inventory account? A) The inventory account will decrease by $200. B) The inventory account will decrease by $130. C) The inventory account will decrease by $70. D) There is no effect on the inventory account.

82) Faust Company uses the perpetual inventory system. Faust sold goods that cost $5,400 for $8,800. The sale was made on account. What is the net effect of the sale on the company’s financial statements?(Consider the effects of both parts of this event.) A) Increase total assets by $5,400 B) Increase total stockholders’ equity by $8,800 C) Increase total assets by $3,400 D) Increase total assets by $8,800

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83) Faust Company uses the perpetual inventory system. Faust sold goods that cost $2,300 for $3,600. The sale was made on account. What is the net effect of the sale on the company’s financial statements? (Consider the effects of both parts of this event.) A) Increase total assets by $2,300. B) Increase total stockholders’ equity by $3,600. C) Increase total assets by $1,300. D) Increase total assets by $3,600.

84) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $11,300 of common stock for cash. 2.2) The company paid cash to purchase $7,000 of inventory. 3.3) The company sold inventory that cost $4,400 for $8,650 cash. 4.4) Operating expenses incurred and paid during the year, $3,900. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $9,600 of inventory. 2.2) The company sold inventory that cost $8,600 for $15,250 cash. 3.3) Operating expenses incurred and paid during the year, $4,900. Note: Sanchez uses the perpetual inventory system. What is Sanchez's gross margin for Year 2? A) $8,600 B) $1,750 C) $5,650 D) $6,650

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85) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $42,000 of common stock for cash. 2.2) The company paid cash to purchase $26,400 of inventory. 3.3) The company sold inventory that cost $16,000 for $30,600 cash. 4.4) Operating expenses incurred and paid during the year, $14,000. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $35,200 of inventory. 2.2) The company sold inventory that cost $32,800 for $57,000 cash. 3.3) Operating expenses incurred and paid during the year, $18,000. Note: Sanchez uses the perpetual inventory system. What is Sanchez's gross margin for Year 2? A) $6,200 B) $24,200 C) $21,800 D) $32,800

86) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $13,900 of common stock for cash. 2.2) The company paid cash to purchase $8,300 of inventory. 3.3) The company sold inventory that cost $5,700 for $11,900 cash. 4.4) Operating expenses incurred and paid during the year, $5,200. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $12,200 of inventory. 2.2) The company sold inventory that cost $9,900 for $18,500 cash. 3.3) Operating expenses incurred and paid during the year, $6,200. Note: Sanchez uses the perpetual inventory system. What is the amount of inventory that will be shown on the balance sheet at December 31, Year 2? A) $4,900 B) $2,300 C) $22,400 D) $10,600

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87) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $42,000 of common stock for cash. 2.2) The company paid cash to purchase $26,400 of inventory. 3.3) The company sold inventory that cost $16,000 for $30,600 cash. 4.4) Operating expenses incurred and paid during the year, $14,000. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $35,200 of inventory. 2.2) The company sold inventory that cost $32,800 for $57,000 cash. 3.3) Operating expenses incurred and paid during the year, $18,000. Note: Sanchez uses the perpetual inventory system. What is the amount of inventory that will be shown on the balance sheet at December 31, Year 2? A) $2,400 B) $12,800 C) $61,600 D) $28,800

88) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $11,900 of common stock for cash. 2.2) The company paid cash to purchase $7,300 of inventory. 3.3) The company sold inventory that cost $4,700 for $9,400 cash. 4.4) Operating expenses incurred and paid during the year, $4,200. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $10,200 of inventory. 2.2) The company sold inventory that cost $8,900 for $16,000 cash. 3.3) Operating expenses incurred and paid during the year, $5,200. Note: Sanchez uses the perpetual inventory system. What is the amount of retained earnings that will be shown on the balance sheet at December 31, Year 2? A) $1,900 B) $2,400 C) $7,200 D) $11,300

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89) Sanchez Company engaged in the following transactions during Year 1: 1.1) Started the business by issuing $42,000 of common stock for cash. 2.2) The company paid cash to purchase $26,400 of inventory. 3.3) The company sold inventory that cost $16,000 for $30,600 cash. 4.4) Operating expenses incurred and paid during the year, $14,000. Sanchez Company engaged in the following transactions during Year 2: 1.1) The company paid cash to purchase $35,200 of inventory. 2.2) The company sold inventory that cost $32,800 for $57,000 cash. 3.3) Operating expenses incurred and paid during the year, $18,000. Note: Sanchez uses the perpetual inventory system. What is the amount of retained earnings that will be shown on the balance sheet at December 31, Year 2? A) $6,200 B) $26,000 C) $6,800 D) $38,800

90) Foote Company was granted a purchase discount of $200 on merchandise the company had purchased a few days ago. Foote uses the perpetual inventory system. Which of the following reflects the effects of this event on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. n/a (200) 200 200 n/a 200 200 OA B.

n/a

(200)

200

n/a

200

n/a

C. (200)

(200)

n/a

(200) OA

D. (200)

(200)

n/a

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A) Option A B) Option B C) Option C D) Option D

91) Howell Company granted a sales allowance of $360 to a customer who was not totally satisfied with the quality of goods received. The customer did not return the goods and had not yet paid for them. Which of the following reflects the effects of this event on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (360) n/a (360) (360) n/a (360) (360) OA B.

n/a

(360)

360

n/a

360

n/a

C. (360)

n/a

(360)

n/a

(360)

n/a

(360)

360

n/a

360

n/a

A) Option A B) Option B C) Option C D) Option D

92) Ramirez Company returns merchandise previously purchased on account. It had not yet been paid for. Ramirez uses the perpetual inventory system. Which of the following reflects the effects on the financial statements of only the purchase return? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + n/a − − n/a − +OA B.

−

Version 1

−

n/a

−

n/a

+/−

n/a

+OA

−

n/a

A) Option A B) Option B C) Option C D) Option D

93)

What happens when merchandise is delivered FOB shipping point?

A) The buyer pays the freight cost. B) The seller pays the freight cost. C) The buyer records transportation cost as an expense. D) The seller records transportation-out expense.

94)

What happens when merchandise is delivered FOB Destination?

A) The seller pays the freight cost. B) The seller records transportation-in expense. C) The buyer pays the freight cost. D) The seller pays the freight cost and records an expense.

95)

What is (are) the term(s) used to describe a discount given to encourage prompt payment? A) Cash discount. B) Sales discount by the seller. C) Purchase discount by the buyer. D) All of these answer choices are correct.

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96) Leonard Company paid freight costs to have goods shipped to one of its customers. What effect willthe payment of these freight costs have on the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. +/− n/a n/a n/a n/a n/a −OA B.

−

n/a

−OA

−

n/a

−

n/a

−

−OA

−

n/a

−

n/a

−IA

A) Option A B) Option B C) Option C D) Option D

97) Ballard Company uses the perpetual inventory system. The company purchased $9,100 of merchandise from Andes Company under the terms 4/10, net/30. Ballard paid for the merchandise within 10 days and also paid $360 freight to obtain the goods under terms FOB shipping point. All of the merchandise purchased was sold for $17,200 cash. What is the amount of gross margin that resulted from these business events?

A) $8,100 B) $8,104 C) $7,740 D) $9,100

98) Ballard Company uses the perpetual inventory system. The company purchased $16,000 of merchandise from Andes Company under the terms 2/10, net/30. Ballard paid for the merchandise within 10 days and also paid $500 freight to obtain the goods under terms FOB shipping point. All of the merchandise purchased was sold for $30,000 cash. What is the amount of gross margin that resulted from these business events?

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A) $14,000 B) $13,820 C) $16,000 D) $13,500

99)

What do the credit terms, 2/15, n/30 mean?

A) A fifteen percent discount can be deducted if the invoice is paid within two days following the date of sale. B) A two percent discount can be deducted for a period up to thirty days following the date of sale. C) A two percent discount can be deducted if the invoice is paid before the fifteenth day following the date of the sale. D) A two percent discount can be deducted if the invoice is paid after the fifteenth day following the sale, but before the thirtieth day.

100) Flagler Company purchased $4,000 of merchandise on account. Flagler sold the merchandise to a customer for $7,000 cash. What is the increase in gross margin and the net change in cash flow from operating activities as a result of these transactions? (Consider the effects of both parts of this event.) Gross Margin

Cash Flow From Operating Activities

$7,000

$4,000 inflow

$3,000

$7,000 inflow

$3,000

$7,000 outflow

$4,000

$7,000 inflow

A) Option A B) Option B C) Option C D) Option D

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101) Vargas Company sold a piece of land for $39,000 that had originally cost $32,500. How does this business event affect the company’s financial statements? A) An increase in cash flows from investing activities by $39,000. B) No effect on operating income. C) An increase in net income by $6,500. D) All of these answer choices are correct.

102) Ashton Company uses the perpetual inventory system. The company's inventory account had a $6,600 balance as of December 31, Year 1. A physical count of inventory shows only $5,900 of merchandise in stock at December 31, Year 1. How will recognizing the missing inventory affect the company’s financial statements? A) Increase assets. B) Increase expense. C) Decrease cash flow from operating activities. D) All of these answer choices are correct.

103) Assume the perpetual inventory system is used. 1.1) Green Company purchased merchandise inventory that cost $17,300 under terms of 2/10, n/30 and FOB shipping point. 2.2) Green Company paid freight cost of $730 to have the merchandise delivered. 3.3) Payment was made to the supplier on the inventory within 10 days. 4.4) All of the merchandise was sold to customers for $26,100 cash and delivered under terms FOB destination with freight cost amounting to $530. What is the amount of gross margin that results from these transactions?

A) $8,416 B) $9,146 C) $8,616 D) $7,886

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104) Assume the perpetual inventory system is used. 1.1) Green Company purchased merchandise inventory that cost $64,000 under terms of 2/10, n/30 and FOB shipping point. 2.2) Green Company paid freight cost of $2,400 to have the merchandise delivered. 3.3) Payment was made to the supplier on the inventory within 10 days. 4.4) All of the merchandise was sold to customers for $94,000 cash and delivered under terms FOB destination with freight cost amounting to $1,600. What is the amount of gross margin that results from these transactions?

A) $31,280 B) $27,280 C) $28,880 D) $29,680

105) Assume the perpetual inventory system is used. 1.1) Green Company purchased merchandise inventory that cost $16,900 under terms of 3/10, n/30 and FOB shipping point. 2.2) Green Company paid freight cost of $690 to have the merchandise delivered. 3.3) Payment was made to the supplier on the inventory within 10 days. 4.4) All of the merchandise was sold to customers for $25,300 cash and delivered under terms FOB destination with freight cost amounting to $490. What is the net cash flow from operating activities that results from these transactions?

A) $17,573 outflow B) $25,300 inflow C) $8,907 inflow D) $7,727 inflow

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106) Assume the perpetual inventory system is used. 1.1) Green Company purchased merchandise inventory that cost $64,000 under terms of 2/10, n/30 and FOB shipping point. 2.2) Green Company paid freight cost of $2,400 to have the merchandise delivered. 3.3) Payment was made to the supplier on the inventory within 10 days. 4.4) All of the merchandise was sold to customers for $94,000 cash and delivered under terms FOB destination with freight cost amounting to $1,600. What is the net cash flow from operating activities that results from these transactions?

A) $94,000 inflow B) $27,280 inflow C) $66,720 outflow D) $31,280 inflow

107) Garrett Company uses the perpetual inventory system. The company’s records showed a book balance of $18,000 in the Merchandise Inventory account, and a physical count finds only $16,250 of inventory. Which of the following represents the financial statement effect of writingdown the inventory? Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders Revenue − Expens = Net Cash s ’ Equity e Income Flows A (1,750) n/a (1,750) n/a 1,750 (1,750) n/a . B n/a 1,750 (1,750) n/a 1,750 (1,750) n/a . C 16,250 n/a 16,250 16,250 n/a 16,250 16,250 . IA D (18,000 n/a (18,000) (18,000 n/a (18,000 n/a . ) ) )

A) Option A B) Option B C) Option C D) Option D

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108)

Which of the following describes the purpose of a common size financial statement?

A) Compare the amount of common stock to other types of stock. B) Make comparisons between firms of different sizes. C) Make comparisons between different time periods. D) Make comparisons between firms of different sizes and between different time periods.

109) Which of the following retailers would be expected to have the highest gross margin percentage? A) Kmart B) Neiman Marcus C) Walmart D) A supermarket chain such as Safeway

110)

How is the net income percentage calculated? A) Net Sales divided by net Income. B) Net Income divided by net Sales. C) Total stockholders’ equity divided by net sales. D) Net Income divided by Gross Margin.

111)

The following are the income statements for Ace and Diamond Companies. Ace

Diamond

Revenue

$70,000

$76,000

Cost of goods sold

49,000

45,600

Gross margin

21,000

30,400

Operating expenses

9,500

12,500

$11,500

$17,900

Net income

What are the net income percentages for Ace and Diamond, respectively?

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A) 6.09% and 4.25% B) 1.83% and 1.70% C) 16.4% and 23.6% D) 30% and 40%

112) The following are the income statements of the Hancock Company for two consecutive years. Increases in which of the expenses contributed to the net loss in Year 2? Year 2

Year 1

Revenue Cost of goods sold Gross margin Operating expenses:

$30,000 17,800 12,200

$20,000 12,000 8,000

Selling expenses Administrative expenses Total operating expenses

4,800 7,800 12,600

4,600 3,000 7,600

Net income

$(400)

$400

A) Cost of goods sold and selling expenses B) Selling expenses and administrative expenses C) Cost of goods sold and administrative expenses D) Administrative expenses

113) Company A

Company B

Company C

Company D

Sales Cost of goods sold Gross margin Operating expenses

$80,000 48,000 32,000 9,600

$180,000 135,000 45,000 12,600

$120,000 72,000 48,000 10,800

$100,000 60,000 40,000 10,000

Net income

$22,400

$32,400

$37,200

$30,000

Based on common-sized income statements, which of the companies spent the least on operating expenses in relationship to its sales? Version 1

A) Company A B) Company B C) Company C D) Company D

114) Company A

Company B

Company C

Company D

Sales Cost of goods sold Gross margin Operating expenses

$80,000 48,000 32,000 9,600

$180,000 135,000 45,000 12,600

$120,000 72,000 48,000 10,800

$100,000 60,000 40,000 10,000

Net income

$22,400

$32,400

$37,200

$30,000

Three of the companies are upscale stores and one is a discount store. Which company is most likely to be the discount store? A) Company A B) Company B C) Company C D) Company D

115)

The following data is from the income statement of Ralston Company:

Revenue Cost of goods sold Operating expenses Net income

$3,200 (1,800) (900) $ 500

What is the company's gross margin percentage? (Round your answers to three decimal places.):

Version 1

A) 15.625% B) 43.750% C) 56.250% D) 35.710%

116)

The following data is from the income statement of Ralston Company:

Revenue Cost of goods sold Operating expenses Net income

$36,000 (14,400) (16,000) $5,600

What is the company's gross margin percentage? A) 66.67% B) 25.93% C) 60.00% D) 15.60%

117) During the current year, Gomez Company had beginning inventory of $1,500 and ending inventory of $1,100. The cost of goods sold was $3,900. What is the amount of inventory purchased during the year? A) $5,000 B) $3,900 C) $6,500 D) $3,500

118) During the current year, Gomez Company had beginning inventory of $2,400 and ending inventory of $1,200. The cost of goods sold was $9,600. What is the amount of inventory purchased during the year?

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A) $8,400 B) $9,600 C) $10,800 D) $13,200

119) SX Company sold merchandise on account for $16,000. The merchandise had cost the company $6,000. What is the effect of the sale on the income statement? A) Revenue increases by $10,000. B) Expenses increase by $6,000. C) Net income increases by $16,000. D) All of these answer choices are correct.

120) Exeter Company sold merchandise for $10,000 cash. The merchandise had cost the company $4,500. What is the effect of the sale on the balance sheet? A) Cash increases by $10,000. B) Inventory decreases by $4,500. C) Retained earnings increases by $5,500. D) All of these answer choices are correct.

121) Butte Company recognized $24,000 of revenue on the cash sale of merchandise that cost $11,000. How will the sale be reported on the statement of cash flows? A) Cash inflow from investing activities. B) Cash inflow from operating activities. C) Cash inflow from financing activities. D) Cash inflow from principal activities.

122) When a company recognizes cost of goods sold, how does that event impact the elements of the financial statements? (Ignore the effects of recognizing sales revenue.)

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A) Assets increase. B) Liabilities increase. C) Stockholders' equity decreases. D) Dividends decrease.

123) Olly Company is a merchandising business that sells dog food. Based on the following information, what is the gross margin for Olly Company? Sales Revenue Cash Accounts Receivable Inventory Cost of goods sold Operating expenses

$500,000 100,000 50,000 25,000 300,000 40,000

A) $135,000 B) $160,000 C) $200,000 D) $285,000

124) JCS Incorporated experienced the following transactions during its first year of business. The company purchased $16,000 of merchandise from Kent Company. The company paid $2,000 for selling and administrative expenses and purchased land for $5,000. All of the merchandise purchased was sold for $30,000 cash. What is the company’s gross margin? A) $7,000 B) $14,000 C) $23,000 D) $30,000

125)

Which of the following statements regarding a multistep income statement is true?

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A) When a company sells inventory for more than its cost, the difference between the sales revenue and the cost of goods sold is called the operating income. B) A single-step income statement shows sales, gross margin, and net income. C) Gross margin is calculated as sales revenue minus cost of goods sold. D) Gross margin equals net income.

126)

The financial statements of Tin Company included the following:

Sales Gross margin Ending Inventory

$1,000,000 300,000 100,000

Based on the information provided, what was the company’s cost of goods sold? A) $200,000 B) $600,000 C) $700,000 D) $900,000

127)

Sam Company reported the following amounts on its income statement:

Net income Cost of goods sold Gross margin

$100,000 400,000 200,000

Based on the information provided, what was the amount of sales reported on the income statement? A) $700,000 B) $600,000 C) $300,000 D) $200,000

128) Jake Company purchased on account merchandise with a list price of $90,000. Payment terms were 1/15, n/45. If payment occurs within 18 days, what discount will Jake Company recognize on the merchandise?

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A) $13,500 B) $900 C) $500 D) $0

129) JJ Company purchased on account merchandise with a list price of $10,000. Payment terms were 1/15, n/45. If payment occurs before the discount expires, what is the effect of the purchase discount on the balance sheet?

A) Decreases accounts receivable B) Decreases inventory C) Increases accounts payable D) Increases cash

130) Glen Company uses the perpetual inventory system. The company entered into the following events: 1.1) Purchased merchandise inventory that cost $10,000 under terms of 2/10, n/30. 2.2) Made payment to the supplier within the discount period. 3.3) Sold all of the goods to customers on account for $22,000. What is Glen’s cost of goods sold as a result of these three transactions? A) $9,000 B) $9,800 C) $10,000 D) $21,800

131) Aaron Company uses the periodic inventory system. If Aaron's ending inventory is understated due to an accounting error, what is the effect on net income and the ending balance of retained earnings? Net Income A.

Understated

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Retained Earnings Understated 44

Understated

Overstated

Understated

Overstated

A) Option A B) Option B C) Option C D) Option D

132) Sullivan Company uses the periodic inventory system. The following balances were drawn from the accounts of Sullivan Company prior to the closing process: Sales revenue Beginning inventory balance Purchases Transportation-in Transportation-out Purchase discounts Ending inventory balance

$12,500 3,300 8,100 450 650 250 3,700

What is the gross margin that will be shown on the income statement? A) $3,700 B) $4,600 C) $7,900 D) $9,900

133) Sullivan Company uses the periodic inventory system. The following balances were drawn from the accounts of Sullivan Company prior to the closing process: Sales revenue Beginning inventory balance Purchases Transportation-in Transportation-out Purchase discounts Ending inventory balance

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$24,000 6,400 16,000 800 1,200 400 7,200

What is the gross margin that will be shown on the income statement? A) $8,400 B) $7,200 C) $15,600 D) $18,400

134) The following information for Year 2 is taken from the accounts of Tuttle Company. The company uses the periodic inventory system. Inventory, December 31, Year 1 Purchases Purchase returns and allowances Purchase discounts Freight on goods purchased under terms FOB shipping point Freight on goods sold under terms FOB destination Cost of goods sold

$9,700 41,700 770 570 1,770 970 30,100

Based on this information, what is the inventory at December 31, Year 2? A) $12,370 B) $19,060 C) $21,730 D) $29,130

135) The following information for Year 2 is taken from the accounts of Tuttle Company. The company uses the periodic inventory system. Inventory, December 31, Year 1 Purchases Purchase returns and allowances Purchase discounts Freight on goods purchased under terms FOB shipping point Freight on goods sold under terms FOB destination Cost of goods sold

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$16,000 80,000 1,200 800 3,200 1,600 56,800

Based on this information, what is the inventory at December 31, Year 2? A) $55,200 B) $24,400 C) $38,800 D) $40,400

136)

What is the chief advantage of the periodic system? A) Efficiency and ease of recording. B) Immediate feedback on the inventory on hand at any time during the period. C) Timely discovery of losses due to theft. D) Better control over inventory.

137)

Which of the following account titles is normally used in a periodic inventory system? A) Transportation-in. B) Purchases. C) Purchase Returns and Allowances. D) All of these answer choices are normally used.

138) Which factor has removed most of the practical limitations associated with use of the perpetual inventory system? A) A more honest work force. B) Recent changes in GAAP. C) Recent changes in federal and state laws. D) Advancements in technology.

139) Under a periodic system, the account that is increased for freight costs on goods received from the vendor is called:

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A) Merchandise Inventory B) Cost of Goods Sold C) Transportation-out D) Transportation-in

140) Assume a company uses the periodic inventory system. Which of the following accounts would not be affected when recording purchases and related transactions? A) Merchandise Inventory B) Purchase Returns and Allowances C) Purchase Discounts D) Purchases

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Answer Key Test name: Chap 04_2e_Test Bank_MCQs_TF 1) TRUE Wholesale companies primarily sell goods to other businesses, while retail companies primarily sell goods to the public. 2) FALSE Retailers and wholesalers, but not manufacturers, are merchandising companies. 3) FALSE Selling costs are period costs. 4) FALSE Beginning inventory + Inventory purchased during the period = Cost of goods available for sale. Cost of goods available for sale is allocated between the asset account Merchandise Inventory and an expense account called Cost of Goods Sold. The cost of inventory items that have not been sold (Merchandise Inventory) is reported as an asset on the balance sheet, and the cost of the items sold (Cost of Goods Sold) is expensed on the income statement. 5) TRUE Product costs are charged to the merchandise inventory account and expensed when goods are sold. 6) FALSE Selling and administrative costs are recognized as expenses in the period in which they are incurred. In contrast, product costs are expensed when inventory is sold. 7) FALSE Version 1

Gross margin is equal to net sales minus cost of goods sold. 8) TRUE In a perpetual system, inventory is updated for purchases, sales, and returns of inventory. 9) FALSE In a perpetual system, the cost of merchandise inventory is recognized as cost of goods sold when inventory is sold, not when it is purchased. 10) TRUE When a perpetual inventory system is used, recording the sale increases assets (Cash or Accounts Receivable) and stockholders' equity (Retained Earnings) by the selling price of the inventory. Sales revenue and net income increase by the same amount. Recording the cost of the merchandise sold decreases assets (Merchandise Inventory) and stockholders' equity (Retained Earnings) by the cost of the inventory. The expense (cost of goods sold) increases and net income decreases by that same amount. The net effect on assets and stockholders' equity is an increase to each by the amount of the gross margin (or the selling price minus the cost of the inventory sold). 11) FALSE A purchase allowance decreases assets (merchandise inventory) and liabilities (accounts payable). A purchase allowance does not directly affect the income statement. 12) TRUE A purchase discount decreases the purchaser's assets (Merchandise Inventory) and liabilities (Accounts Payable). 13) FALSE Purchase discount = $3,300 × 0.02 = $66 Cost of goods sold = List price of purchase − Purchase discount Cost of goods sold = $3,300 − $66 = $3,234 14) TRUE Version 1

Product costs are recognized as expenses when goods are sold, not when they are purchased. 15) FALSE If goods are delivered FOB shipping point, the buyer, not the seller, is responsible for freight costs. 16) TRUE Transportation-out is reported on the income statement as an operating expense in the section below gross margin. 17) FALSE Gains (and losses) on the sale of land are recorded when the land is sold for more (or less) than its cost. 18) TRUE Multistep income statements show gross margin, but single-step income statements do not. 19) TRUE Multistep income statements separate operating expenses from peripheral or nonoperating items such as gains, losses, and interest. 20) TRUE A physical count may reveal inventory shrinkage if the physical count is lower than the book inventory. 21) TRUE The write-off decreases assets (Merchandise Inventory) and stockholders' equity (Retained Earnings). The write-off increases expenses and decreases net income. 22) FALSE Net sales is calculated by subtracting sales returns, discounts, and allowances from sales revenue. 23) TRUE

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A sales discount is recorded as a decrease in sales and a decrease in accounts receivable. A purchase discount is recorded as a decrease in inventory and a decrease in accounts payable. 24) TRUE A common size income statement shows each item as a percentage of net sales, and a common size balance sheet shows each item as a percentage of total assets. 25) FALSE All amounts on the common size income statement are divided by net sales, not net income. 26) FALSE Net sales = Sales − Sales returns − Sales discounts Gross margin = Net sales − Cost of goods sold Thus, sales discounts decrease net sales and gross margin equally. 27) FALSE That is a description of gross margin percentage. 28) TRUE In a periodic inventory system, inventory purchases are recorded in the Purchases account. 29) FALSE No entries for the cost of merchandise purchases or sales are recorded in the Inventory account during the period. The cost of goods sold is determined at the end of the period. 30) TRUE The choice of perpetual or periodic inventory system does not affect the amount of cost of goods sold reported on the income statement. It only affects the manner in which transactions are entered into the accounting system. 31) A

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Freight cost on goods delivered to customers FOB destination is a period cost (expense) called transportation-out. 32) B Merchandising companies, such as retailers, purchase goods and resell them without making significant changes to those goods. 33) D Regal Cinemas is a service business. Its primary business does not involve purchasing goods and reselling them. 34) A Retail firms sell merchandise to the general public, whereas wholesale firms sell merchandise to other businesses. Both are considered merchandising businesses. 35) A The revenue recognition is the first part of a two-part transaction. The sales part represents a source of assets (cash increases from earning sales revenue). Both assets (Cash) and stockholders’ equity (Retained Earnings) increase. Sales revenue and net income on the income statement increase. The $2,000 cash inflow is reported in the operating activities section of the statement of cash flows. 36) B Both assets (Inventory) and stockholders’ equity (Retained Earnings) decrease. An expense account, cost of goods sold, is reported on the income statement which decreases net income. There is no effect on the statement of cash flows. 37) C Transportation cost on purchased goods is a product cost that increases the merchandise inventory account and is reported as a component of cost of goods sold on the income statement when the inventory is sold. 38) B

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Advertising expense is a selling and administrative expense, or period cost. 39) D Because inventory items are referred to as products, inventory costs are frequently called product costs. Product costs are matched directly with sales revenue, (that is, expensed) when inventory is sold, regardless of when it was purchased. 40) B Purchasing merchandise inventory for cash is an asset exchange transaction. One asset, Cash, decreases while another asset, Merchandise Inventory, increases. Total assets remain unchanged. 41) D Cost of goods sold is the expense recognized when merchandise is sold. 42) C When a merchandising company sells inventory, it will recognize sales revenue for the amount of the sales price. The company will also recognize a cost of goods sold expense for the amount of the cost of the goods that were sold. 43) B Gross margin is the difference between sales revenue and the cost of goods sold expense. It is normally shown as the first step in a multi-step income statement. The operating expenses are then subtracted from gross margin to determine the amount of net income. In contrast, on a single step income statement cost of goods sold is shown as one of a number of operating expenses that are subtracted from sales revenue to determine net income. This single-step format does not show the determination of gross margin. Multistep and single-step formats are used only for income statements, they do not apply to the balance sheet. 44) A

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Most period costs, such as advertising, salaries and wages, rent, and insurance, are expensed when they are incurred. 45) A Payment of the amount due on an account payable decreases assets (Cash) and liabilities (Accounts Payable). It does not affect net income but will be reported as a cash outflow from operating activities. 46) C The payment of transportation-in is an asset exchange transaction that increases one asset (Merchandise Inventory) and decreases another asset (Cash). 47) B Purchasing merchandise inventory for cash is an asset exchange transaction. One asset, Cash, decreases while another asset, Merchandise Inventory, increases. Total assets remain unchanged. 48) C The return of merchandise before payment has been made decreases assets (Merchandise Inventory) and liabilities (Accounts Payable) by the full invoiced amount of the merchandise returned of $2,100. 49) C The return of merchandise before payment has been made decreases assets (Merchandise Inventory) and liabilities (Accounts Payable) by the full invoiced amount of the merchandise returned of $1,200. 50) A

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Purchase discount = (List price of purchase− List price of return) × discount percentage Purchase discount = ($13,300 − $2,800) × 0.02 = $210 Cost of goods sold = List price of purchase − List price of return − Purchase discount Cost of goods sold = $13,300 − $2,800 − $210 = $10,290 Gross margin = Net sales − Cost of goods sold Gross margin = $20,600 − $10,290 = $10,310 51) B Purchase discount = (List price of purchase − List price of return) × discount percentage Purchase discount = ($12,500 − $1,200) × 0.02 = $226 Cost of goods sold = List price of purchase − List price of return − Purchase discount Cost of goods sold = $12,500 − $1,200 − $226 = $11,074 Gross margin = Net sales − Cost of goods sold Gross margin = $18,800 − $11,074 = $7,726 52) A Purchase discount = (List price of purchase− List price of return) × discount percentage Purchase discount = ($12,200 − $1,700) × 0.02 = $210 Cash outflow for inventory purchase = $12,200 − $1,700 − $210 = $10,290 Cash inflow from inventory sale = $18,400 Net cash flow from operating activities = $18,400 − $10,290 = $8,110 53) B

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Purchase discount = (List price of purchase − List price of return) × discount percentage Purchase discount = ($12,500 − $1,200) × 0.02 = $226 Cash outflow for inventory purchase = $12,500 − $1,200 − $226 = $11,074 Cash inflow from inventory sale = $18,800 Net cash flow from operating activities = $18,800 − $11,074 = $7,726 54) B The sales return decreases assets (Cash) and stockholders’ equity (Retained Earnings) by $6,400. Sales and net income decrease by that same amount. Because the company got the inventory back, the sales return increases assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by $3,700. The expense (cost of goods sold) decreases and net income increases by that same amount. The net effect of both parts of this business event is a decrease to assets and stockholders’ equity of $2,700 (or $6,400− $3,700). 55) A The sales return decreases assets (Cash) and stockholders’ equity (Retained Earnings) by $2,600. Sales and net income decrease by that same amount. Because the company got the inventory back, the sales return increases assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by $1,700. The expense (cost of goods sold) decreases and net income increases by that same amount. The net effect of both parts of this business event is a decrease to assets and stockholders’ equity of $900 (or $2,600 − $1,700). 56) C

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Purchasing merchandise inventory on account increases assets (Merchandise Inventory) and increases liabilities (Accounts Payable). Because product costs are expensed when inventory is sold, not when the goods are purchased, the event does not affect net income. Since the inventory was purchased on account, it does not affect the statement of cash flows. 57) D A purchase return would decrease assets (Merchandise Inventory) and decrease liabilities (Accounts Payable). It would not affect stockholders’ equity, revenue, expenses, or net income. It would not affect the statement of cash flows. 58) B The amount of the return is $100. The return reduces the cost of the inventory thereby reducing assets. It also reduces the balance due on the account payable thereby reducing liabilities. The income statement will not be affected. While the return reduces the amount of the account payable, it does not immediately affect cash flow. Accordingly, the return has no effect on the statement of cash flows. 59) B The cost of the inventory is $8,000 ($10,000 original cost − $2,000 purchase return). The amount of the cost of the inventory will remain in the inventory account until the inventory is sold. 60) D The amount of the return is $200. Since the inventory was purchased for cash, cash will be received when the inventory is returned. The return increases Cash and decreases Inventory. The return is simply an asset exchange. The income statement will not be affected. It does affect cash flow. The return increases operating cash flow by $200. 61) A

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The cost of the inventory is $8,000 ($10,000 original cost − $2,000 purchase return). The inventory was sold to customers for $10,000. Net income would be $2,000 (Sales $10,000 − Cost of Goods Sold $8,000). 62) B Only Event 3 affects cash flow. The account payable is $8,000 ($10,000 original cost − $2,000 purchase return) and is paid in cash. Therefore, Net Operating Cash Flow is ($8,000). Event 4 does not affect cash because the inventory was sold on account to customers. 63) B The amount of the discount is $80 [($10,000 original cost − $2,000 purchase return) × 0.01]. The discount reduces the cost of the inventory thereby reducing assets. It also reduces the balance due on the account payable thereby reducing liabilities. The income statement will not be affected until the inventory is sold. While the discount reduces the amount of the account payable, it does not immediately affect cash flow. The cash flow occurs when the account payable is paid. Accordingly, the discount has no effect on the statement of cash flows. 64) A The cost of the inventory is $7,920 ($10,000 original cost − $2,000 purchase return − $80 cash discount). The amount of the cost of the inventory will remain in the inventory account until the inventory is sold. 65) D The balance in accounts payable after the three events is 7,920 (For Example 10,000 − 2,000 return − 80 discount). Paying off the account payable balance decreases assets (Cash) and liabilities (Accounts Payable). It does not affect the income statement as the expense is recognized when the inventory is sold not when the account payable is paid off. This transaction does affect the statement of cash flows. It is a $7,920 cash outflow for operating activities. Version 1

66) B If the Company pays after the discount period has expired, there will be no discount granted. The amount due will be $8,000 ($10,000 original account payable − $2,000 reduction in the account payable due to the purchase return). 67) C Since the terms are FOB shipping point, Taylor (the buyer) takes ownership of the goods at the point where the goods are shipped. Since the buyer owns the goods before they are transported, the buyer is responsible for paying the cost of transporting the goods. In this case, Taylor would classify the freight cost as transportation-in or freight-in. Since Taylor had to pay the freight cost to obtain the inventory, the transportation-in cost is part of the cost of the inventory and is added to the inventory account. The cash purchase of inventory including freight cost is an asset exchange transaction. One asset account (Cash) decreases and another asset account (Inventory) increases. The income statement is affected when inventory is sold not when inventory is purchased. As a result, there is no impact on the income statement. Since the cash was paid to purchase a short-term asset used in the operations of the company, the cash outflow is an operating activity. 68) D Since the terms are FOB destination the seller owns the goods until they reach their destination. Therefore, the seller must pay the cost of delivering the goods to Taha. Since Taha did not have to pay the freight cost, the cost of the inventory is $9,000. The purchase is an asset exchange transaction. One asset account (Cash) decreases and another asset account (Inventory) increases. The income statement is not affected at the time inventory is purchased. Since the cash was paid to purchase a short-term asset used in the operations of the company, the cash outflow is an operating activity. Version 1

69) D Inventory shrinkage means that a company has experienced an economic sacrifice in the form of a decrease in its assets. The shrinkage may have been due to lost, damaged, or stolen goods. Regardless of the specific reason, the company experienced a decrease in its assets in the process of conducting its normal operating activities. Therefore, the inventory shrinkage is classified as an expense. The recognition of the shrinkage will cause assets (inventory) to decrease and expenses to increase. The increase in expenses will cause net income and ultimately equity (retained earnings) to decrease. Since cash was not affected by the shrinkage, the statement of cash flows is not affected. If the amount of the shrinkage is material, it must be shown as an operating expense on the income statement. However, the amount of the shrinkage is normally immaterial and is usually included in cost of goods sold as a matter of convenience. 70) A Sales discount = $50,000 sales revenue × 3% = $1,500 Snell Company would collect $48,500 cash (or $50,000 sales revenue − $1,500) from the customer. Assets (Cash) would increase by $48,500 and assets (Accounts Receivable) would decrease by $50,000 (resulting in an overall decrease to total assets of $1,500) and stockholders’ equity (Retained Earnings) would decrease by $1,500. On the income statement, sales revenue would decrease by $1,500, which would decrease net income. The company would report a $48,500 cash inflow from operating activities. 71) C

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The revenue recognition is the first part of a two-part transaction. Recognizing the revenue would have increased both assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) by the selling price of the merchandise that was sold. The expense recognition is the second part of the two-part transaction. Recognizing the expense would have decreased assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by the cost of the merchandise that was sold. If the company fails to record both parts of this two-part transaction, assets and stockholders’ equity would be understated by the difference between the selling price of the merchandise and its cost. 72) B The payment for transportation-in will decrease one asset (Cash) and increase another asset (Merchandise Inventory). It will not affect net income but will be reported as a cash outflow for operating activities on the statement of cash flows. 73) D Transportation-in is a product cost that increases one asset (Merchandise Inventory) and decreases another asset (Cash). Because product costs are expensed when inventory is sold, not when the goods are purchased, the event does not affect net income. It is reported as a cash outflow for operating activities. 74) A Cost of goods sold (3), transportation-out (4), selling expense (7), loss on the sale of land (8), and sales (9) will all appear on the income statement. The remaining accounts appear on the balance sheet, except for dividends which appear on the statement of changes in stockholders' equity. 75) C

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Cash (1), merchandise inventory (2), and common stock (6) appear on the balance sheet. The remaining accounts appear on the income statement, except for dividends which appear on the statement of changes in stockholders' equity. 76) B Gross margin is calculated as sales (9) minus cost of goods sold (3). 77) C Operating income is the amount of income that is generated from the normal recurring operations of a business. Items that are not expected to recur on a regular basis are subtracted from the operating income to determine the amount of net income. Here, operating income includes sales (9), cost of goods sold (3), transportation-out (4) and selling expense (7). The loss on the sale of the land (8) would not be expected to recur on a regular basis; thus, it does not affect operating income. 78) B Paying cash for transportation-out decreases assets (Cash) and decreases stockholders' equity (Retained Earnings). Transportation-out is a period cost, which increases expenses and decreases net income. 79) D The purchase of inventory on account increases assets (Merchandise Inventory) and liabilities (Accounts Payable). 80) B The sale will cause the inventory account to decrease by $155, the cost of the item sold. 81) B The sale will cause the inventory account to decrease by $130, the cost of the item sold. 82) C

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Recognizing the sales revenue part of the transaction will increase assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) by $8,800. Recognizing the expense part of the transaction will decrease assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by $5,400; this expense will be reported on the income statement as cost of goods sold. The net effect is an increase to total assets and total stockholders’ equity of $3,400 (or $8,800 − $5,400). 83) C Recognizing the sales revenue part of the transaction will increase assets (Accounts Receivable) and stockholders’ equity (Retained Earnings) by $3,600. Recognizing the expense part of the transaction will decrease assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings) by $2,300; this expense will be reported on the income statement as cost of goods sold. The net effect is an increase to total assets and total stockholders’ equity of $1,300 (or $3,600 − $2,300). 84) D Gross margin = Net sales− Cost of goods sold Gross margin = $15,250 − $8,600 = $6,650 85) B Gross margin = Net sales − Cost of goods sold Gross margin = $57,000 − $32,800 = $24,200 86) A Inventory at end of Year 2 = Inventory at beginning of Year 1 + Purchases during Years 1 and 2 − Cost of goods sold during Years 1 and 2 Inventory at end of Year 2 = $0 + ($8,300 + $12,200) − ($5,700 + $9,900) = $4,900 87) B

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Inventory at end of Year 2 = Inventory at beginning of Year 1 + Purchases during Years 1 and 2 − Cost of goods sold during Years 1 and 2 Inventory at end of Year 2 = $0 + ($26,400 + $35,200) − ($16,000 + $32,800) = $12,800 88) B Net income = Sales − Cost of goods sold − Operating expenses +/− Nonoperating items (which are zero here) Year 1 Net income = $9,400 − $4,700 − $4,200 = $500 Year 2 Net income = $16,000 − $8,900 − $5,200 = $1,900 Retained earnings at end of Year 2 = Retained earnings at beginning of Year 1 + Net income for Years 1 and 2 − Dividends (which are zero here) Retained earnings at end of Year 2 = $0 + $500 + $1,900 = $2,400 89) C Net income = Sales − Cost of goods sold − Operating expenses +/− Nonoperating items (which are zero here) Year 1 Net income = $30,600 − $16,000 − $14,000 = $600 Year 2 Net income = $57,000 − $32,800 − $18,000 = $6,200 Retained earnings at end of Year 2 = Retained earnings at beginning of Year 1 + Net income for Years 1 and 2 − Dividends (which are zero here) Retained earnings at end of Year 2 = $0 + $600 + $6,200 = $6,800 90) D A purchase discount reduces the cost of the merchandise inventory and the associated account payable on the balance sheet. A purchase discount does not directly affect the income statement or the statement of cash flows. 91) C

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Granting a sales allowance to a customer decreases assets (Accounts Receivable) and stockholders' equity (Retained Earnings). It decreases revenue and net income. It does not affect the statement of cash flows. 92) D The purchase return will decrease assets (Merchandise Inventory) and liabilities (Accounts Payable). It will not affect net income or the statement of cash flows. 93) A If goods are delivered FOB shipping point, the buyer is responsible for the freight cost. 94) D If goods are delivered FOB destination, the seller is responsible for the freight costs. The seller will record an expense (transportation-out). 95) D The same cash discount is treated as a sales discount by the seller and as a purchase discount by the buyer. 96) C Paying for transportation-out decreases assets (Cash) and stockholders' equity (Retained Earnings). It increases expenses (transportation-out), which decreases net income. It is reported as a cash outflow from operating activities. 97) B Note that the cost of inventory sold is the list price less any purchase returns and allowances and purchase discounts, plus transportation-in costs. Cost of goods sold = List price of purchase − Purchase discount + Transportation-in Cost of goods sold = $9,100 − ($9,100 × 0.04) + $360 = $9,096 Gross margin = Net sales − Cost of goods sold Gross margin = $17,200 − $9,096 = $8,104 Version 1

98) B Note that the cost of inventory sold is the list price less any purchase returns and allowances and purchase discounts, plus transportation-in costs. Cost of goods sold = List price of purchase − Purchase discount + Transportation-in Cost of goods sold = $16,000 − ($16,000 × 0.02) + $500 = $16,180 Gross margin = Net sales − Cost of goods sold Gross margin = $30,000 − $16,180 = $13,820 99) C These terms mean the seller will allow a 2 percent cash discount if the purchaser pays cash within 15 days from the date of purchase. The amount not paid within the first 15 days is due at the end of 30 days from date of purchase. 100) B Gross margin = Net sales − Cost of goods sold Gross margin = $7,000 − $4,000 = $3,000 The sale of the inventory generates a cash inflow from operating activities of $7,000. Since it was purchased on account, the purchase of the inventory for $4,000 does not affect the statement of cash flows. 101) D Vargas would record a gain on the sale of land of $6,500 (or $39,000 − $32,500). The sale would be reported as a cash inflow from investing activities. The gain would affect net income but is shown below operating income on the income statement. 102) B The write-off decreases both assets (Merchandise Inventory) and stockholders' equity (Retained Earnings). The write-off increases expenses {inventory loss (cost of goods sold)} and decreases net income. Cash flow is not affected. Version 1

103) A Green Company is responsible for the transportation-in costs of $730 since the inventory was shipped FOB shipping point by the supplier. Purchases = Purchases − Purchase discount + Transportation-in Purchases = $17,300 − ($17,300 × 0.02) + $730 = $17,684 All of the merchandise sold to customers was delivered under terms FOB destination; as such Green Company was responsible for the transportation-out cost of $530. However, transportation-out is an operating expense and, as such, does not affect the gross margin calculation. Gross margin = Net sales − Cost of goods sold Gross margin = $26,100 − $17,684 = $8,416 104) C Green Company is responsible for the transportation-in costs of $2,400 since the inventory was shipped FOB shipping point by the supplier. Purchases = Purchases − Purchase discount + Transportation-in Purchases = $64,000 − ($64,000 × 0.02) + $2,400 = $65,120 All of the merchandise sold to customers was delivered under terms FOB destination; as such Green Company was responsible for the transportation-out cost of $1,600. However, transportation-out is an operating expense and, as such, does not affect the gross margin calculation. Gross margin = Net sales − Cost of goods sold Gross margin = $94,000 − $65,120 = $28,880 105) D

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Green Company was responsible for the transportation-in costs of $690 since the inventory was shipped FOB shipping point by the supplier. Purchases = Purchases− Purchase discount + Transportation-in Purchases = $16,900 − ($16,900 × 0.03) + $690 = $17,083 All of the merchandise sold to customers was delivered under terms FOB destination; as such Green Company was responsible for the transportation-out cost of $490. Net cash flow from operating activities = Inflow from sale − Outflow for purchases − Outflow for transportation-out Net cash flow from operating activities = $25,300 − $17,083 − $490 = $7,727 106) B Green Company was responsible for the transportation-in costs of $2,400 since the inventory was shipped FOB shipping point by the supplier. Purchases = Purchases − Purchase discount + Transportation-in Purchases = $64,000 − ($64,000 × 0.02) + $2,400 = $65,120 All of the merchandise sold to customers was delivered under terms FOB destination; as such Green Company was responsible for the transportation-out cost of $1,600. Net cash flow from operating activities = Inflow from sale − Outflow for purchases − Outflow for transportation-out Net cash flow from operating activities = $94,000 − $65,120 − $1,600 = $27,280 107) A

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Under these circumstances the company must make an adjusting entry to write down assets (Merchandise Inventory) so the amount reported on the financial statements agrees with the amount actually on hand at the end of the period. The write down of $1,750 (or $18,000 book balance − $16,250 physical count) decreases both assets (Merchandise Inventory) and stockholders’ equity (Retained Earnings). The write-down increases expenses and decreases net income. It does not affect cash flows. 108) D Common size statements can be used to make comparisons between different firms or between different time periods. 109) B Neiman Marcus, a retailer selling higher priced goods, is likely to have the highest gross margin percentage. 110) B Net income percentage is net income as a percentage of net sales. The net income percentage is frequently referred to as return-on-sales ratio. 111) C Net income percentage = Net income ÷ Net sales Ace $11,500 ÷ $70,000 = 16.4% Diamond $17,900 ÷ $76,000 = 23.6% 112) D Administrative expenses increased as a percentage of sales from Year 1 to Year 2. Selling expenses and cost of goods sold did not increase as a percentage of sales. 113) B

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Operating expenses as a percentage of sales: Company A: $9,600 ÷ $80,000 = 12.0% Company B: $12,600 ÷ $180,000 = 7.0% Company C: $10,800 ÷ $120,000 = 9.0% Company D: $10,000 ÷ $100,000 = 10.0% 114) B Discount stores have lower gross margin percentages than upscale department stores. Gross margin percentage: Company A: $32,000 ÷ $80,000 = 40% Company B: $45,000 ÷ $180,000 = 25% Company C: $48,000 ÷ $120,000 = 40% Company D: $40,000 ÷ $100,000= 40% The discount retailer would have a lower gross margin percentage. 115) B Gross margin = Net sales − Cost of goods sold Gross margin = $3,200 − $1,800 = $1,400 Gross margin percentage = $1,400/$3,200 = 43.750% 116) C Gross margin = Net sales − Cost of goods sold Gross margin = $36,000 − $14,400 = $21,600 Gross margin percentage = $21,600 ÷ $36,000 = 60% 117) D Beginning inventory + Purchases − Cost of goods sold = Ending inventory $1,500 + Purchases − $3,900 = $1,100 Purchases = $1,100 + $3,900 − $1,500 = $3,500 118) A

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Beginning inventory + Purchases − Cost of goods sold = Ending inventory $2,400 + Purchases − $9,600 = $1,200 Purchases = $1,200 + $9,600 − $2,400 = $8,400 119) B Selling merchandise on account will increase revenue by $16,000, increase expenses by $6,000, and increase net income by the difference between the two of $10,000. 120) D This transaction will increase assets (Cash) by $10,000 and decrease assets (Merchandise Inventory) by $4,500. It will also increase stockholders' equity (Retained Earnings) by $5,500. It will increase revenue by $10,000, increase expenses (cost of goods sold) by $4,500, and increase net income by $5,500 (or $10,000 − $4,500). 121) B Selling merchandise for cash is recognized as an operating activity. 122) C Recognizing cost of goods sold decreases stockholders' equity (Retained Earnings). It increases expenses and decreases net income. 123) C Gross margin = Sales − Cost of goods sold $500,000 − $300,000 = $200,000 124) B Gross margin = Sales − Cost of goods sold $30,000 − $16,000 = $14,000 125) C Gross margin = Sales − Cost of goods sold Gross margin is shown on a multistep income statement, but it is not shown on a single-step income statement. 126) C Version 1

Gross margin = Sales − Cost of goods sold $300,000 = $1,000,000 − X X = $1,000,000 − $300,000 Cost of goods sold = $700,000 127) B Gross margin = Sales − Cost of goods sold $200,000 = X − $400,000 X = $400,000 + $200,000 Sales = $600,000 128) D The terms 1/15, n/45 indicate that the seller will allow a 1 percent discount if the purchaser pays cash within 15 days from the date of purchase. The amount not paid within the first 15 days is due at the end of 45 days from the date of purchase. In this case, Jake Company did not meet the 15-day requirement. It took Jake Company 18 days to pay which means Jake does not get the 1 percent discount. 129) B A purchase discount reduces the cost of the inventory and the associated account payable on the balance sheet. 130) B Cost of goods sold = Purchases − Purchase discount Cost of goods sold = $10,000 − ($10,000 × 2%) Cost of goods sold = $9,800 131) A Understating ending inventory in a periodic inventory system will overstate cost of goods sold. If cost of goods sold is overstated, net income for that year and ending retained earnings will be understated. 132) B

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Cost of goods sold = Beginning inventory + Purchases − Purchase returns and allowances − Purchase discounts + Transportation-in− Ending inventory Cost of goods sold = $3,300 + $8,100 + $450 − $250 − $3,700 = $7,900 Gross margin = Net sales − Cost of goods sold Gross margin = $12,500 − $7,900 = $4,600 133) A Cost of goods sold = Beginning inventory + Purchases − Purchase returns and allowances − Purchase discounts + Transportation-in − Ending inventory Cost of goods sold = $6,400 + $16,000 + $800 − $400 − $7,200 = $15,600 Gross margin = Net sales − Cost of goods sold Gross margin = $24,000 − $15,600 = $8,400 134) C Ending inventory = Beginning inventory + Purchases− Purchase returns and allowances − Purchase discounts + Transportation-in − Cost of goods sold Ending inventory = $9,700 + $41,700 − $770 − $570 + $1,770 − $30,100 = $21,730 135) D Ending inventory = Beginning inventory + Purchases − Purchase returns and allowances − Purchase discounts + Transportation-in − Cost of goods sold Ending inventory = $16,000 + $80,000 − $1,200 − $800 + $3,200 − $56,800 = $40,400 136) A The chief advantage of the periodic method is recording efficiency. 137) D 138) D Version 1

Advancements in technology, specifically bar coding, has removed most of the practical limitations associated with use of the perpetual inventory system. 139) D In a periodic inventory system, freight costs on purchases are recorded in the account Transportation-in. 140) A In a periodic inventory system, purchases and related transactions are not recorded to the merchandise inventory account. The merchandise inventory account is only adjusted at the end of the period as the result of a physical count.

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CHAPTER 5: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Stan's Surf Shack purchased five surfboards for $200 each. Later it purchased two additional surfboards for $250 each. Stan's sold a total of six surfboards during the period for $350 cash each. The company uses the perpetual inventory system and has not yet accrued any income taxes for the period. Indicate how the event described in the question affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Stan's purchased the first five surfboards on account. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

2) Stan's Surf Shack purchased five surfboards for $200 each. Later it purchased two additional surfboards for $250 each. Stan's sold a total of six surfboards during the period for $350 cash each. The company uses the perpetual inventory system and has not yet accrued any income taxes for the period. Indicate how the event described in the question affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Stan's Surf Shack made the second purchase of two additional surfboards for cash. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

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3) Stan's Surf Shack purchased five surfboards for $200 each. Later it purchased two additional surfboards for $250 each. Stan's sold a total of six surfboards during the period for $350 cash each. The company uses the perpetual inventory system and has not yet accrued any income taxes for the period. Indicate how the event described in the question affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Stan's sold the six surfboards for cash. The company uses the LIFO inventory cost flow method. (Consider the effects of both parts of this event.) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

4) Stan's Surf Shack purchased five surfboards for $200 each. Later it purchased two additional surfboards for $250 each. Stan's sold a total of six surfboards during the period for $350 cash each. The company uses the perpetual inventory system and has not yet accrued any income taxes for the period. Indicate how the event described in the question affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Stan's sold the six surfboards for cash. The company uses the FIFO inventory cost flow method. (Consider the effects of both parts of this event.) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

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5) Stan's Surf Shack purchased five surfboards for $200 each. Later it purchased two additional surfboards for $250 each. Stan's sold a total of six surfboards during the period for $350 cash each. The company uses the perpetual inventory system and has not yet accrued any income taxes for the period. Indicate how the event described in the question affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Stan's pays the income taxes incurred for the current accounting period. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

6) Gladding, Incorporated applies the lower-of-cost-or-market rule to the entire stock of its inventory in the aggregate. At the end of the accounting period, it is determined that the cost of the inventory is $26,985 and the market (replacement) value is $25,886. Indicate how the required adjustment affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

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7) Steven, Incorporated uses the perpetual inventory system. The company's management, under pressure to report favorable results to shareholders, included $15,000 of inventory that had already been sold in its ending inventory. Indicate whether this misstatement would overstate (O), understate (U), or not affect (NA) each of the elements of the financial statements. You do not need to enter amounts. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

8) Howard Company uses the perpetual inventory system. The company applies the lowerof-cost-or-market rule to the entire stock of inventory in the aggregate. At the end of the current year, the cost of the inventory was $19,456 and its current market value is $19,950. Indicate how the required adjustment affects the elements of the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = IDecrease = DNot Affected = NA Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income

Define the terms FIFO and LIFO.

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10) In an inflationary environment, which inventory cost flow method, FIFO or LIFO, reports the lowest amount of net income?

11) In an inflationary environment, which inventory cost flow method, FIFO or LIFO, results in the largest balance in ending inventory?

12) In an inflationary period, which inventory cost flow method, FIFO or LIFO, is more desirable from a tax standpoint? Why?

13)

How does the physical flow of goods differ from the flow of costs?

14) Ignoring the impact of income tax, how does the choice between FIFO and LIFO affect a company's cash flows in an inflationary environment? How does income tax impact your answer? Why?

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15) If Bowman Company is using FIFO and sales and purchases occur intermittently, how is cost of goods sold computed when recording a sale under the perpetual inventory system?

16) When maintaining perpetual inventory records, what difficulties arise when the LIFO cost flow method is used, and sales and purchases occur intermittently? How can accountants deal with these difficulties?

17) Sierra Company uses the perpetual inventory system. How would the company calculate the cost of goods sold when recording a sale under the weighted-average cost flow method?

18) If the company's inventory items have declined in value from damage or obsolescence, what effect will the lower-of-cost-or-market rule have on the amount of inventory shown on the balance sheet? Why?

19) Kincaid Camera Shop applies the lower-of-cost-or-market rule to individual items of inventory. During the year, some of Kincaid's inventory items decreased in market value due to obsolescence. Other items increased in market value during the year. In total, the market value of Kincaid's inventory was higher at the end of the year than the cost of the inventory. Would Kincaid have an adjustment to make at the end of the year due to the lower-of-cost-or-market rule? Why or why not? Would the answer be any different if Kincaid applied the rule to the entire stock of inventory in the aggregate rather than to individual items?

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20)

How is the lower-of-cost-or-market rule applied to each individual inventory item?

21) Explain the meaning of the terms, cost and market, as used in the application of the lower-of-cost-or-market rule.

22) What accounting steps would a firm normally take when it discovers a material difference between a physical inventory count and the book inventory figure? Assume that the company uses a perpetual inventory system.

23) Explain the effects of an understatement of ending inventory on both the present year's net income and the following year's net income. What is the effect of this error on the inventory balance at the end of the following year?

24) What are the circumstances that might cause a company to need an estimate of the amount of its inventory?

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25) List the specific steps used in computing the estimated inventory balance using the gross margin method.

26)

Explain the computation of and the significance of inventory turnover.

27)

Discuss the significance of the average number of days to sell inventory.

28) What ratio (usually an average from prior periods) can be used in estimating the current period's ending inventory?

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 29) On June 1, Delaware Company had one unit in beginning inventory that cost $10.00. During June, Delaware paid cash to purchase two additional inventory items. Delaware purchased the first item for cash at a cost of $10.00, and the second at a cost of $12.00. Delaware Company sold two inventory items for $24.00 each, receiving cash. Based on this information alone, indicate whether each of the following items is true or false. ________ a) The amount of ending inventory will be $10 assuming the LIFO cost flow method was used. ________ b) Cost of goods sold would be $24 assuming the weighted-average cost flow method was used. ________ c) Cash flow from operating activities in June would be $28 assuming a FIFO cost flow method was used. ________ d) Cash flow from operating activities in June would be $26 independent of what cost flow method was used. ________ e) The amount of gross margin would be $26 assuming the FIFO cost flow method was used.

30) Indicate whether each of the following statements is true or false. ________ a) The FIFO cost flow method assumes that the company physically rotates inventory so that the oldest inventory is sold first. ________ b) In a period of rising inventory prices, FIFO gives higher cost of goods sold than LIFO. ________ c) Under the weighted-average cost flow method, the average cost per unit equals the cost of goods available for sale divided by the number of units available for sale. ________ d) In a period of declining inventory prices, LIFO will result in higher income tax expense than FIFO. ________ e) In a period of rising inventory prices, FIFO gives higher ending inventory than LIFO does.

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31) Indicate whether each of the following statements related to inventory is true or false. ________ a) The higher a company's inventory turnover ratio, the higher its cost of financing inventory. ________ b) The selling price a company charges for its goods probably will not be affected by the inventory cost flow method it uses. ________ c) Other things being equal, if inventory prices are rising, a company that uses the LIFO inventory method will have a higher amount of total assets than if it had used FIFO. ________ d) A company that plans to offer a higher level of customer service than its competitors probably will have a higher gross margin percentage than its competitors. ________ e) The lower-of-cost-or-market rule may decrease a company's net income, but it will never increase net income.

32) Indicate whether each of the following statements is true or false. ________ a) To compute cost of goods sold under the weighted-average method, it is necessary to first compute the average cost per unit. ________ b) The average cost per unit is computed by dividing the total cost of goods purchased by the number of units sold. ________ c) Under the FIFO method, each time units are sold, the cost per unit of the oldest inventory is applied to the number of units sold. ________ d) If a company uses the perpetual inventory system and sales and purchases occur intermittently, the company will not be able to use the LIFO method of cost flow. ________ e) A U.S. company can use LIFO for income tax purposes only if it also uses LIFO for financial reporting purposes.

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33) The Warren Company uses the perpetual inventory system and has computed the cost of its inventory to be $12,800 as follows: 200 units of Product A at a cost per unit of $20; 300 units of Product B at a cost per unit of $24; and 100 units of Product C at a cost per unit of $16. The current replacement cost of each of the above items is $25, $22 and $14, respectively. Warren's accountant is not sure yet whether to apply the lower-of-cost-or-market rule to each individual item or to the entire stock of inventory in the aggregate. Indicate whether each of the following statements pertaining to the Warren Company is true or false. ________ a) When referring to Product B, the "cost" totals $7,200. ________ b) If Warren applies the lower-of-cost-or-market rule to each individual inventory item, Product A would be listed at $25 per unit. ________ c) Warren would record a write-down of inventory if it applies this rule to each individual inventory item but would not have a write-down if it applies the rule to the entire stock of inventory in the aggregate. ________ d) If Warren applies this rule to each individual inventory item, inventory of $12,000 will be shown on the balance sheet. ________ e) The lower of cost or market is $1,600 for the 100 units of Product C.

34) On February 2, Year 2, a fire destroyed the entire inventory of Orange Co. The following information was found in accounting records: purchases of $420,000, sales of $690,000, beginning inventory of $120,000, and average gross margin percentage of 30%. Based on the above information, indicate whether each of the following statements is true or false. ________ a) The cost of goods available for sale is $540,000. ________ b) The cost of goods sold as a percent of sales is 70%. ________ c) The estimated cost of goods sold is $303,000. ________ d) Estimated inventory lost in the fire is $66,000. ________ e) Estimated gross margin for the period up to the date of the fire was $483,000.

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35) Iona Corporation's ending inventory as of December 31, Year 1, was overstated by $28,000. Indicate whether each of the following statements relating to the above error is true or false. ________ a) Cost of goods sold is overstated in Year 1 by $28,000. ________ b) Net Income is overstated in Year 1 by $14,000. ________ c) Retained Earnings at December 31, Year 1 is overstated by $28,000. ________ d) Beginning inventory will be understated in Year 2 by $28,000. ________ e) Retained Earnings will not be affected by this error at the end of Year 2.

36) Bell Company has provided the following figures as of December 31, Year 2: sales of $600,000, cost of goods sold of $320,000, net income of $120,000, and ending inventory of $64,000. Indicate whether each of the above statements pertaining to the Bell Company is true or false. ________ a) Bell's inventory turnover is 5.0. ________ b) Bell's average number of days to sell inventory is 39.5. ________ c) Bell could increase its inventory turnover by increasing prices. ________ d) Bell's gross margin as a percentage of sales was 46.7%. ________ e) A local competitor in the same line of business has an inventory turnover of 3.5. Assuming each firm has approximately the same gross margin rate, Bell Company is likely to be more profitable than the competitor.

37) Singh Company sold 75 units @ $350 each on October 31, Year 2. The following information is also available: Beginning inventory February 2 purchase June 15 purchase October 1 purchase

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25 units @ $175 20 units @ $180 45 units @ $200 30 units @ $220

Required: a) Determine the amount of cost of goods sold using: 1) FIFO 2) LIFO 3) Weighted Average b) Determine the amount of ending inventory using: 1) FIFO 2) LIFO 3) Weighted Average

38) During December Year 2, Crowe Company sold 125 units @ $225 each. Cash selling and administrative expenses for the year were $11,000. All transactions were cash transactions. The following information is also available: Beginning inventory April 18 purchase August 5 purchase

60 units @ $100 90 units @ $115 30 units @ $120

The company's income tax rate is 30%. Required: a) Prepare an income statement for Crowe Company for Year 2 assuming: 1) FIFO inventory cost flow 2) LIFO inventory cost flow b) Prepare the operating activities section of the statement of cash flows for Year 2 assuming: 1) FIFO inventory cost flow 2) LIFO inventory cost flow

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39) Chopin Company sells product A. The beginning inventory for product A was 70 units @ $240 per unit. During the year, Chopin purchased 110 units of product A at $216 per unit. The company sold 140 units of product A @ $400 per unit at the end of the year. Required: Determine the amount of product cost that would be allocated to cost of goods sold and ending inventory using (1) FIFO, (2) LIFO, and (3) weighted average (when calculating weighted average cost per unit round to 2 decimal places).

40)

The following transactions apply to Sam's Skateboards.

1–January 12–January 19–March 8–January 4–November

Beginning inventory Purchase Sales Purchase Sales

50 units @ $120 30 units @ $104 60 units @ $190 20 units @ $116 35 units @ $200

Assume the use of the perpetual inventory method and that all transactions were for cash. Required: Determine the amount of ending inventory using a FIFO cost flow.

41)

Curtis Company had the following transactions for the month of January:

1-January 6-January

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Beginning inventory Purchase

30 units @ $150 40 units @ $160

8-January 19-January 22-January 30-January

Sales Purchase Sales Purchase

50 units @ $260 20 units @ $164 30 units @ $260 15 units @ $156

Assume that Curtis uses the perpetual inventory method and that all transactions were for cash. Required: 1.a) Determine the inventory balance and the cost of goods sold after each transaction. 2.b) Determine the amount of ending inventory using the FIFO cost flow method.

42) Max Company's first year in operation was Year 1. The following inventory purchase information comes from Max's accounting records for the year: 19–January 20–April 15–October

120 units @ $280 240 units @ $304 90 units @ $320

In December Year 1, Max sold 350 units for $480 each. Operating expenses for the year were $30,000, and the tax rate was 30%. Required: 1.a) Calculate the cost of goods sold using LIFO. 2.b) Calculate the cost of goods sold using FIFO. 3.c) What amount of income tax would Max have to pay if it uses LIFO? 4.d) What amount of income tax would Max have to pay if it uses FIFO? 5.e) Assuming that the results for Year 2 are representative of what Max can generally expect; would you recommend that the company use LIFO or FIFO? Explain.

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43) Jones Company sells exercise bikes. Its beginning inventory was 100 units at $200 per unit. During the year, Jones made two purchases of the bikes: first, a 300-unit purchase at $220 per unit, and then 200 units at $250 per unit. The ending inventory for the year was 250 units. Required: Determine the amount of product costs that would be allocated to cost of goods sold and ending inventory, assuming that Jones uses each of the following inventory cost flow methods: 1.a) FIFO 2.b) LIFO 3.c) Weighted average (Round intermediate calculations to two decimal places. Round final answers to whole dollars.) Cost of Goods Sold

Ending Inventory

a) FIFO b) LIFO c) Weighted average

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44) Maynard Company started the year with no inventory. During the year, it purchased two identical inventory items at different times. The first unit cost $1,100 and the second, $1,200. One of the items was sold during the year. Based on this information, how much product cost would be allocated to cost of goods sold and ending inventory, assuming use of each of the following methods: 1.a) FIFO 2.b) LIFO 3.c) Weighted average

Cost of Goods Sold

Ending Inventory

a. FIFO b. LIFO c. Weighted average

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45)

The following information is for Choi Company for Year 2:

Beginning inventory 120 units @ $100 Units purchased 180 units @ $112 Choi sold 250 units for $190 each Required: 1.a) Calculate gross margin assuming Choi uses: 1.1) FIFO. 2.2) LIFO. 3.3) Weighted average. 1.b) Disregarding the effect of income taxes, what would be the dollar amount of difference in net income between FIFO and LIFO? 1.c) Again, disregard the effect of income taxes. Calculate the Year 2 cash flow from operating activities assuming that Choi uses: 1.1) FIFO. 2.2) LIFO.

46) 2:

Curtis Company's inventory records reflect the following for the month of October, Year

1-October 12-October 18-October 21-October 25-October 31-October

Beginning inventory First purchase Cash sales Second purchase Third purchase Cash sales

950 units @ $17.00 800 units @ $19.00 1,500 units @ $36.00 600 units @ $16.40 300 units @ $17.40 1,000 units @ $38.00

Assuming that Curtis Company uses the FIFO cost flow method in a perpetual inventory system. Required: 1.a) Calculate the cost of goods sold for the month ending October 31, Year 2. 2.b) Calculate the ending inventory at October 31, Year 2.

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47) Diaz Company's first year in operation was Year 1. For Year 1, its cost of goods sold using FIFO was $240,000, and its ending inventory was $58,400. If Diaz had used the LIFO cost flow method, its ending inventory would have been $56,000. Required: 1.a) What would the cost of goods sold have been with LIFO? 2.b) Based on this information, was Year 1 a period of rising inventory prices or falling inventory prices?

48) The Atkins Company uses the FIFO cost flow method. The company had the following beginning inventory, purchases, and sales of inventory during the first quarter of Year 2: Date

Units 1,200 500 700

Cost per Unit $60 $64

1-January 2-January 25-January

Beginning inventory Purchase Sale

5-February 18-February

Purchase Sale

600 800

$68

15-March

Purchase

600

$64

Required: 1.1) Determine the cost of goods sold during the first quarter of Year 2 2.2) Determine the ending inventory at Year 2.

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49) Rowe Company has six different categories of inventory. Quantity, cost, and market value information for each inventory category is shown below: Item A B C D E F

Quantity

Cost per Unit

700 950 520 115 400 90

$ 10.90 $ 3.65 $ 15.00 $ 23.30 $ 44.25 $ 89.10

Market Value per Unit $ 10.75 $ 4.00 $ 13.90 $ 21.50 $ 47.60 $ 91.55

Required: 1.a) Determine the value of ending inventory after applying the lower-of-cost-or-market rule to each individual category of inventory. 2.b) Determine the value of ending inventory after applying the lower-of-cost-or-market rule to the entire stock of inventory in the aggregate.

50) Burton Supply uses the perpetual inventory method. At the end of the year Burton Supply had the following items in inventory. Item

Quantity

Cost per Unit

A1 A2 A3 A4

40 30 50 20

$ 120.00 $ 84.00 $ 170.00 $ 152.00

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Market Value per Unit $ 124.00 $ 80.00 $ 162.00 $ 158.00

Required: 1.a) Determine the amount of inventory Burton Supply is showing on its books before any adjustment. 2.b) Determine the amount of ending inventory using lower of cost or market applied to each individual inventory item. 3.c) Determine the amount of ending inventory using lower of cost or market applied to the total stock of inventory in the aggregate. 4.d) Which approach of applying the lower-of-cost-or-market rule (apply to each individual inventory item or apply to the entire stock of inventory in the aggregate) produces the smallest amount of total assets?

51) The accountant for the Bay Company made an error, which understated the ending inventory for Year 1 by $7,000. Bay Company uses the perpetual inventory system. Assuming that this error is not caught and corrected, indicate the effect of the error on each of the following items. Write U (understated), O (overstated) or N (not affected) next to each item. 1.Year 2 Beginning Inventory: ________ 2.Year 2 Purchases: ________ 3.Year 1 Goods Available for Sale: ________ 4.Year 1 Net Income: ________ 5.Year 1 Retained Earnings ending balance: ________ 6.Year 1 Total Assets at end of year: ________ 7.Year 2 Net Income: ________ 8.Year 2 Retained Earnings ending balance: ________ 9.Year 1 Cost of Goods Sold: ________ 10.Year 1 Gross Margin: ________

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52) Byrne Company had its entire inventory destroyed when a fire swept through the company's warehouse on April 30, Year 2. Fortunately, the accounting records were locked in a fireproof safe and were not damaged. The following information for the period up to the date of the fire was taken from the accounting records: Sales Purchases Beginning inventory

$ 275,000 190,000 22,500

Required: Assuming that the gross margin has averaged 35%, what is the estimated value of the inventory destroyed in the fire?

53)

The following information is for Lattimore Company for Year 2:

Beginning inventory Purchase May 12 Purchase October 9 Sales

200 units @ $108 100 units @ $130 150 units @ $132 360 units @ $180

Required: Assuming that Lattimore uses the LIFO cost flow method: 1.a) Determine the cost of goods sold during Year 2. 2.b) Determine the inventory balance at the end of Year 2. 3.c) Calculate the average number of days to sell inventory for Year 2. (Round your answer to the nearest day.)

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54) The following information relating to the current year was taken from the records of Poole Company: Beginning inventory Purchase May 12 Purchase October 9 Sales

200 units @ $110 100 units @ $120 150 units @ $125 360 units @ $180

Required: 1.a) Assuming that Poole uses the LIFO cost flow method, determine how much product cost would be allocated to cost of goods sold, and how much to inventory at the end of the year. 2.b) Based on your results from part (a), calculate inventory turnover and average number of days to sell inventory. 3.c) Assuming that Poole uses the FIFO cost flow method, determine how much product cost would be allocated to Cost of Goods sold, and how much to inventory at the end of the year. 4.d) Based on your results from part (c), calculate inventory turnover and average number of days to sell inventory. 5.e) Compare your results from parts (b) and (d). Do LIFO and FIFO give the same results for inventory turnover? Which is higher, and why?

LIFO

FIFO

Cost of goods sold Inventory balance at end of year Inventory turnover Average # of days to sell inventory

55)

The following information is for Benitez Company for Year 2:

Beginning inventory Purchase April 8 Purchase September 12 Sales

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300 units @ $25 150 units @ $30 250 units @ $34 590 units @ $50

Required: Assuming that Benitez uses the FIFO cost flow method, 1.a) How much product cost would be allocated to cost of goods sold? 2.b) How much product cost would be allocated to inventory at the end of the year? 3.c) Calculate the average number of days to sell inventory for the year.

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Answer Key Test name: Chap 05_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income I I NA NA NA NA NA

The purchase of inventory on account increases assets (Inventory) and increases liabilities (Accounts Payable). It does not affect stockholders' equity or net income. Because the purchase was made on account, this transaction does not affect the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA D

The purchase of inventory for cash increases one asset (Inventory) and decreases another asset (Cash). It does not affect stockholders' equity or net income. It is reported as a cash outflow from operating activities. 3) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income I NA I I I I I

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Recording the sale increases assets (Cash) and stockholders' equity (Retained Earnings) by the selling price of the surfboards. It increases revenue, which increases net income by the same amount. Recording the cost of the merchandise sold decreases assets (Inventory) and stockholders' equity (Retained Earnings). The expense (cost of goods sold) increases and net income decreases by the same amount. The net effect on assets and stockholders' equity is an increase to each by the difference between the selling price and the cost of the six surfboards. The cash received from the sale will be reported as a cash inflow from operating activities on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income I NA I I I I I

Recording the sale increases assets (Cash) and stockholders' equity (Retained Earnings) by the selling price of the surfboards. It increases revenue, which increases net income by the same amount. Recording the cost of the merchandise sold decreases assets (Inventory) and stockholders' equity (Retained Earnings). The expense (cost of goods sold) increases and net income decreases by the same amount. The net effect on assets and stockholders' equity is an increase to each by the difference between the selling price and the cost of the six surfboards. The cash received from the sale will be reported as a cash inflow from operating activities on the statement of cash flows. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income D NA D NA I D D

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Payment of income tax will decrease assets (Cash) and stockholders' equity (Retained Earnings). Expenses (income tax expense) increase, which decreases net income. It is reported as a cash outflow from operating activities. 6) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income D NA D NA I D D

Because the market value of the entire stock of inventory in the aggregate is lower than cost, the company will write down the inventory to the lower market value. The write-down will decrease assets (Inventory) and stockholders' equity (Retained Earnings). It increases expenses [cost of goods sold (if immaterial) or operating expenses (if material)], which decreases net income. It does not affect the statement of cash flows. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income O NA O NA U O NA

Counting inventory that does not belong to the company overstates assets (Inventory) and stockholders' equity (Retained Earnings). It understates expenses (cost of goods sold), which overstates net income. It does not affect the statement of cash flows. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

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Because the market value is higher than the inventory's cost, there is no adjustment necessary. 9) The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. The lastin, first-out (LIFO) cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. 10) LIFO The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. The last-in, first-out (LIFO) cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. In an inflationary environment, LIFO will produce a higher cost of goods sold, so it will result in the lowest net income and the smallest balance in ending inventory. 11) FIFO The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. The last-in, first-out (LIFO) cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. In an inflationary period, FIFO reports the lowest cost of goods sold (earliest purchases) and the largest balance in ending inventory (most recent purchases). 12) LIFO The last-in, first-out (LIFO) cost flow method requires that the cost of the items purchased last (most expensive items) be charged to cost of goods sold. As a result, LIFO results in recognizing the lowest gross margin, lowest net income, and the lowest income tax expense. The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold.

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13) Goods usually move physically on a FIFO basis, which means that the first items of merchandise acquired by a company (first-in) are the first items sold to its customers (first-out). The inventory items on hand at the end of the accounting period are typically the last items in (the most recently acquired goods). If companies did not sell their oldest inventory items first, inventories would include dated, less marketable merchandise. Cost flow, however, can differ from physical flow. For example, a company may use LIFO or weighted average for financial reporting even if its goods flow physically on a FIFO basis. 14) If the impact of income tax is ignored, the cash flow from operating activities on the statement of cash flows is identical under all three methods. Regardless of the cost flow reporting method, the company pays the same amount of cash to purchase inventory and receives the same amount of cash when it sells inventory. However, income tax does have an impact on this decision. In an inflationary environment, FIFO produces the highest gross margin; it also produces the highest net income and the highest income tax expense. In contrast, LIFO results in recognizing the lowest gross margin, lowest net income, and the lowest income tax expense. The use of LIFO results in a lower cash outflow for income taxes. 15) The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. The inventory records are maintained in layers. Each time a transaction occurs, the cost per unit in the first layer of inventory is assigned to the items sold. If the number of items sold exceeds the number of items in the first layer, the cost per unit of the next layer is assigned to the remaining number of units sold, and so on.

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16) When maintaining perpetual inventory records, using the LIFO cost flow method leads to timing difficulties. The last-in, first-out (LIFO) cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. When sales and purchases occur intermittently, the cost of the last items purchased isn't known at the time earlier sales occur. Accountants can solve cost flow timing problems by keeping perpetual records of the quantity (number of units) of items purchased and sold separately from the related costs. 17) When weighted-average is used, first, the average cost per unit is calculated by dividing the total cost of goods available for sale by the total number of units available. Then, cost of goods sold is calculated by multiplying the average cost per unit by the number of units sold. 18) If the company's inventory items have declined in value from damage or obsolescence, the market value of the inventory, in aggregate, will be lower than its cost and the company will write down the inventory to the lower market value. The write-down will decrease assets (inventory) and stockholders' equity (retained earnings). 19) Kincaid would still have an adjustment at the end of the year for those items that lost value because the company applies the rule individually. However, no adjustment would be necessary if Kincaid applied the rule to the entire stock of inventory in the aggregate because the total market value of the inventory exceeded the total cost of the inventory. 20) When the lower-of-cost-or-market rule is applied to each individual inventory item, the accountant looks at each line item in the inventory and determines whether the original cost is higher or lower than the current market value. The lower of the two figures is then multiplied by the number of units. After performing this step for each line item in the inventory, the total of the resultant figures will be the valuation of the inventory. Each item is thus valued at the lower of cost or market. Version 1

21) Cost is determined using the FIFO, LIFO, weighted average, or specific identification cost flow method. Market is defined as the amount the company would have to pay to replace the merchandise. 22) If a material difference is detected between the physical and book inventories, an inventory adjustment is normally made. For example, if the physical count is less than the book figure, cost of goods sold (or an inventory loss account) would be increased and the inventory account would be decreased. 23) Understating ending inventory would cause the following effects in the first year: an overstatement of cost of goods sold and an understatement of gross margin, net income, retained earnings and total assets. In the following year, the error would reverse itself. Beginning inventory would be understated, cost of goods sold would be understated and gross margin and net income would be overstated. Retained earnings and total assets would be correctly stated at the end of the second year. 24) An estimate is helpful in determining the reasonableness of a physical inventory. If the book balance or the physical count is significantly higher than the estimated inventory balance, the analysis suggests the possibility of financial statement manipulation. 25) (1) Calculate the expected gross margin ratio using financial statement data from prior periods. (2) Estimate the dollar amount of gross margin by multiplying the gross margin percentage by the sales. (3) Estimate cost of goods sold by subtracting the estimated gross margin from sales. (4) Estimate ending inventory by subtracting the estimated cost of goods sold from the amount of goods available for sale (beginning inventory plus purchases).

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26) Inventory turnover is computed by dividing cost of goods sold by inventory. This is a measure of the speed with which the inventory is sold. A high turnover is more desirable than a low turnover. 27) Average number of days to sell inventory gives an indication of how much stock is on hand. It shows an average of how long it would take for the average inventory to be sold. 28) Gross margin ratio Gross margin ratio, based on history, can be used, paired with sales of the current period, to estimate cost of goods sold, and subsequently, ending inventory. 29) a) T b) F c) F d) T e) F 1.a) This is true. LIFO will report the cost of the oldest unit of inventory (beginning inventory) as its ending inventory. 2.b) This is false. Average cost per unit = ($10 + $10 + $12) ÷ 3 = $10.67 per unit; Cost of goods sold = 2 units × $10.67 = $21.34 3.c) This is false. Cash flow from operating activities = $24 inflow + $24 inflow − $10 outflow − $12 outflow = $26 inflow 4.d) This is true. Cash flow from operating activities = $24 inflow + $24 inflow − $10 outflow − $12 outflow = $26 inflow. This is unaffected by the inventory cost flow method used. 5.e) This is false. Sales of $48 − Cost of goods sold of ($10 + $10) = $28 gross margin

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30) a) F b) F c) T d) T e) T 1.a) This is false. Although FIFO mimics the physical flow of most inventory, the choice of a cost flow method does not necessarily conform to the physical flow of inventory. 2.b) This is false. In a period of rising inventory prices, the cost of the most recent purchases is higher than the cost of older inventory, so LIFO will produce a higher cost of goods sold than FIFO. 3.c) This is true. Average cost per unit = Cost of goods available for sale ÷ Number of units available for sale. 4.d) This is true. In a period of declining inventory prices, the cost of the most recent purchases is lower than the cost of older inventory, so LIFO will produce a lower cost of goods sold than FIFO, resulting in a higher net income and a higher income tax expense. 5.e) This is true. In a period of rising inventory prices, the cost of the most recent purchases (which remain in inventory using FIFO) is higher than the cost of older inventory.

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31) a) F b) T c) F d) T e) T 1.a) This is false. The lower (not higher) the company's inventory turnover ratio, the longer inventory remains in stock before it is sold, the higher the cost of financing inventory. 2.b) This is true. The decision a company makes regarding inventory cost flow is not related to decisions regarding selling prices. 3.c) This is false. If inventory prices are rising, LIFO will produce lower ending inventory than FIFO. Although LIFO will also result in lower income tax expense (decrease in cash), that difference is not as great as the difference in inventory. Therefore, total assets for LIFO will be lower than for FIFO. 4.d) This is true. A company that plans to offer more customer service will typically need to mark up their inventory more than a company that offers less service. Therefore, gross margin will be higher relative to sales, resulting in a higher gross margin percentage. 5.e) This is true. The lower-of-cost-or-market rule may result in a write-down of inventory, which decreases net income. However, since inventory is carried at cost and market cannot be greater than cost, the application of this rule will never result in a markup of inventory (or a resulting increase in net income).

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32) a) T b) F c) T d) F e) T 1.a) This is true. The first step in applying the weighted-average method is computing the weighted average cost per unit. 2.b) This is false. Average cost per unit is calculate by dividing cost of goods available for sale by the number of units available for sale. 3.c) This is true. Under the FIFO method, each time units are sold, the cost per unit of the oldest inventory is applied to the number of units sold. 4.d) This is false. When maintaining perpetual inventory records, using the weighted-average or LIFO cost flow methods leads to timing difficulties. However, accountants can solve cost flow timing problems by keeping perpetual records of the quantities (number of units) of items purchased and sold separately from the related costs. 5.e) This is true. The U.S. Internal Revenue Service only permits LIFO for tax reporting if it is also used for financial reporting.

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33) a) T b) F c) T d) T e) F 1.a) This is true. Product B's cost is $24 × 300 units = $7,200. 2.b) This is false. If Warren selects to apply the lower-of-cost-ormarket rule to each individual inventory item, Product A would be listed at the lower cost amount of $20. 3.c) This is true. The total market value of Warren's inventory is $13,000 (or 200 units of A × $25 per unit + 300 units of B × $22 per unit + 100 units of C × $14 per unit); since the cost is $12,800, no writedown of inventory would be needed. However, if the rule were applied using the individual method, write-downs of Product B from $24 to $22 and of Product C from $16 to $14 would be needed. 4.d) This is true. If Warren applies the rule to each individual inventory item, inventory in the amount of $12,000 (or 200 units of A × $20 per unit + 300 units of B × $22 per unit + 100 units of C × $14 per unit) would be shown on the balance sheet. 5.e) This is false. Market is lower than cost for Product C; so, the lower of cost or market =100 units × $14 per unit = $1,400.

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34) a) T b) T c) F d) F e) F 1.a) This is true. Cost of goods available for sale = Beginning inventory of $120,000 + Purchases of $420,000 = $540,000. 2.b) This is true. If average gross margin percentage is 30%, cost of goods sold percentage is 100% − 30%, or 70%. 3.c) This is false. Estimated cost of goods sold = Sales of $690,000 × Gross margin percentage of 70% = $483,000. 4.d) This is false. Estimated ending inventory = Beginning inventory of $120,000 + Purchases of $420,000 − Estimated cost of goods sold of $483,000 = $57,000. 5.e) This is false. Sales of $690,000 − Estimated cost of goods sold of $483,000 = $207,000. 35) a) F b) F c) T d) F e) T 1.a) This is false. Overstating ending inventory at the end of Year 1 will understate cost of goods sold by $28,000. 2.b) This is false. Overstating ending inventory for Year 1 by $28,000 also overstates net income for Year 1 by $28,000, not $14,000. 3.c) This is true. Overstating ending inventory for Year 1 by $28,000 also overstates retained earnings at the end of Year 1 by $28,000. 4.d) This is false. Overstating ending inventory for Year 1 will also result in overstating beginning inventory for Year 2. 5.e) This is true. By the end of Year 2, the inventory error for Year 1 will have been reversed and retained earnings will be correctly stated.

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36) a) T b) F c) F d) T e) T 1.a) This is true. Inventory turnover = Cost of goods sold of $320,000 ÷ Inventory of $64,000 = 5.0. 2.b) This is false. Average number of days to sell inventory = 365 days ÷ Inventory turnover of 5.0 = 73 days. 3.c) This is false. Inventory turnover is calculated by dividing cost of goods sold by inventory. Furthermore, increasing prices could cause inventory to sell more slowly. 4.d) This is true. Gross margin = Sales of $600,000 − Cost of goods sold of $320,000 = $280,000; Gross margin percentage = Gross margin of $280,000 ÷ Sales of $600,000 = 46.7%. 5.e) This is true. With an inventory turnover ratio of 5.0, Bell Company turns its inventory more quickly than the competitor, and thus is likely to be more profitable than the competitor. 37) Cost of Goods Sold: a) (1) $13,975 a) (2) $15,600 a) (3) $14,735 Ending Inventory: b) (1) $9,600 b) (2) $7,975 b) (3) $8,841 a) (1) and (2) Cost of goods sold using FIFO and LIFO: FIFO

LIFO

25 @ $175 20 @ $180

$ 4,375 3,600

30 @ $200

6,000

Total

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30 @ $220 45 @ $200

$ 6,600 9,000

Total

$15,600

$13,975

a) (3) Cost of goods sold using weighted average: Average cost per unit = Cost of goods available for sale of [(25 × $175) + (20 × $180) + (45 × $200) + (30 × $220)] ÷ Units available for sale of 120 units = $196.46 per unit Cost of goods sold = Average cost of $196.46 × 75 units = $14,735 b) (1) and (2) Ending inventory using FIFO and LIFO: FIFO

LIFO

15 @ $200 30 @ $220

$ 3,000 6,600

20 @ $180 25 @ $175

$ 3,600 4,375

Total

$ 9,600

Total

$ 7,975

b) (3) Ending inventory using weighted average: Average cost of $196.46 per unit × 45 units = $8,841 38) a) 1) FIFO Income Statement For the Year Ended December 31, Year 2 Sales (125 @ $225) Cost of goods sold Gross margin Selling and administrative expense Net income before taxes Income tax expense

$ 28,125 13,475 14,650 11,000 3,650 1,095

Net income

$ 2,555

2) LIFO Income Statement For the Year Ended December 31, Year 2 Sales (125 @ $225)

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$ 28,125

Cost of goods sold Gross margin Selling and administrative expense Net income before taxes Income tax expense

14,450 13,675 11,000 2,675 803

Net income

$ 1,872

b) 1) FIFO FIFO Cash Flow from Operating Activities Cash received from sales Cash payment for inventory Cash payment for selling and administrative expense Cash payment for income tax expense Net cash flow from operating activities

$ 28,125 (13,950) (11,000) (1,095) $ 2,080

2) LIFO LIFO Cash Flow from Operating Activities Cash received from sales Cash payment for inventory Cash payment for selling and administrative expense Cash payment for income tax expense Net cash flow from operating activities

$ 28,125 (13,950) (11,000) (803) $ 2,372

a) (1) and (2) Cost of goods sold: FIFO 60 @ $100 65 @ $115 Total

LIFO 30 @ $120 90 @ $115 5 @ $100

$ 6,000 7,475 $ 13,475 Total

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$ 3,600 10,350 500 $ 14,450

39) (1) FIFO: Cost of goods sold = $31,920 Ending inventory = $8,640 (2) LIFO: Cost of goods sold = $30,960 Ending inventory = $9,600 (3) Weighted Average: Cost of goods sold = $31,546 Ending inventory = $9,013 (1) FIFO FIFO Cost of goods sold: 70 @ $240 70 @ $216 Total

$ 16,800 15,120 $ 31,920

Ending inventory: 40 @ $216 = $8,640 (2) LIFO LIFO Cost of goods sold: 110 @ $216 30 @ $240 Total

$ 23,760 7,200 $ 30,960

Ending inventory: 40 @ $240 = $9,600 (3) Weighted Average

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70 @ $240 = 110@ $216 =

$ 16,800 23,760

Cost of goods available for sale

$ 40,560

Weighted average cost per unit:

$40,560/180 units = 140 × $225.33 = 40 × $225.33 =

Cost of goods sold: Ending inventory:

$ 225.33 31,546 9,013

40) $580 FIFO Ending Inventory: 5 units × $116 per unit = $580 41) a) Date January 1 January 6 January 8

Unit Purchased (Sold) 30 40 (30)

January 19 January 22

January 30

Cost per Unit 150 160 150

Total

Balance

4,500 6,400 (4,500)

4,500 10,900

(20)

160

(3,200)

3,200

20 (20)

164 160

3,280 (3,200)

6,480

(10)

164

(1,640)

1,640

156

2,340

3,980

b) Ending inventory: 10 units @ $164 = 15 units @ $156 =

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$ 1,640 2,340 $ 3,980

42) a) $107,360 b) $103,520 c) $9,192 d) $10,344 e) Based on this information, Max would be better off to use LIFO because of the lower amount of income taxes it would pay. a) For LIFO, cost of goods sold = (90 @ $320) + (240 @ $304) + (20 @ $280) = $107,360 b) For FIFO, cost of goods sold = (120 @ $280) + (230 @ $304) = $103,520 c) and d) Income Statement LIFO

FIFO

Sales (350 @ $480) Cost of goods sold Gross margin Operating expenses Net income before taxes Income tax expense

$168,000 107,360 60,640 30,000 30,640 9,192

$168,000 103,520 64,480 30,000 34,480 10,344

Net income

$ 21,448

$ 24,136

43)

a) FIFO b) LIFO c) Weighted average

Cost of Goods Sold

Ending Inventory

$ 75,000 $ 83,000 $ 79,335 Cost of Goods Sold

$ 61,000 $ 53,000 $ 56,668 Ending Inventory

a) FIFO

$75,000 (100 × $200) + (250 × $220) b) LIFO $83,000 (200 × $250) + (150 × $220) c) Weighted average $79,335 (350 × $226.67)

$61,000 (200 × $250) + (50 × 220) $53,000 (100 × $220) + (150 × 220) $56,668 (250 × $226.67)

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Average cost per unit: [(100 × $200) + (300 × $220) + (200 × $250)] ÷ 600 = $226.67 (rounded to 2 decimal places) 44) Cost of Goods Sold a) FIFO b) LIFO c) Weighted average

$ 1,100 $ 1,200 $ 1,150

Ending Inventory $ 1,200 $ 1,100 $ 1,150

The first-in, first-out (FIFO) cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. The last-in, first-out (LIFO) cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. The weighted-average method first determines the average cost per unit as the total cost of the inventory available divided by the total number of units available, and then multiplies that result by the number of units.

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45) a) (1) $20,940 a) (2) $20,340 a) (3) $20,700 b) $600 c) (1) $27,340 c) (2) $27,340 a) (1) FIFO Cost of goods sold = (120 @ $100) + (130 @ $112) = $26,560 Gross margin = $47,500 − 26,560 = $20,940 a) (2) LIFO Cost of goods sold = (180 @ $112) + (70 @ $100) = $27,160 Gross margin = $47,500 − 27,160 = $20,340 a) (3) Weighted Average Average cost per unit = [(120 @ $100) + (180 @ $112)] ÷ 300 = $107.20 Cost of goods sold = 250 @ $107.20 = $26,800 Gross margin = $47,500 − 26,800 = $20,700 b) FIFO gross margin of $20,940 − LIFO gross margin of $20,340 = Difference in net income of $600 By FIFO, net income will be $600 higher than by LIFO, ignoring the effect of income taxes. c) (1) FIFO cash flow from operating activities = $47,500 − (180 units @ $112 per unit) = $27,340 c) (2) LIFO cash flow from operating activities = $47,500 − (180 units @ $112 per unit) = $27,340 46) (a) $43,800 (b) $2,610 (a) and (b) Date

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Units Cost per Purchased Unit

Total

Cost of Inventory Goods Sold Balance

(Sold) 950

October Beginning 1 inventory October First 800 12 purchase October Cash sales (950) 18 (550) October Second 600 21 purchase October Third 300 25 purchase October Cash sales (250) 31 (600) (150)

$ 17.00 $ 19.00 $ 17.00 $ 19.00 $ 16.40 $ 17.40 $ 19.00 $ 16.40 $ 17.40

$ 16,150 $ 15,200

$ 16,150 $ 31,350 $ (16,150) $ (10,450)

$ 9,840 $ 5,220

$ 4,750 $ 14,590 $ 19,810

$ (4,750) $ (9,840) $ (2,610)

Total cost of goods sold

$ 2,610

$(43,800)

Ending inventory

$ 2,610

47) 1.a) $242,400 2.b) Year 1 must have been a year of rising inventory prices because LIFO gives a lower ending inventory and higher cost of goods sold than FIFO. 1.a) Cost of goods available for sale = $240,000 + 58,400 = $298,400 Cost of goods sold = $298,400 − 56,000 = $242,400 48) 1) $91,200 2) $92,000 Date

1-January Beginning

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Units Purchased (Sold) 1,200

Cost per Unit 60

Total

Balance

72,000

15January 25January 5February 18February

15-March

Balance Purchase Sale Purchase Sale

Purchase

72,000 104,000

500

32,200

(700)

600

(500)

(30,000)

(300)

(19,200)

600

(42,000) 40,800

62,000 102,800

38,400

Total cost of goods sold

53,600 92,000

(91,200)

Ending inventory

$ 92,000

49) a) $46,412 b) $47,296 a) ltem Quantity

700

950

520

115

400

Cost per Unit $ 10.90 $ 3.65 $ 15.00 $ 23.30 $ 44.25 $ 89.10

Market Total Cost Total Value Market per Unit $ $ $ 10.75 7,630.00 7,525.00 $ $ $ 4.00 3,467.50 3,800.00 $ $ $ 13.90 7,800.00 7,228.00 $ $ $ 21.50 2,679.50 2,472.50 $ $ $ 47.60 17,700.00 19,040.00 $ $ $ 91.55 8,019.00 8,239.50 $ 47,296.00

$ 48,305.00

LCM

Loss

$ 7,525.00 $ 3,467.50 $ 7,228.00 $ 2,472.50 $ 17,700.00 $ 8,019.00

$ 105.00 $ -

$ 46,412.00

$ 884.00

Total Market

Loss

$ 572.00 $ 207.00 $ $ -

b) ltem

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Quantity

Cost per

Market

Total Cost

Unit A B C D E

700 950 520 115 400

$ 10.90 $ 3.65 $ 15.00 $ 23.30 $ 44.25

Value per Unit $ 10.75 $ 7,630.00 $ 4.00 $ 3,467.50 $ 13.90 $ 7,800.00 $ 21.50 $ 2,679.50 $ 47.60 $ 17,700.00

$ 89.10

$ 91.55

$ 7,525.00 $ 3,800.00 $ 7,228.00 $ 2,472.50 $ 19,040.00

$ $ $ $ -

$ 8,019.00

$ 8,239.50

$ -

$ 47,296.00

$ 48,305.00

$ -

50) a) $18,860.00 b) $18,340.00 c) $18,620.00 d) Applying the lower-of-cost-or-market rule to each individual inventory item results in the smallest total assets. a), b), c), and d) ltem Quantity

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Cost per Unit $ 120.00 $ 84.00 $ 170.00 $ 152.00

Market Total Cost Value per Unit $ $ 124.00 4,800.00 $ $ 80.00 2,520.00 $ $ 162.00 8,500.00 $ $ 158.00 3,040.00

Total Market

LCM

Loss

$ 4,960.00 $ 2,400.00 $ 8,100.00 $ 3,160.00

$ 4,800.00 $ 2,400.00 $ 8,100.00 $ 3,040.00

$ -

$ 18,860.00

$ 18,620.00

$ 18,340.00

$ 120.00 $ 400.00 $ $ 520.00

51) 1.Year 2 Beginning Inventory: U 2.Year 2 Purchases: N 3.Year 1 Goods Available for Sale: N 4.Year 1 Net Income: U 5.Year 1 Retained Earnings ending balance: U 6.Year 1 Total Assets at end of year: U 7.Year 2 Net Income: O 8.Year 2 Retained Earnings ending balance: N 9.Year 1 Cost of Goods Sold: O 10.Year 1 Gross Margin: U Effect of error on elements of Year 1 financial statements: Understating ending inventory understates total assets (inventory) and stockholders' equity (retained earnings). It overstates expenses (since ending inventory is subtracted in the calculation of cost of goods sold), which understates gross margin and net income. It does not affect purchases or the statement of cash flows. Effect of error on elements of Year 2 financial statements: The Year 1 ending inventory becomes the Year 2 beginning inventory. Understating beginning inventory does not impact total assets or stockholders' equity (retained earnings). It understates expenses (since beginning inventory is added in the calculation of cost of goods sold), which overstates gross margin and net income. It does not affect the statement of cash flows. 52) $33,750 Sales

$ 275,000

Beginning inventory

$ 22,500

Purchases

190,000

Cost of goods available for sale Less: Ending inventory

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$ 212,500 ??????

Cost of goods sold

178,750

($275,000 × 65%)

Gross margin

$ 96,250

($275,000 × 35%)

53) a) $44,680 b) $9,720 c) 79 days 1.a) Cost of goods sold = (150 × $132) + (100 × $130) + (110 × $108) = $44,680 2.b) Ending inventory = 90 × $108 = $9,720 3.c) Average number of days to sell inventory = 365 ÷ Inventory turnover Inventory turnover = $44,680 cost of goods sold ÷ $9,720 ending inventory = 4.60 Average number of days to sell inventory = 365 ÷ 4.60 = 79.3 days (rounds to 79 days) 54) a) through d) Cost of goods sold Inventory balance at end of year Inventory turnover Average # of days to sell inventory

LIFO

FIFO

(150 × $125) + (100 × $120) + (110 × $110) = $42,850 90 × $110 = $9,900

(200 × $110) + (100 × $120) + (60 × $125) = $41,500 90 × $125 = $11,250

$42,850/$9,900 = 4.33

$41,500/$11,250 = 3.69

365/4.33 = 84 days

365/3.69 = 99 days

e) LIFO and FIFO do not give the same results for inventory turnover. In this case, LIFO gave a higher inventory turnover. The higher turnover occurred because LIFO gave a higher amount for cost of goods sold and a lower amount for ending inventory.

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55) a) $16,760 b) $3,740 c) 81 days 1.a) Cost of goods sold = (300 × $25) + (150 × $30) + (140 × $34) = $16,760 2.b) Ending inventory = 110 × $34 = $3,740 3.c) Average number of days to sell inventory = 365 ÷ Inventory turnover Inventory turnover = $16,760 ÷ $3,740 = 4.48 Average number of days to sell inventory = 365 ÷ 4.48 = 81 days

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CHAPTER 5 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) One of the disadvantages of the specific identification inventory cost flow method is that it can allow managers of a business to manipulate the amount of income the business reports. ⊚ true ⊚ false

2) The specific identification inventory method is not practical for companies that sell many low-priced, high turnover items. ⊚ true ⊚ false

3) The LIFO cost flow method assigns the cost of the items purchased first to ending inventory. ⊚ ⊚

true false

4) Generally accepted accounting principles do not allow the cost flow pattern for merchandise inventory to differ from the physical flow of merchandise within the business. ⊚ true ⊚ false

5) In most businesses, the physical flow of goods occurs on a FIFO basis, but a different cost flow method is allowed under generally accepted accounting principles. ⊚ ⊚

true false

6) A company's gross margin reported on the income statement is not affected by the inventory cost flow method it uses. ⊚ true ⊚ false

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7) During a period of rising inventory prices the LIFO cost flow method will result in higher total assets than FIFO. ⊚ ⊚

true false

8) During a period of rising inventory prices, a company's cost of goods sold would be higher using the LIFO cost flow method than with FIFO. ⊚ ⊚

true false

9) During a period of declining prices, a company would report a lower gross margin using the FIFO cost flow method than with LIFO. ⊚ ⊚

true false

10) A company uses a cost flow method (such as last-in, LIFO or FIFO) to allocate product costs between cost of goods sold and beginning inventory. ⊚ ⊚

true false

11) During a period of rising inventory prices, the amount of ending inventory reported on the balance sheet will be lower using the LIFO cost flow method than with FIFO. ⊚ true ⊚ false

12) Generally accepted accounting principles often allow companies to account for the same types of events in different ways.

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⊚ ⊚

true false

13) In a period of rising inventory prices, use of the FIFO cost flow method would cause a company to pay more income taxes than would use of LIFO. ⊚ ⊚

true false

14) If a company uses the FIFO cost flow method for its income tax return it must also use FIFO for financial reporting. ⊚ ⊚

true false

15) Generally accepted accounting principles restrict or limit a company's freedom to change inventory cost flow methods from one year to the next. ⊚ true ⊚ false

16)

Singleton Company's perpetual inventory records included the following information:

Date

Activities

January 1 March 4 September 28

Beginning inventory Purchase Purchase

Number of units and unit cost 360 units @ $15

Total cost

310 units @ $24 670 units @ $17

$7,440 $11,390

$5,400

Number of units sold during the year: 1,000 If Singleton uses the LIFO cost flow method, its ending inventory would be $5,100. ⊚ ⊚

17)

true false

Singleton Company's perpetual inventory records included the following information:

Date

Version 1

Activities

Number of units and

Total

January 1 March 4 September 28

Beginning inventory Purchase Purchase

unit cost 200 units @ $7.00

cost $1,400

150 units @ $8.00 350 units @ $9.00

$1,200 $3,150

Number of units sold during the year: 520 If Singleton uses the LIFO cost flow method, its ending inventory would be $1,260. ⊚ ⊚

18)

true false

Singleton Company's perpetual inventory records included the following information:

Date

Activities

January 1 March 4 September 28

Beginning inventory Purchase Purchase

Number of units and unit cost 220units @ $8

Total cost $1,760

170 units @ $10 390units @ $10

$1,700 $3,900

Number of units sold during the year: 580 If Singleton uses the FIFO cost flow method, its cost of goods sold would be $5,250. ⊚ ⊚

19)

true false

Singleton Company's perpetual inventory records included the following information:

Date

Activities

January 1 March 4 September 28

Beginning inventory Purchase Purchase

Number of units and unit cost 200 units @ $7.00

Total cost $1,400

150 units @ $8.00 350 units @ $9.00

$1,200 $3,150

Number of units sold during the year: 520 If Singleton uses the FIFO cost flow method, its cost of goods sold would be $4,490. ⊚ ⊚

20)

true false

Singleton Company's perpetual inventory records included the following information:

Version 1

Date

Activities

January 1 March 4 September 28

Beginning inventory Purchase Purchase

Number of units and unit cost 380units @ $16

Total cost

330 units @ $26 710units @ $18

$8,580 $12,780

$6,080

Number of units sold during the year: 1,060 If Singleton uses the weighted-average cost flow method, its average cost per unit would be $26.00. ⊚ true ⊚ false

21)

Singleton Company's perpetual inventory records included the following information:

Date January 1 March 4 September 28

Activities Beginning inventory Purchase Purchase

Number of units and unit cost 200 units @ $7.00

Total cost $1,400

150 units @ $8.00 350 units @ $9.00

$1,200 $3,150

Number of units sold during the year: 520 If Singleton uses the weighted-average cost flow method, its average cost per unit would be $8.00. ⊚ true ⊚ false

22) Warner Company purchased twelve units of a product for $18 eachand later purchased six more for $19.50. If the company uses the weighted average cost flow method, and it sold one unit of the product for $40, its gross margin would be $21.50. ⊚ true ⊚ false

23) Warner Company purchased two units of a product for $36 and later purchased one more for $40. If the company uses the weighted average cost flow method, and it sold one unit of the product for $60, its gross margin would be $22.00. ⊚ true ⊚ false

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24) The Internal Revenue Service allows a company to use LIFO for income tax purposes only if it also uses LIFO for financial reporting. ⊚ ⊚

true false

25) International Financial Reporting Standards (IFRS) do not permit the use of the LIFO inventory cost flow method. ⊚ ⊚

true false

26) If a company uses the LIFO cost flow method, it is not required by generally accepted accounting principles to apply the lower-of-cost-or-market rule. ⊚ ⊚

true false

27) If the replacement cost of inventory is greater than its historical cost, the increase in value does not affect the company's financial statements. ⊚ true ⊚ false

28) A loss resulting from application of the lower-of-cost-or-market rule is included in cost of goods sold if the loss is material in amount. ⊚ true ⊚ false

29) If a company overstates its Inventory balance at the end of Year 1 due to an error, its Retained Earnings will also be overstated on the Year 1 balance sheet. ⊚ true ⊚ false

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30) The gross margin method of estimating inventory is not useful in detecting inventory fraud. ⊚ true ⊚ false

31) A discount merchandiser is likely to have a higher inventory turnover than more upscale stores with higher merchandise prices. ⊚ true ⊚ false

32)

The cost flow method chosen by a company will impact its inventory turnover ratio. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 33) During a time of declining prices, which inventory cost flow method will result in the highest ending inventory?

A) Weighted-average B) FIFO C) LIFO D) Either weighted-average or FIFO

34) When prices are rising, which method of inventory, if any, will result in the lowest relative net cash outflow (including the effects of taxes, if any)?

A) LIFO. B) FIFO. C) Weighted average. D) None of these; the choice of inventory methods does not affect cash flows.

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35) Which inventory costing method will produce an amount for cost of goods sold that is closest to current market value?

A) Weighted average B) Specific identification C) LIFO D) FIFO

36) Blake Company purchased two identical inventory items. The item purchased first cost $27.00, and the item purchased second cost $28.00. Blake sold one of the items for $50.00. Which of the following statements is true?

A) Ending inventory will be lower if Blake usesthe weighted-average rather than the FIFO inventory cost flow method. B) Cost of goods sold will be higher if Blake uses the FIFO rather than the weightedaverage inventory cost flow method. C) The dollar amount assigned to ending inventory will be the same no matter which inventorycost flow method is used. D) Gross margin will be higher if Blake uses LIFO rather than the FIFO inventory cost flow method.

37) Blake Company purchased two identical inventory items. The item purchased first cost $16.00, and the item purchased second cost $18.00. Blake sold one of the items for $24.00. Which of the following statements is true?

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A) Ending inventory will be lower if Blake uses the weighted-average rather than the FIFO inventory cost flow method. B) Cost of goods sold will be higher if Blake uses the FIFO rather than the weightedaverage inventory cost flow method. C) The dollar amount assigned to ending inventory will be the same no matter which inventory cost flow method is used. D) Gross margin will be higher if Blake uses LIFO rather than the FIFO inventory cost flow method.

38)

What happens when prices are falling?

A) LIFO will result in lower net income and a lower inventory valuation than will FIFO. B) LIFO will result in lower net income and a higher inventory valuation than will FIFO. C) LIFO will result in higher net income and a higher inventory valuation than will FIFO. D) LIFO will result in higher net income and a lower inventory valuation than will FIFO.

39) If prices are rising, which inventory cost flow method will produce the lowest amount of cost of goods sold?

A) LIFO. B) FIFO. C) Weighted average. D) LIFO, FIFO, and the weighted-average inventory cost flow methods will all produce equal amounts of cost of goods sold.

40) Barker Company paid cash to purchase two identical inventory items. The first purchase cost $18.00 cash and the second cost $20.00 cash. Barker sold one inventory item for $30.00 cash. Based on this information alone, without considering the effect of income taxes, which of the following statements is correct?

Version 1

A) Cash flow from operating activities is $11.00 assuming the weighted-average inventory cost flow method is used. B) Cash flow from operating activities is $12.00 assuming the FIFO inventory cost flow method is used. C) Cash flow from operating activities is $10.00 assuming the LIFO inventory cost flow method is used. D) The amount of cash flow from operating activities is not affected by the inventory cost flow method chosen.

41) When the cost of purchasing inventory is declining, which inventory cost flow method will produce the highest amount of cost of goods sold?

A) Weighted-average. B) LIFO. C) FIFO. D) LIFO, FIFO, and weighted-average will all produce the same amount of cost of goods sold.

42)

What happens when a company is operating in an inflationary environment?

A) The company's net income will be higher if it uses LIFO than if it uses FIFO. B) The company's cost of goods sold will be lower if it uses LIFO as opposed to FIFO. C) The company's net income will be the same regardless of whether LIFO or FIFO is used. D) The company's assets will be lower if it uses LIFO as opposed to FIFO cost flow.

43) Hoover Company purchased two identical inventory items. The item purchased first cost $38.50. The item purchased second cost $43.00. Then Hoover sold one of the inventory items for $65. Based on this information, which of the following statements is true?

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A) The ending inventory is $43.00 if Hoover uses the LIFO cost flow method. B) The gross margin is $24.25 if Hoover uses the weighted-average cost flow method. C) The cost of goods sold is $43.00 if Hoover uses the FIFO cost flow method. D) The cost of goods sold is $38.50 if Hoover uses the LIFO cost flow method.

44) Hoover Company purchased two identical inventory items. The item purchased first cost $33.00. The item purchased second cost $35.00. Then Hoover sold one of the inventory items for $62.00. Based on this information, which of the following statements is true?

A) The ending inventory is $35.00 if Hoover uses the LIFO cost flow method. B) The gross margin is $28.00 if Hoover uses the weighted-average cost flow method. C) The cost of goods sold is $35.00 if Hoover uses the FIFO cost flow method. D) The cost of goods sold is $33.00 if Hoover uses the LIFO cost flow method.

45) Anton Company uses the perpetual inventory system and FIFO cost flow method. During the year, Anton purchased 520 units of inventory that cost $8 each and then purchased an additional 690 units of inventory that cost $10 each. If Anton sells 850 units of inventory, what is the amount of cost of goods sold? A) $8,500 B) $7,460 C) $6,800 D) $8,420

46) Anton Company uses the perpetual inventory system and FIFO cost flow method. During the year, Anton purchased 400 units of inventory that cost $12.00 each and then purchased an additional 600 units of inventory that cost $16.00 each. If Anton sells 700 units of inventory, what is the amount of cost of goods sold?

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A) $11,200 B) $10,400 C) $8,400 D) $9,600

47)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

2,200 units @ $6.00 2,300 units @ $6.20 2,500 units @ $6.30 2,100 units @ $6.40 6,900 units @ $7.90

If the company uses the weighted-average inventory cost flow method, what is the average cost per unit (rounded) for May? A) $6.23 B) $6.17 C) $6.30 D) $7.90

48)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase@ May 7 Second purchase@ May 17 Third purchase@ May 23 Sales @ May 31

100 units @ $4.00 300 units @ $4.40 500 units @ $4.60 100 units @ $4.80 900 units @ $7.80

If the company uses the weighted-average inventory cost flow method, what is the average cost per unit (rounded) for May? A) $4.45 B) $4.50 C) $5.12 D) $6.34

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49)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

400 units @ $2.40 500 units @ $2.60 700 units @ $2.70 300 units @ $2.80 1,500 units @ $4.30

What is the amount of cost of goods sold assuming the LIFO cost flow method?

A) $4,200 B) $4,030 C) $3,900 D) $3,600

50)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

100 units @ $4.00 300 units @ $4.40 500 units @ $4.60 100 units @ $4.80 900 units @ $7.80

What is the amount of cost of goods sold assuming the LIFO cost flow method?

A) $4,100 B) $4,320 C) $2,360 D) $3,600

51)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

Version 1

1,100 units @ $3.80 1,200 units @ $4.00 1,400 units @ $4.10 1,000 units @ $4.20 3,700 units @ $5.70

What is the amount of ending inventory assuming the FIFO cost flow method?

A) $4,400 B) $4,200 C) $4,180 D) $4,040

52)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase@ May 7 Second purchase@ May 17 Third purchase@ May 23 Sales @ May 31

100 units @ $4.00 300 units @ $4.40 500 units @ $4.60 100 units @ $4.80 900 units @ $7.80

What is the amount of ending inventory assuming the FIFO cost flow method?

A) $480 B) $440 C) $400 D) $940

53)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

1,100 units @ $3.80 1,200 units @ $4.00 1,400 units @ $4.10 1,000 units @ $4.20 3,600 units @ $5.70

What is the amount of gross margin assuming the weighted-average inventory cost flow method? (Round your intermediate calculations to two decimal places.)

Version 1

A) $6,012 B) $15,120 C) $5,400 D) $9,360

54)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

100 units @ $4.00 300 units @ $4.40 500 units @ $4.60 100 units @ $4.80 900 units @ $7.80

What is the amount of gross margin assuming the weighted-average inventory cost flow method? A) $3,015 B) $2,412 C) $1,314 D) $2,970

55)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase @ May 7 Second purchase @ May 17 Third purchase @ May 23 Sales @ May 31

500 units @ $2.60 600 units @ $2.80 800 units @ $2.90 400 units @ $3.00 1,900 units @ $4.50

What is the amount of gross margin assuming the FIFO cost flow method?

A) $2,600 B) $3,400 C) $5,300 D) $3,250

56)

The inventory records for Radford Company reflected the following:

Beginning inventory @ May 1 First purchase@ May 7

Version 1

100 units @ $4.00 300 units @ $4.40 15

Second purchase@ May 17 Third purchase@ May 23 Sales @ May 31

500 units @ $4.60 100 units @ $4.80 900 units @ $7.80

What is the amount of gross margin assuming the FIFO cost flow method? A) $2,920 B) $3,420 C) $3,000 D) $4,020

57) Glasgow Enterprises started the period with 75 units in beginning inventory that cost $2.00 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

Number of Items 370 115 60

Cost $2.50 $2.60 $3.00

Glasgow sold 395 units after purchase 3 for $8.10 each. What is Glasgow's cost of goods sold under FIFO? A) $950 B) $790 C) $1,185 D) $1,051

58) Glasgow Enterprises started the period with 80 units in beginning inventory that cost $7.50 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

Version 1

Number of Items 200 150 50

Cost $9.00 $9.30 $10.50

Glasgow sold 220 units after purchase 3 for $17.00 each. What is Glasgow's cost of goods sold under FIFO?

A) $1,650 B) $1,860 C) $2,310 D) $2,100

59) Glasgow Enterprises started the period with 65 units in beginning inventory that cost $3.40 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

Number of Items 310 145 60

Cost $3.90 $4.00 $4.40

Glasgow sold 335 units after purchase 3 for $12.30 each. What isGlasgow's ending inventory under LIFO?

A) $1,078 B) $980 C) $923 D) $833

60) Glasgow Enterprises started the period with 80 units in beginning inventory that cost $7.50 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

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Number of Items 200 150 50

Cost $9.00 $9.30 $10.50

Glasgow sold 220 units after purchase 3 for $17.00 each. What is Glasgow's ending inventory under LIFO?

A) $2,730 B) $2,460 C) $2,220 D) $1,950

61) Glasgow Enterprises started the period with 70 units in beginning inventory that cost $2.10 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

Number of Items 280 190 60

Cost $2.60 $2.70 $3.10

Glasgow sold 305 units after purchase 3 for $8.40 each. What is Glasgow's ending inventory under weighted-average? (Round your intermediate computation to 2 decimal places.) A) $773 B) $780 C) $799 D) $650

62) Glasgow Enterprises started the period with 80 units in beginning inventory that cost $7.50 each. During the period, the company purchased inventory items as follows: Purchase 1 2 3

Number of Items 200 150 50

Cost $9.00 $9.30 $10.50

Glasgow sold 220 units after purchase 3 for $17.00 each. What is Glasgow's ending inventory under weighted-average (rounded)?

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A) $2,361 B) $2,340 C) $1,980 D) $1,998

63) Poole Company purchased two identical inventory items. One of the items, purchased in January, cost $28. The other, purchased in February, cost $34. One of the items was sold in March at a selling price of $80. Poole uses LIFO. Which of the following statements is true?

A) The balance in ending inventory would be $34. B) The amount of gross margin would be $46. C) The amount of ending inventory would be $31. D) The amount of cost of goods sold would be $28.

64) Poole Company purchased two identical inventory items. One of the items, purchased in January, cost $4.50. The other, purchased in February, cost $4.75. One of the items was sold in March at a selling price of $7.50. Poole uses LIFO. Which of the following statements is true?

A) The balance in ending inventory would be $4.75. B) The amount of gross margin would be $2.75. C) The amount of ending inventory would be $4.625. D) The amount of cost of goods sold would be $4.50.

65) Koontz Company uses the perpetual inventory method and the weighted-average method. On January 1, Year 1, the company's first day of operations, Koontz purchased 456 units of inventory that cost $7.50 each. On January 10, Year 1, the company purchased an additional 684 units of inventory that cost $9.00 each. If the company sells 550 units of inventory, what is the amount of inventory that would appear on the balance sheet immediately following the sale?

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A) $4,256 B) $4,763 C) $4,956 D) $5,970

66) Koontz Company uses the perpetual inventory method and the weighted-average method. On January 1, Year 1, the company’s first day of operations, Koontz purchased 400 units of inventory that cost $7.50 each. On January 10, Year 1, the company purchased an additional 600 units of inventory that cost $9.00 each. If the company sells 550 units of inventory, what is the amount of inventory that would appear on the balance sheet immediately following the sale? A) $3,780 B) $4,738 C) $3,080 D) $3,713

67) Stubbs Company uses the perpetual inventory method and the weighted-average cost flow method. On January 1, Year 2, Stubbs purchased 550 units of inventory that cost $3.50 each. On January 10, Year 2, the company purchased an additional 600 units of inventory that cost $3.00 each. If the company sells 1,000 units of inventory for $7 each, what is the amount of gross margin reported on the income statement? (Round your intermediate calculations to two decimal places.) A) $3,725 B) $3,760 C) $4,000 D) $3,240

68) Stubbs Company uses the perpetual inventory method and the weighted-average cost flow method. On January 1, Year 2, Stubbs purchased 400 units of inventory that cost $8.00 each. On January 10, Year 2, the company purchased an additional 600 units of inventory that cost $9.00 each. If the company sells 700 units of inventory for $16.00 each, what is the amount of gross margin reported on the income statement?

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A) $5,180 B) $5,250 C) $5,000 D) $6,020

69) Melbourne Company uses the perpetual inventory system and LIFO cost flow method. Melbourne purchased 2,000 units of inventory that cost $13.25 each. At a later date, the company purchased an additional 2,100 units of inventory that cost $13.75 each. If the company sells 2,300 units of inventory, what amount of ending inventory will appear on a balance sheet prepared immediately after the sale? A) $31,525 B) $24,300 C) $23,850 D) $24,750

70) Melbourne Company uses the perpetual inventory system and LIFO cost flow method. Melbourne purchased 500 units of inventory that cost $4.00 each. At a later date, the company purchased an additional 600 units of inventory that cost $5.00 each. If the company sells 800 units of inventory, what amount of ending inventory will appear on a balance sheet prepared immediately after the sale?

A) $3,800. B) $1,350. C) $1,500. D) $1,200.

71) Vargas Company uses the perpetual inventory system and the FIFO cost flow method. During the current year, Vargas purchased 2,100 units of inventory that cost $22 each. At a later dateduring the year, the company purchased an additional 2,500 units of inventory that cost $23 each. Vargas sold 2,200 units of inventory for $26.What is the amount of cost of goods sold that will appear on the current year’s income statement?

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A) $8,700 B) $46,200 C) $6,600 D) $48,500

72) Vargas Company uses the perpetual inventory system and the FIFO cost flow method. During the current year, Vargas purchased 400 units of inventory that cost $15.00 each. At a later date during the year, the company purchased an additional 800 units of inventory that cost $18.00 each. Vargas sold 500 units of inventory for $27.00. What is the amount of cost of goods sold that will appear on the current year’s income statement?

A) $7,800 B) $6,000 C) $4,500 D) $5,700

73) Which of the following businesses is most likely to use a specific identification cost flow method? A) Car dealership B) Grocery store C) Hardware store D) Roofing company

74) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

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Beginning inventory Purchase Sales Purchase Purchase Sales

2,000 units @ $5.70 2,100 units @ $5.50 2,200 units @ $7.20 2,000 units @ $5.80 1,800 units @ $5.60 2,150 units @ $7.20

Assuming Chase uses a LIFO cost flow method, what is the amount of cost of goods sold for the sales transaction on January 18?

A) $12,540 B) $12,120 C) $12,100 D) $12,500

75) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

300 units @ $2.30 400 units @ $2.10 500 units @ $3.80 300 units @ $2.40 100 units @ $2.20 450 units @ $3.80

Assuming Chase uses a LIFO cost flow method, what is the amount of cost of goods sold for the sales transaction on January 18?

A) $1,150 B) $1,050 C) $1,070 D) $1,130

76) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

1,200 units @ $4.10 1,300 units @ $3.90 1,400 units @ $5.60 1,200 units @ $4.20 1,000 units @ $4.00 1,350 units @ $5.60

Assuming Chase uses a FIFO cost flow method, what is the cost of goods sold for the sales transaction on January 31?

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A) $5,505 B) $5,340 C) $5,725 D) $7,990

77) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

300 units @ $2.30 400 units @ $2.10 500 units @ $3.80 300 units @ $2.40 100 units @ $2.20 450 units @ $3.80

Assuming Chase uses a first-in, first-out (FIFO) cost flow method, what is the cost of goods sold for the sales transaction on January 31?

A) $1,020 B) $1,005 C) $1,045 D) $340

78) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

2,000 units @ $5.70 2,100 units @ $5.50 2,200 units @ $7.20 2,000 units @ $5.80 1,800 units @ $5.60 2,150 units @ $7.20

Assuming Chase uses a FIFO cost flow method, what is the ending inventory on January 31?

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A) $10,545 B) $10,360 C) $20,230 D) $11,900

79) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

300 units @ $2.30 400 units @ $2.10 500 units @ $3.80 300 units @ $2.40 100 units @ $2.20 450 units @ $3.80

Assuming Chase uses a FIFO cost flow method, what is the ending inventory on January 31?

A) $345 B) $340 C) $330 D) $1,020

80) Rowan Company has four different categories of inventory. The quantity, cost, and market value for each of the inventory categories are as follows: Item 1 2 3 4

Quantity

Cost Per Unit

220 130 100 25

$ 4.40 $ 6.20 $10.00 $20.50

Market Value Per Unit $ 4.60 $ 6.00 $ 9.25 $25.00

The company carries inventory at lower-of-cost-or-market applied to the entire stock of inventory in the aggregate. How would the implementation of the lower-of-cost-or-market rule impact the elements of the company’s financial statements?

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A) Increase total assets and stockholders’ equity by $55.50. B) Decrease total assets and stockholders’ equity by $101.00. C) Decrease total assets and stockholders’ equity by $79.00. D) Have no effect on total assets or stockholders’ equity.

81)

The lower-of-cost-or-market rule can be applied to which of the following? A) Major classes or categories of inventory B) The entire stock of inventory in the aggregate C) Each individual inventory item D) All of these answer choices are correct.

82) If a company is using the lower-of-cost-or-market rule and a write-down is required, how will that write-down affect the company's financial statements? A) Net income will increase. B) Gross margin will decrease. C) Total assets will decrease. D) Net income and total assets will both decrease.

83)

What is meant by "market" in the lower-of-cost-or-market rule? A) The amount of gross margin earned by selling merchandise. B) The amount the goods were sold for during the period. C) The amount that would have to be paid to replace the merchandise. D) The amount originally paid for the merchandise.

84) Which of the following methods of applying the lower-of-cost-or-market rule will result in the fewest number of inventory write-downs?

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A) Each individual inventory item B) Average of cost of goods sold for the past three years C) Major classes or categories of inventory D) The entire stock of inventory in the aggregate

85) Nelson Corporation is required to record an inventory write-down of $2,500 as a result of using the lower-of-cost-or-market rule. Which of the following shows how this business event would affect the financial statements?

Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. (2,500) N/A (2,500) N/A 2,500 (2,500) N/A B. (2,500)

(2,500)

N/A

(2,500)

2,500

N/A

2,500

N/A

(2,500)

N/A

2,500

(2,500) (2,500)

N/A

D. (2,500)

A) Option A B) Option B C) Option C D) Option D

86) At the end of the Year 2 accounting period, DeYoung Company determined that the market value of its inventory was $79,800. The historical cost of this inventory was $81,400. DeFazio uses the perpetual inventory method. Assuming the amount is immaterial, how will the necessary write-down to reduce the inventory to the lower-of-cost-or-market affect the company's financial statements? A) Decrease total assets and gross margin B) Decrease total assets and net income C) Increase total assets and net income D) Decrease total assets, gross margin, and net income

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87) For which of the following cost flow methods does generally accepted accounting principles require application of the lower-of-cost-or-market rule? A) FIFO B) LIFO C) Weighted average D) Specific identification E) All of these cost flow methods

88) Assume a company paid $1,000 for a television that it plans to sell to its customers. Suppose that because of new technology the company could buy the same television today for $800. How would the lower-of-cost-or-market rule affect the financial statements? A) Decrease common stock reported on the balance sheet B) Decrease net income C) Increase liabilities on the balance sheet D) Increase stockholders’ equity on the balance sheet

89) The adjusting entry to recognize the write down of inventory based on the lower-of-costor-market rule will A) decrease the cash flow from operating activities. B) decrease the amount of liabilities. C) increase the amount of assets. D) increase the amount of expenses.

90) An analysis of the inventory owned by Owens Company as of the Company’s fiscal closing date is shown in the following table. Item A B C

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Quantity

Cost Per Unit

300 100 200

$30 $50 $44

Market Value Per Unit $27 $55 $40

120

$25

$30

Assuming Owens applies the lower-of-cost-or-market rule on an individual basis, the Company would be required to recognize an expense amounting to A) $1,700 B) $2,200 C) $2,800 D) $1,100

91) West Corporation's Year 1 ending inventory was overstated by $20,000; however, ending inventory for Year 2 was correct. Which of the following statements is correct? A) Net income for Year 1 is understated. B) Retained earnings at the end of Year 2 is overstated. C) Cost of goods sold for Year 1 is overstated. D) Cost of goods sold for Year 2 is overstated.

92) Phipps Corporation overstated its ending inventory on December 31, Year 1. Which of the following correctly identifies the effect of the error on Year 2 financial statements? A) Cost of goods sold is overstated. B) Gross margin overstated. C) Ending inventory is understated. D) Net income is overstated.

93) Why are the inventory and cost of goods sold accounts attractive targets for managerial fraud? A) There are few if any procedures that can check for fraud in these accounts. B) There are no adequate methods of record keeping for inventory. C) These accounts are more significant than most other accounts. D) Cost of goods sold and Inventory accounts are not attractive targets of fraud.

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94) On December 31, Year 1, Owings Corporation overstates the ending inventory by $5,000. How will this affect the amount of retained earnings shown on the balance sheet at December 31, Year 2? A) Retained Earnings will be correctly stated. B) Retained Earnings will be understated by $5,000. C) Retained Earnings will be overstated by $5,000. D) Cannot be determined with the above information.

95) What effect will an overstatement of ending inventory at the end of Year 1 have on the amounts reported on the Year 1 financial statements? A) Overstatement of cost of goods sold B) Overstatement of total assets C) Understatement of net income D) Understatement of retained earnings

96) Zinke Company understated its ending inventory at the end of Year 1. Which of the following correctly states the effect of the error on the amounts shown on the Year 1 financial statements? A) Overstatement of total assets and cost of goods sold. B) Overstatement of cost of goods sold and retained earnings. C) Understatement of liabilities and retained earnings. D) Understatement of total assets and gross margin.

97) When the perpetual inventory system is used, where can the best estimate of the amount of inventory on hand be found? A) On the previous period's balance sheet B) In the Inventory account C) By applying the gross margin method D) By subtracting sales for the period from the beginning Inventory account balance

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98)

Which of the following is not required to apply the gross margin method? A) Total sales for the current period B) The amount of inventory on hand at the end of the current period C) Amount of purchases during the current period D) The beginning inventory for the current period

99) Which of the following circumstances would be a valid reason to estimate the amount of inventory that is on hand at the end of the period? A) To complete the company's annual income tax return. B) To avoid taking a physical count of inventory. C) To test for financial statement manipulation. D) All of the answer choices are valid reasons for estimating the ending inventory.

100) When using the gross margin method to estimate inventory, which of the following is a step in the computation? A) Add the amount goods available for sale to estimated cost of goods sold B) Add estimated gross margin to sales C) Subtract estimated goods available for sale from beginning inventory D) Subtract estimated cost of goods sold from the amount of goods available for sale

101) Landis Company is preparing its financial statements. Gross margin is normally 40% of sales. Information taken from the company's records revealed sales of $75,000; beginning inventory of $7,500 and purchases of $52,500. What is the estimated amount of ending inventory at the end of the period? A) $15,000 B) $45,000 C) $30,000 D) $24,000

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102) Landis Company is preparing its financial statements. Gross margin is normally 40% of sales. Information taken from the company's records revealed sales of $25,000; beginning inventory of $2,500 and purchases of $17,500. What is the estimated amount of ending inventory at the end of the period? A) $15,000 B) $5,000 C) $8,000 D) $10,000

103) How does an error that results in an overstatement of ending inventory affect the elements of the company's financial statements in the current year? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + N/A + N/A + N/A B.

−

N/A

−

N/A

−

N/A

+OA

N/A

−

A) Option A B) Option B C) Option C D) Option D

104) When preparing its quarterly financial statements, Pace Company uses the gross margin method to estimate ending inventory. The following information is available for the quarter ending March 31, Year 2: Beginning inventory Purchases Sales Estimated gross margin percentage

$ 229,000 $ 824,000 $1,185,000 45%

What is the estimated amount of inventory that is on hand on March 31, Year 2? (Do not round your intermediate calculations.)

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A) $533,250 B) $651,750 C) $401,250 D) $519,750

105) When preparing its quarterly financial statements, Pace Company uses the gross margin method to estimate ending inventory. The following information is available for the quarter ending March 31, Year 2: Beginning inventory Purchases Sales Estimated gross margin percentage

$110,000 $385,000 $525,000 45%

What is the estimated amount of inventory that is on hand on March 31, Year 2? A) $236,250 B) $288,750 C) $206,250 D) $258,750

106) Taylor Company had beginning inventory of $890 and ending inventory of $1,270. Taylor Company had cost of goods sold amounting to $2,810. What is the amount of inventory that was purchased during the period? A) $2,300 B) $3,190 C) $4,970 D) $4,080

107) Taylor Company had beginning inventory of $400 and ending inventory of $600. Taylor Company had cost of goods sold amounting to $1,800. What is the amount of inventory that was purchased during the period?

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A) $1,600 B) $2,800 C) $2,000 D) $2,400

108) Account Cost of goods sold Inventory

Company X $4,270,000 $ 504,000

Company Y $8,972,500 $ 747,000

Company Z $6,778,000 $ 633,600

What is the average number of days to sell inventory for Company Y? (Do not round your intermediate calculations. Use 365 days in a year.) A) 12.0 B) 43.1 C) 30.4 D) 34.1

109) Account Cost of goods sold Inventory

Company X $1,980,000 $ 175,000

Company Y $4,338,000 $ 295,000

Company Z $3,234,000 $ 250,500

What is the average number of days to sell inventory for Company Y? (Use 365 days in a year.) A) 15.3 B) 24.8 C) 23.9 D) 25.6

110) Account Cost of goods sold Inventory

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Company X $4,630,000 $ 704,000

Company Y $9,332,500 $ 947,000

Company Z $7,138,000 $ 833,600

Assuming that longer inventory holding periods act to increase expenses, which of the three companies would be expected to have the lowest inventory holding costs? (Use 365 days in a year.) A) All three companies have equal holding costs B) Company X C) Company Y D) Company Z

111) Account Cost of goods sold Inventory

Company X $1,980,000 $ 175,000

Company Y $4,338,000 $ 295,000

Company Z $3,234,000 $ 250,500

112)

How is inventory turnover calculated? A) Cost of goods sold divided by inventory B) Sales divided by inventory C) Beginning inventory divided by the ending inventory D) Inventory divided by cost of goods sold

113) Carson Company has an inventory turnover of 12.25, and its inventory amounts to $4,800,000. What is the amount of cost of goods sold?

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A) $391,837 B) $58,800,000 C) $39,183,673 D) $72,000

114) Carson Company has an inventory turnover of 12.75, and its inventory amounts to $2,400,000. What is the amount of cost of goods sold? A) $30,600,000 B) $188,235 C) $26,666,667 D) $51,000

115) Misty Mountain Outfitters is a merchandiser of specialized fly fishing gear. Its cost of goods sold for Year 2 was $2,270,650, and sales were $3,428,050. The amount of merchandise on hand was $629,000, and total assets amounted to $3,534,950. What is the average number of days to sell inventory? (Do not round your intermediate calculations. Use 365 days in a year. Round to the nearest day.) A) 101 days B) 67 days C) 65 days D) 198 days

116) Misty Mountain Outfitters is a merchandiser of specialized fly fishing gear. Its cost of goods sold for Year 2 was $295,000, and sales were $690,000. The amount of merchandise on hand was $50,000, and total assets amounted to $585,000. What is the average number of days to sell inventory? (Use 365 days in a year. Round to the nearest day.) A) 26 days B) 62 days C) 31 days D) 40 days

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117) Which of the following statements is not correct regarding the importance of inventory turnover to a company's profitability? A) Companies will prefer to have a low inventory turnover rather than a high inventory turnover. B) It is sometimes more desirable to sell a large amount of merchandise with a small amount of gross margin than a small amount of merchandise with a large amount of gross margin. C) A company's profitability is affected by how rapidly inventory sells. D) A company’s profitability is affected by the spread between cost and selling price.

118) Chase Company uses the perpetual inventory method. The inventory records for Chase reflected the following information: January 1 January 12 January 18 January 21 January 25 January 31

Beginning inventory Purchase Sales Purchase Purchase Sales

300 units @ $2.30 400 units @ $2.10 500 units @ $3.80 300 units @ $2.40 100 units @ $2.20 450 units @ $3.80

Assuming Chase uses a FIFO cost flow method, what is the cost of goods sold for the sales transaction on January 31?

A) $1,020 B) $1,005 C) $1,045 D) $340

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Answer Key Test name: Chap 05_2e_Test Bank_MCQs_TF 1) TRUE Managers can choose which costs to assign to cost of goods sold if specific identification is used. 2) TRUE It is not cost effective for companies to track the specific costs of lowpriced items. 3) TRUE LIFO assigns the cost of the items purchased last to cost of goods sold, so the cost of the goods purchased first is assigned to ending inventory. 4) FALSE Companies do not need to select a cost flow method that matches the physical flow of goods. 5) TRUE Most companies rotate their inventory so as to sell the oldest inventory first. However, the company is free to choose other cost flow methods. 6) FALSE The selection of cost flow method impacts cost of goods sold, which impacts gross margin. 7) FALSE FIFO will report lower cost of goods sold (older, lower prices), and higher ending inventory (newer, higher prices). 8) TRUE During a period of rising inventory prices, cost of goods sold will include the higher, most recent prices when LIFO is used. 9) TRUE

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During a period of declining prices, cost of goods sold will include the lower, most recent prices when LIFO is used, resulting in higher gross margin. 10) FALSE The selection of cost flow method allocates product costs between cost of goods sold and ending, not beginning, inventory. 11) TRUE During a period of rising inventory prices, ending inventory will include the lower, older prices when using last-in, first-out. 12) TRUE The different cost flow methods—FIFO, LIFO, weighted average, and specific identification—are examples of alternative accounting procedures allowed by GAAP. 13) TRUE In a period of rising inventory prices, FIFO will produce the lowest cost of goods sold, resulting in the highest net income and the highest income tax expense. 14) FALSE The requirement to match cost flow for income tax reporting and financial reporting applies only to the LIFO inventory cost flow method. 15) TRUE A change in inventory cost flow method must be justified by reasons other than earnings management. 16) TRUE The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Units in ending inventory = Units available for sale of (360 + 310 + 670) − Units sold of 1,000 = 340 Ending inventory = 340 units × January 1 unit cost of $15 = $5,100 17) TRUE Version 1

The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Units in ending inventory = Units available for sale of (200 + 150 + 350) − Units sold of 520 = 180 Ending inventory = 180 units × January 1 unit cost of $7.00 = $1,260 18) FALSE The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (220 units × $8 per unit) + (170 × $10 per unit) + (190 × $10 per unit) = $5,360 19) FALSE The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (200 units × $7.00 per unit) + (150 × $8.00 per unit) + (170 × $9.00 per unit) = $4,130 20) FALSE Average cost per unit = Cost of goods available for sale of [(380 × $16) + (330 × $26) + (710 × $18)] ÷ Units available for sale of 1,420 = $19.32 per unit 21) FALSE Average cost per unit = Cost of goods available for sale of [(200 × $7.00) + (150 × $8.00) + (350 × $9.00)] ÷ Units available for sale of 700 = $8.21 per unit 22) TRUE Average cost per unit = Cost of goods available for sale of [(12 × $18) + (6 × $19.50)] ÷ Units available for sale of 18 = $18.50 per unit Selling price of $40 − Cost of goods sold of $18.50 = $21.50 23) FALSE

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Average cost per unit = Cost of goods available for sale of [(2 × $36) + (1 × $40)] ÷ Units available for sale of 3 = $37.33 per unit Selling price of $60 − Cost of goods sold of $37.33 = $22.67 24) TRUE The IRS requires that companies using LIFO for income tax purposes must also use LIFO for financial reporting. 25) TRUE This is a difference between IFRS and U.S. GAAP. 26) FALSE The lower-of-cost-or-market rule must be applied regardless of the inventory cost flow method in use. 27) TRUE If the replacement cost is greater than the historical cost, no adjustment is made. Adjustments are only made if the replacement cost is lower than the historical cost. 28) FALSE The loss resulting from application of the lower-of-cost-or-market rule is only included in cost of goods sold if the amount is immaterial. The loss should be reported as an operating expense if it is material. 29) TRUE Overstating inventory will understate cost of goods sold, resulting in higher net income and higher retained earnings in the current year. 30) FALSE The gross margin method can be used to anticipate what the ending inventory balance should be, and when compared with physical ending inventory, can detect fraud. 31) TRUE A discount merchandiser operates at lower margin and relies on higher inventory turnover to make a profit. 32) TRUE Version 1

Because the amounts of ending inventory and cost of goods sold are affected by the cost flow method (FIFO, LIFO, etc.) a company uses, the gross margin and inventory turnover ratios are also affected by the cost flow method used. 33) C In a period of declining prices, LIFO will result in the lowest cost of goods sold (most recent purchases) and the highest ending inventory (earliest purchases). 34) A When prices are rising, LIFO will result in the highest cost of goods sold (most recent purchases), and therefore will result in the lowest income tax expense. Income tax expense is the only cash flow affected by the choice of an inventory cost flow method. 35) C LIFO will produce cost of goods sold that is based on the most recent purchases. 36) A If Blake uses the weighted-average inventory cost flow method, ending inventory will be $27.50. If the company uses FIFO, ending inventory will be $28.00. 37) A If Blake uses the weighted-average inventory cost flow method, ending inventory will be $17.00. If the company uses FIFO, ending inventory will be $18.00. 38) C When prices are falling, LIFO will produce a low cost of goods sold (most recent purchases) and a high ending inventory (earliest purchases), compared to FIFO, which will produce a high cost of goods sold (earliest purchases) and low ending inventory (most recent purchases). 39) B Version 1

When prices are rising, FIFO will produce the lowest cost of goods sold compared with other methods because it is based on the earliest, lowest priced, purchases. 40) D Regardless of the inventory cost flow method, Barker reported outflow of $38.00 for the purchases of the two items and inflow of $30.00 for the sale of one item. 41) C When prices are declining, FIFO will produce the highest cost of goods sold (earliest purchases) compared with LIFO which will be based on more recent, lower priced purchases. Weighted average will be somewhere in between. 42) D In an inflationary environment, prices are rising. LIFO will produce the lowest ending inventory (earliest purchases) compared with FIFO. 43) B Using weighted average, cost of goods sold is calculated by multiplying the average cost per unit by the number of units sold. If Hoover uses weighted-average, the average cost per unit is $40.75. Therefore, gross margin will be $24.25 (or Sales of $65 − Cost of goods sold of $40.75). The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. If Hoover uses FIFO, cost of goods sold will be $38.50 (earliest purchase) rather than $43.00. The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. If Hoover uses LIFO, cost of goods sold will be $43.00 (most recent purchase) and ending inventory will be $38.50 rather than $43.00. 44) B

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Using weighted average, cost of goods sold is calculated by multiplying the average cost per unit by the number of units sold. If Hoover uses weighted-average, the average cost per unit is $34.00. Therefore, gross margin will be $28.00 (or Sales of $62.00 − Cost of goods sold of $34.00). The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. If Hoover uses FIFO, cost of goods sold will be $33.00 (earliest purchase) rather than $35.00. The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. If Hoover uses LIFO, cost of goods sold will be $35.00 (most recent purchase) and ending inventory will be $33.00 rather than $35.00. 45) B The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (520 × $8) + (330 × $10) = $7,460 46) D The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (400 × $12.00) + (300 × $16.00) = $9,600 47) A Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(2,200 × $6.00) + (2,300 × $6.20) + (2,500 × $6.30) + (2,100 × $6.40)] ÷ 9,100 units = $6.23 per unit 48) B

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Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(100 × $4.00) + (300 × $4.40) + (500 × $4.60) + (100 × $4.80)] ÷ 1,000 units = $4.50 per unit 49) B The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Cost of goods sold = (300 × $2.80) + (700 × $2.70) + (500 × $2.60) = $4,030 50) A The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Cost of goods sold = (100 × $4.80) + (500 × $4.60) + (300 × $4.40) = $4,100 51) B The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Ending inventory units = 4,700 units available for sale − 3,700 units sold = 1,000 units in ending inventory Ending inventory = 1,000 units × $4.20per unit = $4,200 52) A The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Ending inventory units = 1,000 units available for sale− 900 units sold = 100 units in ending inventory Ending inventory = 100 units × $4.80 per unit = $480 53) A

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Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(1,100 × $3.80) + (1,200 × $4.00) + (1,400 × $4.10) + (1,000 × $4.20)] ÷ 4,700 units = $4.03 per unit Cost of goods sold = Average cost per unit × Number of units sold Cost of goods sold = 3,600 units × $4.03 per unit = $14,508 Gross margin = Sales − Cost of goods sold Gross margin = (3,600 × $5.70) − $14,508 = $6,012 54) D Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(100 × $4.00) + (300 × $4.40) + (500 × $4.60) + (100 × $4.80)] ÷ 1,000 units = $4.50 per unit Cost of goods sold = Average cost per unit × Number of units sold Cost of goods sold = 900 units × $4.50 per unit = $4,050 Gross margin = Sales − Cost of goods sold Gross margin = (900 × $7.80) − $4,050 = $2,970 55) D The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (500 × $2.60) + (600 × $2.80) + (800 × $2.90) = $2,000 Gross margin = Sales − Cost of goods sold Gross margin = $8,550 − $2,000 = $3,250 56) C

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The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (100 × $4.00) + (300 × $4.40) + (500 × $4.60) = $4,020 Gross margin = Sales − Cost of goods sold Gross margin = $7,020 − $4,020 = $3,000 57) A The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (75 × $2.00) + (320 × $2.50) = $950 58) B The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (80 × $7.50) + (140 × $9.00) = $1,860 59) C The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Units in ending inventory = 65 units + 515 units purchased − 335 units sold = 245 Cost of goods sold = (65 × $3.40) + (180 × $3.90) = $923 60) C The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Units in ending inventory = 80 units + 400 units purchased − 220 units sold = 260 Cost of goods sold = (80 × $7.50) + (180 × $9.00) = $2,220 61) A

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Units in ending inventory = 70 units + 530 units purchased − 305 units sold = 295 Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(70 × $2.10) + (280 × $2.60) + (190 × $2.70) + (60 × $3.10)] ÷ 600 units = $2.62 per unit Ending inventory = Average cost per unit × Number of units in ending inventory Ending inventory = $2.62 per unit × 295 = $773 62) B Units in ending inventory = 80 units + 400 units purchased − 220 units sold = 260 Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(80 × $7.50) + (200 × $9.00) + (150 × $9.30) + (50 × $10.50)] ÷ 480 units = $9.00 per unit Ending inventory = Average cost per unit × Number of units in ending inventory Ending inventory =$9.00 per unit × 260 = $2,340 63) B The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Ending inventory = $28 (earliest purchase) Gross margin = Sales − Cost of goods sold Gross margin = $80 − $34 = $46 64) B

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The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Ending inventory = $4.50 (earliest purchase) Gross margin = Sales − Cost of goods sold Gross margin = $7.50 − $4.75 = $2.75 65) C Ending inventory units = 456 units + 684 units − 550 units sold = 590 Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(456 × $7.50) + (684 × $9.00)]÷ 1,140 = $8.40 per unit Cost of goods sold = Average cost per unit × Number of units sold Cost of goods sold = $8.40 per unit × 590 units = $4,956 66) A Ending inventory units = 400 units + 600 units − 550 units sold = 450 Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(400 × $7.50) + (600 × $9.00)] ÷ 1,000 = $8.40 per unit Cost of goods sold = Average cost per unit × Number of units sold Cost of goods sold = $8.40 per unit × 450 units = $3,780 67) B Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(550 × $3.50) + (600 × $3.00)] ÷ 1,150 = $3.24 per unit Cost of goods sold = 1,000 × $3.24 = $3,240 Gross margin = Sales − Cost of goods sold Gross margin = $7,000 − $3,240 = $3,760 68) A Version 1

Average cost per unit = Total cost of the inventory available ÷ Total number of units available Average cost per unit = [(400 × $8.00) + (600 × $9.00)] ÷ 1,000 = $8.60 per unit Cost of goods sold = 700 × $8.60 = $6,020 Gross margin = Sales − Cost of goods sold Gross margin = $11,200 − $6,020 = $5,180 69) C The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Ending inventory units = 2,000 units + 2,100 units − 2,300 units sold = 1,800 units Ending inventory = 1,800 units × $13.25 (earliest purchase) = $23,850 70) D The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Ending inventory units = 500 units + 600 units − 800 units sold = 300 units Ending inventory = 300 units × $4.00 (earliest purchase) = $1,200 71) D The FIFO cost flow method requires that the cost of the items purchased first be charged to cost of goods sold. Cost of goods sold = (2,100 × $22) + (100 × $23) = $48,500 72) A The FIFO cost flow method requires that the cost of the items purchased first be charged to cost of goods sold. Cost of goods sold = (400 × $15.00) + (100 × $18.00) = $7,800 73) A

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Specific identification is frequently used for high-priced, low-turnover inventory items such as automobiles. For big ticket items like cars, customer demands for specific products limit management’s ability to select which merchandise is sold, and volume is low enough to manage the recordkeeping. 74) B The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Cost of goods sold = (2,100 × $5.50) + (100 × $5.70) = $12,120 75) C The LIFO cost flow method requires that the cost of the items purchased last be charged to cost of goods sold. Cost of goods sold = (400 × $2.10) + (100 × $2.30) = $1,070 76) B The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (1,100 × $3.90) + (250 × $4.20) = $5,340 77) A The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (200 × $2.10) + (250 × $2.40) = $1,020 78) C The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Ending inventory = (1,750 × $5.80) + (1,800 × $5.60) = $20,230 79) B The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Ending inventory = (50 × $2.40) + (100 × $2.20) = $340 80) D Version 1

Total cost = (220 × $4.40) + (130 × $6.20) + (100 × $10.00) + (25 × $20.50) = $3,286.50 Total market value = (220 × $4.60) + (130 × $6.00) + (100 × 9.25) + (25 × $25.00) = $3,342 Because the total market value is higher than total cost, no write-down is necessary. 81) D The lower-of-cost-or-market rule can be applied to (1) each individual inventory item, (2) major classes or categories of inventory, or (3) the entire stock of inventory in the aggregate. 82) D A write-down resulting from applying the lower-of-cost-or-market rule decreases total assets (Inventory) and stockholders' equity (Retained Earnings). It increases expenses [cost of goods sold (if immaterial) or operating expenses (if material)], which decreases net income. 83) C Market is defined as the amount the company would have to pay to replace the merchandise. 84) D The lower-of-cost-or-market rule can be applied to (1) each individual inventory item, (2) major classes or categories of inventory, or (3) the entire stock of inventory in the aggregate. When a company applies the lower-of-cost-or-market rule to the entire stock of inventory in the aggregate, items that have market values that are higher than cost will cancel out others that have market values that are lower than cost, resulting in fewer write-downs. 85) A

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The business event will decrease assets (Inventory) and stockholders' equity (Retained Earnings). It increases expenses [cost of goods sold (if immaterial) or operating expenses (if material)], which decreases net income. It does not affect the statement of cash flows. 86) D The write-down will decrease assets (Inventory) and stockholders' equity (Retained Earnings). It increases expenses (cost of goods sold), which decreases both gross margin and net income. Since it is immaterial, the amount of the write down can be included in cost of goods sold. If it were material, the loss would be reported as an operating expense (not as cost of goods sold). 87) E Regardless of whether a company uses FIFO, LIFO, weighted average, or specific identification, once the cost of the ending inventory has been determined, GAAP require that the cost be compared with the end of the period market value and that the inventory be reported at lower of cost or market. 88) B Writing down the inventory reduces the amount of total assets and increases expenses which decreases net income and stockholders’ equity. Therefore, the only correct answer is “decrease net income on the income statement”. 89) D Writing down inventory decreases the amount of assets (Inventory) and stockholders’ equity (Retained Earnings) on the balance sheet. On the income statement, it increases the amount of expenses which decreases net income. Liabilities and cash flow are not affected. 90) A

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Since the market values of items A and C are below their cost, these items would have to be written down as follows: Item A C

Quantity 300 200

× × ×

Write Down per Unit ($30 − $27) ($44 − $40)

= = = Total

Write Down $ 900 800 $1,700

91) D Overstating inventory at the end of Year 1, but correctly reporting inventory at the end of Year 2 will cause cost of goods sold to be understated for Year 1 and overstated for Year 2. However, by the end of Year 2, retained earnings will be correctly stated. 92) A Overstating inventory at the end of Year 1, but correctly reporting inventory at the end of Year 2, will cause cost of goods sold to be understated for Year 1 and overstated for Year 2. This error will not impact the amount of inventory reported at the end of Year 2. 93) C Because the inventory and cost of goods sold accounts are so significant, they are attractive targets for concealing fraud. 94) A Overstating inventory at the end of Year 1 will cause cost of goods sold to be understated for Year 1, which causes net income to be overstated. Since the Year 1 ending inventory becomes the Year 2 beginning inventory, cost of goods sold will be overstated for Year 2, which will cause net income to be understated. The overstatement of Year 1 net income will be offset by the understatement of Year 2 net income and retained earnings will be correctly stated at the end of Year 2. 95) B

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An overstatement of inventory at the end of Year 1 overstates assets (Inventory) and stockholders’ equity (Retained Earnings) at the end of Year 1. The overstatement also understates expenses (cost of goods sold), which overstates the amount of net income reported for Year 1. 96) D Understating inventory at the end of Year 1 understates assets (Inventory) and stockholders’ equity (Retained Earnings). It also overstates the cost of goods sold, which understates gross margin and net income for Year 1. 97) B In a perpetual inventory system, the balance in the inventory account should provide the best estimate of inventory on hand. The gross margin method should only be used if a book inventory and a physical inventory are unavailable. 98) B The gross margin method is used when ending inventory amount at the end of the current period is not available. The beginning inventory balance, sales, and purchases for the current period are required to use this method to estimate the amount of inventory on hand. 99) C Auditors and financial analysts have developed tools to test for financial statement manipulation. The gross margin method of estimating the ending inventory balance is such a tool. 100) D

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When applying the gross margin method, the estimated cost of the ending inventory is computed as follows: (1) Calculate the expected gross margin ratio using financial statement data from prior periods. (2) Multiply the expected gross margin ratio by the current period’s sales. (3) Subtract the estimated gross margin from sales to estimate the amount of cost of goods sold. (4) Subtract the estimated cost of goods sold from the amount of goods available for sale to estimate the amount of ending inventory. 101) A Estimated gross margin = Sales × Estimated gross margin percentage Estimated gross margin = $75,000 × 0.40 = $30,000 Estimated cost of goods sold = Sales − Estimated gross margin Estimated cost of goods sold = $75,000 − $30,000 = $45,000 Cost of goods available for sale = Beginning inventory + Purchases Cost of goods available for sale = $7,500 + $52,500 = $60,000 Ending inventory = Estimated cost of goods available for sale − Estimated cost of goods sold Ending inventory = $60,000 − $45,000 = $15,000 102) B Estimated gross margin = Sales × Estimated gross margin percentage Estimated gross margin = $25,000 × 0.40 = $10,000 Estimated cost of goods sold = Sales − Estimated gross margin Estimated cost of goods sold = $25,000 − $10,000 = $15,000 Cost of goods available for sale = Beginning inventory + Purchases Cost of goods available for sale = $2,500 + $17,500 = $20,000 Ending inventory = Estimated cost of goods available for sale − Estimated cost of goods sold Ending inventory = $20,000 − $15,000 = $5,000 103) A

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Overstating ending inventory will increase assets (Inventory) and increase stockholders’ equity (Retained Earnings). It decreases expenses (cost of goods sold) which will increase net income. It will not affect the statement of cash flows. 104) C Estimated gross margin = Sales × Estimated gross margin percentage Estimated gross margin = $1,185,000 × 0.45 = $533,250 Estimated cost of goods sold = Sales − Estimated gross margin Estimated cost of goods sold = $1,185,000 − $533,250 = $651,750 Cost of goods available for sale = Beginning inventory + Purchases Cost of goods available for sale = $229,000 + $824,000 = $1,053,000 Ending inventory = Cost of goods available for sale − Estimated cost of goods sold Ending inventory = $1,053,000 − $651,750 = $401,250 105) C Estimated gross margin = Sales × Estimated gross margin percentage Estimated gross margin = $525,000 × 0.45 = $236,250 Estimated cost of goods sold = Sales − Estimated gross margin Estimated cost of goods sold = $525,000 − $236,250 = $288,750 Cost of goods available for sale = Beginning inventory + Purchases Cost of goods available for sale = $110,000 + $385,000 = $495,000 Ending inventory = Cost of goods available for sale − Estimated cost of goods sold Ending inventory = $495,000 − $288,750 = $206,250 106) B Beginning inventory + Purchases − Ending inventory = Cost of goods sold $890 + Purchases − $1,270 = $2,810 Purchases = $2,810 − $890 + $1,270 = $3,190 107) C Version 1

Beginning inventory + Purchases − Ending inventory = Cost of goods sold $400 + Purchases− $600 = $1,800 Purchases = $1,800 − $400 + $600 = $2,000 108) C Inventory turnover = Cost of goods sold ÷ Inventory Inventory turnover = $8,972,500 ÷ $747,000 = 12.01 Average number of days to sell inventory = 365 ÷ Inventory turnover Average number of days to sell inventory = 365 ÷ 12.01 = 30.4 Days 109) B Inventory turnover = Cost of goods sold ÷ Inventory Inventory turnover = $4,338,000 ÷ $295,000 = 14.71 Average number of days to sell inventory = 365 ÷ Inventory turnover Average number of days to sell inventory = 365 ÷ 14.71 = 24.8 Days 110) C

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Inventory turnover = Cost of goods sold ÷ Inventory Average days to sell inventory = 365 ÷ Inventory turnover Company X: Inventory turnover = Cost of goods sold ÷ Inventory $4,630,000 ÷ $704,000 = 6.58 times Average days to sell inventory = 365 ÷ 6.58 = 55.5 days Company Y: Inventory turnover = Cost of goods sold ÷ Inventory $9,332,500 ÷ $947,000 = 9.85 times Average days to sell inventory = 365 ÷ 9.85 = 37.1 days Company Z: Inventory turnover = Cost of goods sold ÷ Inventory $7,138,000 ÷ $833,600 = 8.56 times Average days to sell inventory = 365 ÷ 8.56 = 42.6 days Company Y, with the lowest number of days to sell inventory, will have the lowest inventory holding cost. 111) C

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Inventory turnover = Cost of goods sold ÷ Inventory Average days to sell inventory = 365 ÷ Inventory turnover Company X: Inventory turnover = Cost of goods sold ÷ Inventory $1,980,000 ÷ $175,000 = 11.31 times Average days to sell inventory = 365 ÷ 11.31 = 32.3 days Company Y: Inventory turnover = Cost of goods sold ÷ Inventory $4,338,000 ÷ $295,000 = 14.71 times Average days to sell inventory = 365 ÷ 14.71 = 24.8 days Company Z: Inventory turnover = Cost of goods sold ÷ Inventory $3,234,000 ÷ $250,500 = 12.91 times Average days to sell inventory = 365 ÷ 12.91 = 28.3 days Company Y, with the lowest number of days to sell inventory, will have the lowest inventory holding cost. 112) A Inventory turnover = Cost of goods sold ÷ Inventory 113) B Inventory turnover = Cost of goods sold ÷ Inventory 12.25 = Cost of goods sold ÷ $4,800,000 Cost of goods sold = 12.25 × $4,800,000 = $58,800,000 114) A Inventory turnover = Cost of goods sold ÷ Inventory 12.75 = Cost of goods sold ÷ $2,400,000 Cost of goods sold = 12.75 × $2,400,000 = $30,600,000 115) A

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Inventory turnover = Cost of goods sold ÷ Inventory Inventory turnover = $2,270,650 ÷ $629,000 = 3.61 times Average number of days to sell inventory = 365 ÷ Inventory turnover Average number of days to sell inventory = 365 ÷ 3.61 times = 101 days 116) B Inventory turnover = Cost of goods sold ÷ Inventory Inventory turnover = $295,000 ÷ $50,000 = 5.9 times Average number of days to sell inventory = 365 ÷ Inventory turnover Average number of days to sell inventory = 365 ÷ 5.9 times = 62 days 117) A Overall profitability depends upon two elements: gross margin and inventory turnover. The most profitable combination would be to carry high margin inventory that turns over rapidly (meaning a high inventory turnover). To be competitive, however, companies must often concentrate on one or the other of the elements. Different companies use different business strategies to achieve their objectives. 118) A The FIFO cost flow method requires that the cost of the items purchased first be assigned to cost of goods sold. Cost of goods sold = (200 × $2.10) + (250 × $2.40) = $1,020

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CHAPTER 6: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation for Heath Company, an employee found that the bank statement reported a bank service charge of $50. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation for Heath Company, an employee discovered that the bank had collected one of the company's accounts receivable in the amount of $20,000. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation for Heath Company, an employee discovered an error. A $654 cash receipt for the collection of an account receivable was recorded in the company's books as $645. The deposit slip was correct, and the bank deposit had been correctly prepared. The error appeared only in the company's accounting records. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

4) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation for Heath Company, a company employee found that the bank statement included an NFS check that the company had received from a customer paying its account at Heath Company. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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5) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA At June 30, when Heath Company was preparing the bank reconciliation, the employee preparing the reconciliation found that the company had outstanding checks in the amount of $2,650. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

6) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation of Heath Company, an employee found that the company had deposits in transit of $2,200. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA In preparing the bank reconciliation for Heath Company, an employee found that a certified check that the company had used to settle an account payable remained outstanding. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA During the process of preparing the bank reconciliation, an employee for Heath Company discovered that a check written by Barrington Company had been charged to Heath Company's account. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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9) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA During the process of preparing the bank reconciliation, an employee for Heath Company discovered that Check #4261 for $65, used to pay an account payable, was recorded in the company books as $56. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

10) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Landau Company established a petty cash fund by issuing a check in the amount of $500 to the petty cash custodian. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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11) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA At Landau Company, the petty cash custodian used petty cash to pay for postage charges. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

12) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below each element. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Landau Company replenished its petty cash fund. The expenditures of the fund included postage, office supplies, and other miscellaneous items. Indicate the effects of recognizing the expenditures on financial statements and the replenishment of the petty cash fund. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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13)

List the features of a strong internal control system.

14)

What does the term, segregation of duties, mean in the context of good internal controls?

15) List and explain three of the five interrelated components of the internal control framework established by The Committee of Sponsoring Organizations of the Treadway Commission (COSO) that serve as the standards for Sarbanes-Oxley compliance.

16) Explain the meaning of the term, internal control, and distinguish between accounting controls and administrative controls.

17) List five features of an internal control system that relate to safeguarding cash and reducing the likelihood of theft.

18)

What is a fidelity bond and what is its purpose?

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19)

How do accounting controls differ from administrative controls?

20)

What asset is generally most susceptible to theft?

21) What is a bank statement debit memo? What effect does a debit memo have on the customer's account balance?

22)

What is a deposit in transit? How does a deposit in transit affect a bank reconciliation?

23) What are non-sufficient funds (NSF) checks? How does a NSF check affect a bank reconciliation?

24)

How are outstanding checks shown on a bank reconciliation?

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25) Is the establishment of a petty cash fund an asset source, asset use, asset exchange, or claims exchange transaction?

26)

Why would a company establish a petty cash fund?

27)

How are petty cash funds typically maintained?

28)

What are the primary roles of the independent auditor?

29)

What is meant by the term, material?

30)

Who can conduct a financial audit?

31) What are the three basic types of audit opinion, and what is the meaning of each? Which type of opinion is the most favorable? Which is the most negative?

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32) Why would an auditor issue a disclaimer of opinion with regards to an audit of financial statements? What does this type of opinion mean?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 33) Indicate whether each of the following statements regarding internal controls is true or false. 1.a) ________ Internal controls are used to provide reasonable assurance that the objectives of an enterprise will be accomplished. 2.b) ________ Internal controls can be divided into accounting controls and administrative controls. 3.c) ________ The mechanics of internal control systems do not vary from company to company. 4.d) ________ Accounting controls are concerned with the evaluation of performance and the assessment of the degree of compliance with company policies and public laws. 5.e) ________ Administrative controls are composed of policies and procedures that are designed to safeguard the assets and to assure that accounting records contain reliable information.

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34) Indicate whether each of the following statements regarding internal controls is true or false. 1.a) ________ Segregation of duties is an internal control feature that requires different individuals to perform the following functions: authorization, recording, and custody of assets. 2.b) ________ Under proper internal controls, the person who collects customer payments should also maintain the records of cash receipts. 3.c) ________ Under proper internal controls, those who are given authority should bear the corresponding responsibility. 4.d) ________ One of the basic rules of internal control is to require some employees to take regular vacations. 5.e) ________ A fidelity bond is a form of insurance that companies ask employees to buy to protect the company from loss due to employee dishonesty.

35) Indicate whether each of the following statements regarding internal controls is true or false. 1.a) ________ The Sarbanes-Oxley Act of 2002 (SOX) requires public companies to evaluate their internal controls and publish those findings with their SEC filings. 2.b) ________ The Sarbanes-Oxley Act (SOX) applies to all companies, while the Enterprise Risk Management (ERM) framework is used by public companies only. 3.c) ________ Enterprise Risk Management (ERM) is an expansion of the earlier framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 4.d) ________ The COSO framework includes five interrelated components: segregation of duties, quality employees, prenumbered documents, physical controls, and performance evaluations. 5.e) ________ Congress passed the Sarbanes-Oxley Act in 2002 (SOX) in response to high profile accounting scandals, such as Enron and WorldCom.

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36) Indicate whether each of the following statements regarding internal controls is true or false. 1.a) ________ Cash receipts should be deposited in a bank when they reach a predetermined level of materiality. 2.b) ________ To improve operating efficiency, a company should make most of its disbursements using cash. 3.c) ________ Supporting documents should be reviewed by the check signer prior to signing the check. 4.d) ________ Supporting documentation should not be marked "paid" until the check clears the bank. 5.e) ________ All spoiled and voided checks should be shredded.

37)

Indicate whether each of the following statements is true or false.

1.a) ________ A bank statement debit memo describes a transaction that increases the depositor's assets. 2.b) ________ A bank statement credit memo describes a transaction that increases the customer’s account balance. 3.c) ________ Service fees charged by a bank appear on bank statements as credit memos. 4.d) ________ Deposits in transit appear on the bank statement as credit memos. 5.e) ________ Outstanding checks do not appear on the bank statement.

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38)

Indicate whether each of the following items regarding internal control is true or false.

1.a) ________ Accounting controls are composed of procedures designed to safeguard assets and ensure accounting records contain reliable information. 2.b) ________ Administrative controls concern the reliability of the financial statements and the accuracy of the general ledger. 3.c) ________ Whenever possible, the functions of authorization, recording and custody should be exercised by the same dependable employee. 4.d) ________ Cash is most susceptible to embezzlement at the points of receipt and disbursement. 5.e) ________ A well-designed internal control system prevents collusion among employees.

39) Indicate whether each of the following items regarding petty cash is true or false. 1.a) ________ The establishment of a petty cash fund is an asset use transaction. 2.b) ________ The replenishment of a petty cash fund is an asset source transaction. 3.c) ________ At any time, the total of the petty cash vouchers plus the remaining coins and currency should equal the balance of the Petty Cash ledger account. 4.d) ________ If a cash shortage occurs, revenue is recognized. 5.e) ________ When petty cash is disbursed, there is no effect on the financial statements.

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40) Indicate whether each of the following statements about the auditor's role in financial accounting is true or false. 1.a) ________ A financial audit guarantees the accuracy of all amounts reported on the financial statements. 2.b) ________ A financial audit is a detailed examination of a company's financial statements and underlying accounting records. 3.c) ________ The primary responsibility of the independent accounting firm is to the public. 4.d) ________ The most favorable type of audit report is called a qualified opinion. 5.e) ________ The ultimate responsibility for the financial statements lies with management of the company rather than the independent accounting firm.

41) Why would a merchandising company need good internal controls related to its inventory? List three of the key elements of an internal control system that would apply to inventory, and explain how each of them does relate to inventory.

42) Michelle Edwards operates a small dress shop that sells various items of apparel and accessories. She employs two clerks who make sales to customers, accept returns when a customer is dissatisfied with merchandise, and put new merchandise on display. One of the clerks, Kristen Scott, was hired recently. Michelle had always done all the accounting for the store and had made bank deposits. However, Kristen has offered to do the accounting for the store during slow periods when there are no customers in the store; she also has begun making bank deposits as she leaves for the day. Having Kristen take these responsibilities allows Michelle more time for acquiring merchandise for the store and for personal errands. What potential risks for the success of Michelle's business are present in this situation?

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43) One of your friends is preparing to open a store that will sell outdoor gear. When you heard that the business would have three or four employees, you told your friend that she would need to pay careful attention to segregation of duties. She has asked you to explain what duties should be separated and why segregation of duties is important in a business. Write a note to your friend explaining these issues.

44) The unadjusted cash account balance for Carson Company at December 31 is $12,615. The bank statement showed an ending balance of $18,250 at December 31. The following information is available from an examination of the bank statement and the company's accounting records: Bank service charge Outstanding checks NSF check from a customer Deposits in transit

$ 20 7,500 425 1,222

Check #433 for the purchase of inventory was written correctly and paid by the bank correctly for $432, but was recorded on the books at $234. Carson uses the perpetual inventory system. Required: 1.a) Determine the true cash balance by preparing a bank reconciliation as of December 31.

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45) As of May 31, the bank statement of Xi Company showed an ending balance of $8,632.52. The following information was available: Bank service charge Outstanding checks NSF check from a customer Deposit in transit Deposit erroneously recorded in Xi's account that should have been recorded in Flowers's account

$ 35.00 2,480.36 127.50 799.55 229.00

Required: Determine the true cash balance by preparing (only) the section of the bank reconciliation that starts with the bank balance.

46) For each of the following items, indicate whether it is an adjustment to the unadjusted bank balance, the unadjusted book balance, or not applicable when preparing a bank reconciliation. Use + for addition, − for subtraction, and NA for no adjustment. Item Deposit in transit

Bank Balance

Book Balance

Debit memo Outstanding check NSF check Error in recording a check on the books (check was wntten for $35 but recorded as $53) Service charge Unadjusted Interest earned on the account

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Unadjusted Petty cash voucher

47) The May 31 balance per bank statement was $12,400. The unadjusted book balance was $17,000. Outstanding checks amounted to $1,700, and deposits in transit were $4,800. The bank statement contained an NSF check for $1,100, a service charge for $50, and a debit memo for direct payment of the telephone bill of $350 (which has not yet been recorded by the company). Required: 1.a) Determine the true cash balance by preparing a bank reconciliation as of May 31.

48) The following information pertains to the bank reconciliation as of January 31 for Greis Company: Unadjusted bank balance Bank collection of a note receivable (no interest): Bank service charge: Deposit in transit: NSF check returned by the bank: Outstanding checks:

$ 18,900 2,000 60 4,000 1,800 6,000

In addition, the reconciliation revealed one error: Check #2146 for $152, written to pay utilities expense, was incorrectly recorded in the books for $125. Required: Using the above information, determine the unadjusted book balance for cash.

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49) Merrifield Lawn Care's bank statement at August 31 showed an ending balance of $23,716.87. The unadjusted cash account balance for Merrifield is $20,237.98. The following data were gathered by Merrifield's accountant: ● Check number 2143 was correctly written for $427. It was recorded in the company's books as $472 for utilities. ● Outstanding checks as of August 31: $7,128.71 ● NSF check from customer: $71.82 ● Debit memo for bank service charge: $8.00 ● Credit memo related to interest earned: $10.00 ● Deposits in transit: $3,625.00 Required: 1.a) Determine the true cash balance by preparing a bank reconciliation as of August 31.

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50) On November 30, Hernandez Company's bank statement showed an ending balance of $37,341. The following information is available about Hernandez's account: 1.Debit memo in bank statement for bank service charge, $39 2.Deposit in transit, $2,988 3.Outstanding checks, $3,156 4.Customer's NSF check for $723 was returned with the bank statement Required: 1.a) Determine the true cash balance as of November 30. 2.b) Determine the unadjusted balance of the company's Cash account as of November 30.

51) Rexrode Company's bank statement at January 31 showed an ending balance of $24,712.80. The unadjusted cash account balance for Rexrode is $21,245.75. The following data were gathered by Rexrode's accountant: ● Outstanding checks as of January 31: $4,895.44 ● NSF check from customer: $183.62 ● Debit memo for bank service charge: $20.00 ● Credit memo for interest earned: $12.00 ● Deposits in transit: $1,236.77 Required: 1.a) Determine the true cash balance by preparing a bank reconciliation as of January 31.

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52)

On May 1, Campbell Company established a petty cash fund in the amount of $400.

Required: 1.a) Is the establishment of the fund an asset source, asset use, or asset exchange transaction? 2.b) Record the establishment of the petty cash fund in the horizontal financial statements model, below. Indicate the dollar amounts of increases and decreases; for accounts that are not affected, indicate NA. For cash flows, show whether they are operating activities (OA), investing activities (IA), or financing activities (FA).

Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders’ Cash s Equity Flows Cas + Pett = Accounts + Commo + Retaine Revenu − Expens = Net h y Payable n d e e Incom Cash Stock Earning e s

53) Fern's Flowers established a $400 petty cash fund. The following expenditures were made from the fund: Office supplies Shipping expense Maintenance expense Miscellaneous expenses

$129.00 86.50 48.68 44.35

A count of the cash in the fund revealed a balance of $89.00. Required: 1.a) Enter the event relating to establishing the fund into the horizontal financial statements model. Indicate dollar amounts of increases and decreases; for accounts that are not affected, indicate NA. For cash flows, show whether they are operating activities (OA), investing activities (IA), or financing activities (FA).

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2.b) What is the amount of the check that must be written to replenish the fund?

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Answer Key Test name: Chap 06_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D D

A bank service charge will create an adjustment to the book balance that will decrease assets (Cash) and stockholders' equity (Retained Earnings). It will increase expenses, which decreases net income. It will be reported as a cash outflow from operating activities on the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA I

When the company records receipt of the collection on an account receivable, it will increase one asset (Cash) and decrease another asset (Accounts Receivable). This asset exchange transaction has no overall effect on total assets. There is no effect on stockholders’ equity or net income. It is reported as a cash inflow from operating activities on the statement of cash flows. 3) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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I/D

When the company corrects the error in recording the cash receipt, it will result in an increase in one asset (Cash) and a decrease in another asset (Accounts Receivable). There is no effect on stockholders’ equity or net income. It is reported as a cash inflow from operating activities on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA D

Recording the NSF check increases one asset (Accounts Receivable) and decreases another asset (Cash). This asset exchange transaction has no overall effect on total assets. There is no effect on stockholders’ equity or net income. Since the company must reduce its Cash account, this transaction is reported as a cash outflow from operating activities on the statement of cash flows. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

Outstanding checks are subtracted from the bank balance on the bank reconciliation. Adjustments to the bank balance have no effect on the company's financial statements. 6) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net

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Statement of Cash

Equity NA

Income NA

Flows NA

Deposits in transit are added to the bank balance on the bank reconciliation. Adjustments to the bank balance have no effect on the company's financial statements. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

A certified check is guaranteed for payment by a bank. A certified check is deducted from the customer's account when the bank certifies that the check is good. Certified checks, therefore, have been subtracted by the bank in determining the unadjusted bank balance, whether they have cleared the bank or remain outstanding as of the date of the bank statement. Thus, a certified check that is still outstanding does not affect any of the elements of the financial statements. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

If an error is found on the bank statement, an adjustment is made to the unadjusted bank balance to determine the true cash balance. The bank should be notified immediately to correct its records. Adjustments to the bank balance have no effect on the elements of the company's financial statements. 9) Version 1

Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D NA NA NA NA D

An error made by the depositor requires an adjustment to the book balance to arrive at the true cash balance. The correction of this error will decrease assets (Cash) and liabilities (Accounts Payable). It does not affect stockholders' equity or net income It is reported as a cash outflow from operating activities on the statement of cash flows. 10) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA NA

Establishing a petty cash fund increases one asset (Petty Cash) and decreases another asset (Cash). This results in no overall effect on total assets. There is no effect on stockholders’ equity or net income. It does not affect the statement of cash flows. 11) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

There is no effect on the financial statements when petty cash funds are disbursed. The effects on the financial statements are recorded only when the petty cash fund is replenished or increased (when additional currency is put into the petty cash safety box). 12)

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Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D D

The combined entries decrease assets (Cash) and stockholders' equity (Retained Earnings). Expenses are increased, which decrease net income. It is reported as a cash outflow from operating activities on the statement of cash flows. 13) The nine features of a strong internal control system include: ● Segregating duties so that fraud or theft requires collusion. ● Hiring and training competent employees. ● Bonding employees to recover losses through insurance. ● Requiring employees to be absent from their jobs so that their replacements can discover errors or fraudulent activity that might have occurred. ● Establishing proper procedures for processing transactions. ● Establishing clear lines of authority and responsibility. ● Using prenumbered documents. ● Implementing physical controls such as locking cash in a safe. ● Conducting performance evaluations through independent internal and external audits. 14) One element of a good internal control system is to segregate duties so that if one person is behaving inappropriately, another is likely to see the misbehavior and take corrective action. This system does not work if many high-level employees are willing to participate in the inappropriate behavior. Even the best systems of internal controls still rely on people.

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15) Any three of the five components listed below should be included in the answer: 1.Control Environment — The integrity and ethical values of the company, including its code of conduct, involvement of the board of directors, and other actions that set the tone of the organization. 2.Risk Assessment — Management's process of identifying potential risks that could result in misstated financial statements and developing actions to address those risks. 3.Control Activities — These are the activities usually thought of as "the internal controls." They include such things as segregation of duties, account reconciliations, and information processing controls designed to safeguard assets and enable an organization to prepare reliable financial statements in a timely manner. 4.Information and Communication — The internal and external reporting process, including an assessment of the technology environment. 5.Monitoring — Assessing the quality of a company's internal control over time and taking actions as necessary to ensure it continues to address the risks of the organization. 16) Internal control is the process designed to ensure reliable financial reporting, effective and efficient operations, and compliance with applicable laws and regulations. Safeguarding assets against theft and unauthorized use, acquisition, or disposal is also part of internal control. Accounting controls are composed of procedures designed to safeguard the assets and ensure that the accounting records contain reliable information. Administrative controls are designed to evaluate performance and the degree of compliance with company policies and public laws.

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17) Any five of the nine features of an internal control system listed below should be included in the answer: ● Segregating duties so that fraud or theft requires collusion. ● Hiring and training competent employees. ● Bonding employees to recover losses through insurance. ● Requiring employees to be absent from their jobs so that their replacements can discover errors or fraudulent activity that might have occurred. ● Establishing proper procedures for processing transactions. ● Establishing clear lines of authority and responsibility. ● Using prenumbered documents. ● Implementing physical controls such as locking cash in a safe. ● Conducting performance evaluations through independent internal and external audits. All nine features help to ensure that cash is safeguarded and reduce the likelihood of theft. 18) A fidelity bond provides insurance that protects a company from losses caused by employee dishonesty. 19) Accounting controls are composed of procedures designed to safeguard the assets and ensure that the accounting records contain reliable information. Administrative controls, on the other hand, are designed to evaluate performance and the degree of compliance with company policies and public laws.

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20) Cash Cash has universal value. A relatively small suitcase filled with highdenomination currency can represent significant value. Furthermore, the rightful owner of currency is difficult to prove. In most cases, possession constitutes ownership. As a result, cash is highly susceptible to theft and must be carefully protected. Cash is most susceptible to embezzlement when it is received or disbursed. 21) A bank statement debit memo describes a transaction that reduces the customer's account balance, for example bank service charges. 22) Companies frequently leave deposits in the bank's night depository or make them on the day following the receipt of cash. Such deposits are called deposits in transit. Because these deposits have been recorded in the depositor's accounting records but have not yet been added to the depositor's account by the bank, they must be added to the unadjusted bank balance. 23) NSF checks are checks that a company obtains from its customers and deposits in its checking account. However, when the checks are submitted to the customers' banks for payment, the banks refuse payment because there is insufficient money in the customers' account. The amount of an NSF check is deducted from the unadjusted book balance on a bank reconciliation. The company is advised of NSF checks through debit memos that appear on the bank statement. The depositor deducts the amounts of the NSF checks from the unadjusted book balance in the process of determining the true cash balance.

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24) Outstanding checks must be subtracted from the unadjusted bank balance to determine the true cash balance. Outstanding checks are disbursements that have been properly recorded as cash deductions on the depositor's books. However, the bank has not deducted the amounts from the depositor's bank account because the checks have not yet been presented by the payee to the bank for payment; that is, the checks have not cleared the bank. Outstanding checks must be subtracted from the unadjusted bank balance to determine the true cash balance. 25) Asset exchange transaction Establishing a petty cash fund increases one asset (petty cash) and decreases another asset (cash). Thus, it is an asset exchange transaction. 26) Companies frequently establish a petty cash fund to maintain effective control over small cash disbursements. Although businesses use checks for most disbursements, they often pay for small items such as postage, delivery charges, taxi fares, employees' supper money, and so on with currency. They frequently establish a petty cash fund to maintain effective control over these small cash disbursements. 27) A petty cash fund is usually maintained on an imprest basis, which means that the money disbursed is periodically replenished. The effects on the financial statements are recorded only when the petty cash fund is replenished or increased.

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28) The primary roles of an independent auditor (CPA) are: ● Conducts a financial audit (a detailed examination of a company's financial statements and underlying accounting records). ● Assumes both legal and professional responsibilities to the public, as well as to the company paying the auditor. ● Determines if financial statements are materially correct rather than absolutely correct. ● Presents conclusions in an audit report that includes an opinion as to whether the statements are prepared in conformity with GAAP. In rare cases, the auditor issues a disclaimer. ● Maintains professional confidentiality of client records. 29) The concept of materiality is very subjective. An error, or other reporting problem, is material if knowing about it would influence the decisions of an average prudent investor. 30) A financial audit is conducted by an independent auditor who must be a CPA who is licensed by a state government to provide services to the public.

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31) ● An unqualified opinion is the most favorable opinion auditors can express. It means the auditor believes the financial statements are in compliance with GAAP without material qualification, reservation, or exception. ● The most negative report an auditor can issue is an adverse opinion. An adverse opinion means that one or more departures from GAAP are so material the financial statements do not present a fair picture of the company's status. A qualified opinion falls between an unqualified and an adverse opinion. A qualified opinion means that for the most part, the company's financial statements are in compliance with GAAP, but the auditors have reservations about something in the statements. 32) If an auditor is unable to perform the audit procedures necessary to determine whether the statements are prepared in accordance with GAAP, the auditor cannot issue an opinion on the financial statements. Instead, the auditor issues a disclaimer of opinion. A disclaimer is neither negative nor positive. It simply means that the auditor is unable to obtain enough information to confirm compliance with GAAP. 33) a) T b) T c) F d) F e) F 1.a) This is true. Internal controls provide reasonable, but not, absolute assurance. 2.b) This is true. Accounting and administrative controls are the two categories of controls. 3.c) This is false. Each company's internal control system is different. 4.d) This is false. This describes administrative controls. 5.e) This is false. This describes accounting controls.

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34) a) T b) F c) T d) T e) F 1.a) This is true. The functions of authorization, recording, and custody of assets should be performed by separate employees to deter fraud. 2.b) This is false. Collecting customer payments and recording cash receipts should be performed by separate employees. 3.c) This is true. Employees who are given authority should bear the corresponding responsibility. 4.d) This is true. Requiring employee vacations helps to prevent employees from covering up fraudulent behavior. 5.e) This is false. A company is protected financially from financial loss due to fraudulent behavior of bonded employees, but it is the company that purchases the fidelity bond, not the employee. 35) a) T b) F c) T d) F e) T 1.a) This is true. SOX requires public companies to evaluate internal controls. 2.b) This is false. SOX applies to public companies, while the ERM framework is used by public and private companies alike. 3.c) This is true. In 2004, COSO updated the framework to help entities design and implement effective enterprise-wide approaches to risk management. The updated document is titled Enterprise Risk Management (ERM)–An Integrated Framework. 4.d) This is false. The five components of the COSO framework include control environment, risk assessment, control activities, information and communication, and monitoring. 5.e) This is true. Enron and WorldCom accounting scandals had such devastating effects that they led Congress to pass SOX.

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36) a) F b) F c) T d) F e) F 1.a) This is false. Depositing cash receipts in a bank should happen on a timely basis (rather than when they reach a predetermined level). 2.b) This is false. Businesses use checks for most disbursements. They often establish a petty cash fund to maintain effective control over small cash disbursements. 3.c) This is true. The check signer should examine supporting documents prior to signing. 4.d) This is false. The supporting documents should be marked "paid" when the check is signed. 5.e) This is false. Spoiled and voided checks should be defaced and retained. If defaced checks are not retained, an employee could steal a check and then claim it was written incorrectly and thrown away. 37) a) F b) T c) F d) F e) T 1.a) This is false. Bank statement debit memos describe transactions that reduce the customer's account balance. 2.b) This is true. Bank statement credit memos describe activities that increase the customer's account balance. 3.c) This is false. Because service fees decrease the depositor's assets, they appear as debit memos (rather than credit memos). 4.d) This is false. Deposits in transit do not appear on the bank statement because the bank is unaware of those deposits. 5.e) This is true. Outstanding checks do not appear on the bank statement because the bank is unaware of those checks.

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38) a) T b) F c) F d) T e) F 1.1) This is true. Accounting controls are composed of procedures designed to safeguard the assets and ensure that the accounting records contain reliable information. 2.b) This is false. Administrative controls are designed to evaluate performance and the degree of compliance with company policies and public laws. 3.c) This is false. Whenever possible, the functions of authorizing, recording, and custody of assets should be performed by separate individuals. 4.d) This is true. Cash is most susceptible to embezzlement when it is received or disbursed. 5.e) This is false. A system of internal controls is designed to prevent or detect errors and fraud. However, no control system is foolproof. Internal controls can be circumvented by collusion among employees. 39) a) F b) F c) T d) F e) T 1.a) This is false. Establishment of a petty cash fund increases one asset (Petty Cash) and decreases another asset (Cash), so it is an asset exchange transaction. 2.b) This is false. Replenishment of a petty cash fund is an asset use transaction that increases expenses and decreases cash. 3.c) This is true. The total of the petty cash vouchers plus the cash on hand should equal the balance in the petty cash account. 4.d) This is false. If a cash shortage occurs, an expense is recognized. 5.e) This is true. There is no effect on the financial statements at the time petty cash funds are disbursed.

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40) a) F b) T c) T d) F e) T 1.a) This is false. Audits are designed to provide reasonable, but not absolute, assurance that financial statements are materially correct. 2.b) This is true. A financial audit is a detailed examination of a company's financial statements and underlying accounting records. 3.c) This is true. Although the independent auditors are chosen by, paid by, and can be fired by their client companies, the auditors are primarily responsible to the public. 4.d) This is false. An unqualified opinion, despite its negativesounding name, is the most favorable opinion auditors can express. It means the auditor believes the financial statements are in compliance with GAAP without material qualification, reservation, or exception. 5.e) This is true. The ultimate responsibility for financial statements rests with the executives of the reporting company.

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41) A merchandising company needs good internal controls related to its inventory for several reasons, such as inventory may be the largest asset on the balance sheet in dollar amount and thus a tempting target for theft; some inventory is small in size and valuable and thus subject to theft or shoplifting; and Cost of Goods Sold may be the largest expense on the income statement. As a result, theft or fraud related to inventory can have a significant impact on the company's reported performance. Most of the key features of internal control systems apply to inventory. For example: 1.1) Segregation of duties — Employees who sell inventory should not count it when a physical count of the inventory is needed. Also, employees who handle inventory should not make journal entries related to inventory. 2.2) Quality of employees — A company should hire motivated employees with good educational background and work experience. The company should also provide training to employees so that they understand policies related to inventory. 3.3) Authority and responsibility — Employees who sell inventory (or who handle inventory in a warehouse) should understand their responsibility and the limits of their authority. 4.4) Physical controls — Physical controls (such as locked storerooms) should be used as appropriate to protect the company's inventory.

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42) Whenever possible, the functions of authorization, recording, and custody of assets should be performed by separate individuals. This situation is risky because there is not sufficient segregation of duties. Kristen could steal merchandise or cash or give items to her family or friends and cover it up by making entries into the accounting system. The situation as described would allow Kristen to engage in systematic, long-term theft from the business, reducing its profitability. 43) The likelihood of fraud or theft is reduced if employees must work together to accomplish it. Clear segregation of duties is frequently used as a deterrent to corruption. When duties are segregated, the work of one employee can act as a check on the work of another employee. Whenever possible, the functions of authorization, recording, and custody of assets should be performed by separate individuals. However, no internal control system is foolproof. Internal controls can be circumvented by collusion among employees. That is, two or more employees working together can hide embezzlement by covering for each other. 44) Unadjusted bank balance Add: Deposits in transit Less: Outstanding checks True cash balance

$ 18,250 1,727 (7,500) $ 11,972

Unadjusted book balance Less: Error (inventory) Less: Bank service charge Less: NSF check True cash balance

$ 12,615 (198) (20) (425) $ 11,972

45) Unadjusted bank balance

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$ 8,632.52

Add: Deposits in transit Less: Outstanding checks Less: Error correction True cash balance

799.55 (2,480.36) (299.00) $ 6,722.71

The bank service charge and NSF check are adjustments to the unadjusted book balance, not the unadjusted bank balance. Because the bank had erroneously added $229.00 to Xi's account and must correct that error, it must be subtracted from the unadjusted bank balance. 46) Item Deposit in transit Debit memo Outstanding check NSF check Error in recording a check on the books (check was wntten for $35 but recorded as $53) Service charge Unadjusted Interest earned on the account Unadjusted Petty cash voucher

Bank Balance + NA − NA NA

Book Balance NA − NA − +

NA NA

− +

47) a) Unadjusted bank balance Add: Deposits in transit Less: Outstanding checks True cash balance

$ 12,400 4,800 (1,700) $ 15,500

Unadjusted book balance Less: NSF check Less: Bank service charge Less: Debit memo True cash balance

$ 17,000 (1,100) (50) (350) $ 15,500

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48) $16,787 True cash balance = Unadjusted bank balance of $18,900 + Deposit in transit of $4,000 - Outstanding checks of $6,000 = $16,900 True cash balance of $16,900 = Unadjusted book balance (the unknown) + Collection of the accounts receivable of $2,000 - Service charge of $60 − NSF check of $1,800 − Error recording Check #2146 of $27 Unadjusted book balance = $16,900 − $2,000 + $60 + $1,800 + $27 = $16,787 The error in recording Check #2146 caused cash to be overstated by $27, which is the difference between the actual amount of check of $152 and the amount recorded of $125. To correct this error, the company must decrease the book balance. 49) (a) Unadjusted bank balance Add: Deposit in transit Less: Outstanding checks True cash balance

$ 23,716.87 3,625.00 (7,128.71) 20,213.16

Unadjusted book balance Less: NSF check Debit memo for service charge Add: Credit memo Error correction True cash balance

$ 20,237.98 (71.82) (8.00) 10.00 45.00 $ 20,213.16

50) 1.a) $37,173 2.b) $37,935 1.a) True cash balance = Unadjusted bank balance of $37,341 + Deposit in transit of $2,988 − Outstanding checks of $3,156 = $37,173 2.b) True cash balance of $37,173 = Unadjusted book balance − Debit memo of $39 − NSF check of $723 NSF Unadjusted book balance = $37,173 + $39 + $723 = $37,935 51) (a) Unadjusted bank balance

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$ 24,712.80

Add: Deposit in transit Less: Outstanding checks True cash balance Unadjusted book balance Add: Credit memo for interest Less: NSF check Debit memo for service charge True cash balance

1,236.77 (4,895.44) 21,054.13 $ 21,245.75 12.00 (183.62) (20.00) $ 21,054.13

52) 1.a) The establishment of the petty cash fund is an asset exchange transaction; cash decreases and petty cash increases and total assets do not change. 2.b) Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders’ Cash s Equity Flows Cash + Pett = Accounts + Commo + Retaine Revenu − Expens = Net y Payable n d e e Incom Cash Stock Earning e s (400 400 n/a n/a n/a n/a n/a n/a n/a )

53) 1.a) Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders’ Cash s Equity Flows Cash + Pett = Accounts + Commo + Retaine Revenu − Expens = Net y Payable n d e e Incom Cash Stock Earning e s (400 400 n/a n/a n/a n/a n/a n/a n/a )

2.b) The petty cash fund needs to be replenished by $311. A check is issued to the bank to obtain the currency needed to return the fund to its imprest balance.

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CHAPTER 6 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A well-designed system of internal controls will eliminate all fraud. ⊚ true ⊚ false

2) Internal controls designed to evaluate performance and the degree of compliance with company policies and public laws are classified as administrative controls. ⊚ true ⊚ false

3) Segregation of duties in an organization should be required to reduce the likelihood of theft. ⊚ true ⊚ false

4) Requiring segregation of duties in a business eliminates the need for the work of one employee to serve as a check on the work of other employees. ⊚ true ⊚ false

5) Even a good system of internal controls can be circumvented by collusion among employees. ⊚ true ⊚ false

6) A savings account that imposes a substantial penalty for early withdrawals should not be classified as Cash on the balance sheet. ⊚ true ⊚ false

7) For financial reporting purposes, cash generally includes currency and other items that are payable on demand, such as checks, money orders, bank drafts, and certain savings accounts.

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⊚ ⊚

true false

8) To ensure proper segregation of duties, after the check is signed, an employee should record the check in the accounting records and review the appropriate supporting documents. ⊚ true ⊚ false

9) A bank statement debit memo describes a transaction that increases a customer's account balance. ⊚ true ⊚ false

10) A bank reconciliation normally begins with the ending cash balance shown on the bank statement and reconciles it to the unadjusted cash account balance on the company's books. ⊚ true ⊚ false

11) Typical adjustments to the unadjusted bank balance on a bank reconciliation include deposits in transit and outstanding checks. ⊚ true ⊚ false

12) Typical adjustments to the unadjusted book balance on a bank reconciliation include bank service charges, customer NSF checks, and certified checks. ⊚ true ⊚ false

13)

Preparing a bank reconciliation is a control activity. ⊚ true ⊚ false

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14) After the adjustments identified on the bank reconciliation have been recorded, the ending cash (book) balance reflected in the company’s records will equal the true cash balance. ⊚ true ⊚ false

15) The true cash balance can only be determined if both the unadjusted bank balance and the unadjusted book balance are known. ⊚ true ⊚ false

16) A business learns about customers' NSF checks through debit memos that are included with the bank statement. ⊚ true ⊚ false

17)

A cash shortage is treated as an expense. ⊚ true ⊚ false

18) The purpose of a petty cash fund is to eliminate the need for control over a business's small cash disbursements. ⊚ true ⊚ false

19)

Establishment of a petty cash fund is an asset exchange transaction. ⊚ true ⊚ false

20)

At the time petty cash funds are disbursed, there is no effect on the financial statements. ⊚ true ⊚ false

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21) For a petty cash fund to be most useful to a business, one of the employees of the business should be designated as responsible for the fund. ⊚ true ⊚ false

22)

Most audits result in unqualified audit opinions. ⊚ true ⊚ false

23)

An error is considered material if it would trigger an IRS audit. ⊚ true ⊚ false

24) The Securities and Exchange Commission is authorized to establish and enforce the accounting rules for public companies. ⊚ ⊚

25)

true false

The primary focus of financial statement audits is the discovery of fraud. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 26) Which of the following is an administrative control? A) Performance evaluation B) Accuracy of the recording procedures C) Keeping cash in a safe D) Maintenance of accurate inventory records

27)

Which of the following statements concerning internal controls is true?

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A) Internal administrative controls are designed to limit the amount of funds spent on investments. B) Strong internal controls provide reasonable assurance that the objectives of a company will be accomplished. C) Internal accounting controls are limited to the policies and procedures used to protect the company from embezzlement. D) The control procedure, segregation of duties, prohibits the employment of a husband and wife or other closely related parties within the same company.

28) Chester Company has established internal control policies and procedures in order to achieve the following objectives: 1.1) Effective evaluation of management performance. 2.2) Assure that the accounting records contain reliable information. 3.3) Safeguard the company's assets. 4.4) Assure that employees comply with company policy. Which of these objectives are achieved by accounting controls? A) Objectives 1 and 2 B) Objectives 2 and 3 C) Objectives 3 and 4 D) All four objectives

29)

Which of the following is not one of the nine features of an internal control system? A) Establishment of clear lines of authority B) Having employees covered by a fidelity bond C) Requiring regular vacations for certain employees D) Customer service comment cards

30)

Which of the following statements accurately describes a fidelity bond?

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A) Procedures to provide reasonable assurance that the objectives of a company are accomplished. B) Proper procedures for processing transactions. C) Insurance that the company buys to protect itself from loss due to employee dishonesty. D) Guidelines or policies that limit the actions of different levels of management.

31)

Which of the following is not a common feature of an internal control system? A) Segregating duties B) Performance evaluation C) Bonding employees D) Implementing the most effective marketing plan

32)

Which of the following is not an example of a common control activity? A) Required absences B) Collusion C) Procedures manual D) Use of prenumbered documents

33)

Which internal control procedure is a deterrent to corruption? A) Segregation of duties B) Physical controls C) Fidelity bonding D) Use of prenumbered documents

34) The accountant for Ye Olde Bookstore balanced out the cash register for the day. The company began the day with $125 and ended the day with $1,150.25 in the cash drawer. That day’s cash register tape shows $1,031.50 in cash sales. What is the effect on the financial statements of recording the day's sales and any related overage or shortage? Balance Sheet

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Income Statement

Statemen

Assets = Liabilitie + Stockholders Revenue − Expens = Net s ’ Equity e Income A 1,150.2 . 5 B 1,031.5 . 0 C 1,025.2 . 5 D 1,025.2 . 5

N/A

1,150.25

N/A

1,031.50

N/A

1,025.25

N/A

1,025.25

1,150.2 5 1,031.5 0 1,031.5 0 1,025.2 5

N/A N/A N/A N/A

t of Cash Flows 1,150.2 1,150.25 5 OA 1,031.5 1,031.50 0 OA 1,025.2 1,025.25 5 OA 1,025.2 1,025.25 5 FA

A) Option A B) Option B C) Option C D) Option D

35) Which of the following is not a common internal control procedure that would be implemented with regards to cash receipts? A) Preparing a record of all cash collections immediately upon receipt B) Providing copies of written receipts to customers C) Depositing cash receipts in a bank on a timely basis D) Marking supporting documents Paid when checks are signed

36) Which of the following is an internal control procedure used to safeguard a company's assets? A) Depositing cash receipts in a bank on a timely basis B) Segregation of duties C) Preparing a bank reconciliation D) All of these answer choices are correct

37)

Which of the following is not a motive for the embezzlement of cash by employees?

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A) Cash is the common unit of measurement B) Ownership of cash is difficult to prove C) Cash has universal appeal D) Small quantities of high-denomination currency can represent significant value

38) Which of the following is not a typical document associated with a bank checking account? A) Signature card B) Bank statement C) Cash register tape D) Deposit ticket

39) Which of the following internal control procedures should be implemented to control cash? A) Disbursements by prenumbered checks B) Depositing cash receipts in the bank on a timely basis C) Providing copies of written receipts to customers D) All of these answer choices are correct

40) A review of the bank statement and accounting records of Blake Company revealed the following items: Item Number 1) 2) 3) 4) 5) 6)

Description Three outstanding checks A debit memo showing a bank service charge A deposit in transit A NSF check written by one of Blake’s customers A certified check written by Blake that remains outstanding A credit memo reflecting interest revenue earned by Blake

Which of the item(s) would be subtracted from the company's unadjusted book balance to determine the true cash balance?

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A) Item numbers 2 and 4 B) Item numbers 2, 4, and 5 C) Item numbers 1 and 4 D) Item numbers 1, 2, 4, and 5

41) A review of the bank statement and accounting records of Blake Company revealed the following items: Item Number 1) 2) 3) 4) 5) 6)

Which of the item(s) would be added to the unadjusted bank balance to determine the true cash balance? A) Item numbers 2 and 3 B) Item number 2 C) Item numbers 3, 4, and 6 D) Item number 3

42) Which of the following describes an activity that increases a company's bank account balance? A) Credit memo B) Debit memo C) Balance sheet D) Certified check

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43) The April 30 bank statement for Trimble Corporation shows an ending balance of $35,851. The unadjusted cash account balance was $29,750. The accountant for Trimble gathered the following information: 1.There was a deposit in transit for $4,530. 2.The bank statement reports a service charge of $74. 3.A credit memo included in the bank statement shows interest earned of $295. 4.Outstanding checks totaled $11,680. 5.The bank statement included a $1,270 NSF check deposited in April. What is the true cash balance as of April 30? A) $27,431 B) $28,701 C) $32,936 D) $33,231

44) The April 30 bank statement for Trimble Corporation shows an ending balance of $34,351. The unadjusted cash account balance was $28,250. The accountant for Trimble gathered the following information: 1.There was a deposit in transit for $4,240. 2.The bank statement reports a service charge of $39. 3.A credit memo included in the bank statement shows interest earned of $95. 4.Outstanding checks totaled $10,935. 5.The bank statement included a $650 NSF check deposited in April. What is the true cash balance as of April 30? A) $27,656 B) $27,006 C) $31,801 D) $31,896

45) At March 31, Cummins Company had an unadjusted balance in its cash account of $10,500. At the end of March, the company determined that it had outstanding checks of $1,130, deposits in transit of $700, a bank service charge of $40, and a NSF check from a customer for $225. What is the true cash balance at March 31?

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A) $10,070 B) $10,235 C) $10,500 D) $9,780

46) At March 31, Cummins Company had an unadjusted balance in its cash account of $10,400. At the end of March, the company determined that it had outstanding checks of $900, deposits in transit of $600, a bank service charge of $20, and a NSF check from a customer for $200. What is the true cash balance at March 31? A) $10,100 B) $10,180 C) $10,380 D) $9,880

47)

Which of the following is not a common internal control procedure over cash payments? A) A receipt should be provided to each cash customer B) Checks should be properly authorized with approval signatures C) All checks should be prenumbered D) Voided checks should be defaced and retained

48) While preparing its bank reconciliation, Maynard Company determined that its bank had collected a $650 account receivable for the company and deducted a $25 collection fee. Which of the following shows the effect of this transaction on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (25) N/A (25) N/A 25 (25) 625 OA B.

625

N/A

625

650

625

650 OA

C. (25)

N/A

(25)

N/A

(25)

650 OA

N/A

625

650

625

625 OA

625

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A) Option A B) Option B C) Option C D) Option D

49) While performing its monthly bank reconciliation, the bookkeeper for Mosaic Company discovered that a check written for $421 for advertising expense was recorded in the firm's books as $241. Which of the following shows the effect of correcting the error on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 180 N/A 180 N/A (180) 180 180 OA B. (180)

N/A

(180)

N/A

180

(180)

(180) OA

C. (421)

N/A

(421)

N/A

421

(421)

(421) OA

D. (180)

N/A

(180)

N/A

180

(180)

(421) OA

A) Option A B) Option B C) Option C D) Option D

50) While performing its monthly bank reconciliation, the bookkeeper for Grace Corporation noted that a deposit of $990 (received from a customer on account) was recorded in the company books as $900. Which of the following shows the effect of correcting the error on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 90 N/A 90 90 N/A 90 90 OA B.

990

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N/A

990

N/A

990 OA

N/A

90 OA

N/A

(90) OA

A) Option A B) Option B C) Option C D) Option D

51) While performing the monthly bank reconciliation, Avon Company adjusted for a bank service charge of $20. Which of the following correctly shows how the adjustment for the bank service charge affects the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. N/A N/A N/A N/A N/A N/A (20) OA B. (20)

(20)

N/A

(20) OA

C. (20)

N/A

(20)

N/A

(20)

(20) OA

D. (20)

N/A

(20)

N/A

(20)

(20) OA

A) Option A B) Option B C) Option C D) Option D

52) Which of the following describes an activity that reduces a company's bank account balance? A) A deposit in transit B) A debit memo C) A credit memo D) A reconciling entry

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53)

How is a customer's NSF check reflected on a bank reconciliation? A) Subtracted from the unadjusted book balance to get the true cash balance B) Added to the unadjusted bank balance to get the true cash balance C) Subtracted from the unadjusted bank balance to get the true cash balance D) Added to the unadjusted book balance to get the true cash balance

54)

How will a certified check be shown on a company's bank reconciliation? A) As a deduction to the company's unadjusted book balance. B) As an increase to the bank's unadjusted bank balance. C) As a deduction to the bank's unadjusted bank balance. D) There is no adjustment when preparing the bank reconciliation.

55) In the reconciliation of the June bank statement, a deposit made on June 30 did not appear on the June bank statement. How is this deposit in transit shown on the bank reconciliation? A) Subtracted from the unadjusted book balance. B) Added to the unadjusted book balance. C) Subtracted from the unadjusted bank balance. D) Added to the unadjusted bank balance.

56)

What is an outstanding check?

A) A check that has been issued by the company but has not been presented to the bank for payment. B) A check that is guaranteed for payment by the bank. C) A check that has been presented to the bank for payment but has not been reported on the bank statement. D) A check that was written for an amount that is greater than the balance in the account holder's bank account.

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57) Jasper Company accepted a check from Harp Company as payment for services rendered. Jasper's bank statement revealed that the Harp check was a NSF check. What effect will recording the NSF check have on the accounting equation of Jasper Company? Total Assets A. B. C. D.

Decrease No effect Decrease No effect

Total Equity Decrease Decrease No effect No effect

A) Option A B) Option B C) Option C D) Option D

58) Owen Company's unadjusted book balance at June 30 is $15,200. The company's bank statement reveals bank service charges of $130. Two credit memos are included in the bank statement: one for $1,570, which represents a collection that the bank made for Owen, and one for $220, which represents the amount of interest that Owen had earned on its interest-bearing account in June. What is the true cash balance? A) $15,200 B) $16,860 C) $16,550 D) $17,120

59) Owen Company's unadjusted book balance at June 30 is $9,700. The company's bank statement reveals bank service charges of $45. Two credit memos are included in the bank statement: one for $900, which represents a collection that the bank made for Owen, and one for $50, which represents the amount of interest that Owen had earned on its interest-bearing account in June. What is the true cash balance? A) $9,700 B) $10,695 C) $10,550 D) $10,605

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60) Duke Company's unadjusted bank balance at March 31 is $4,180. The bank reconciliation revealed outstanding checks amounting to $620 and deposits in transit of $460. What is the true cash balance? A) $3,820 B) $4,220 C) $4,520 D) $4,020

61) Duke Company's unadjusted bank balance at March 31 is $2,300. The bank reconciliation revealed outstanding checks amounting to $500 and deposits in transit of $400. What is the true cash balance? A) $2,200 B) $2,000 C) $2,700 D) $2,400

62) Rainey Company's true cash balance at October 31 is $5,030. The following information is available for the bank reconciliation: ● Outstanding checks, $780 ● Deposits in transit, $540 ● Bank service charges, $105 ● The bank had collected an account receivable for Rainey Company, $1,150 ● The bank statement included a NSF check written by one of Ramsey's customers for $690. What was the unadjusted book balance at October 31? A) $5,270 B) $5,825 C) $4,675 D) $4,780

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63) Rainey Company's true cash balance at October 31 is $5,710. The following information is available for the bank reconciliation: ● Outstanding checks, $600 ● Deposits in transit, $450 ● Bank service charges, $90 ● The bank had collected an account receivable for Rainey Company, $1,000 ● The bank statement included a NSF check written by one of Ramsey's customers for $600. What was the unadjusted book balance at October 31? A) $5,870 B) $5,400 C) $6,400 D) $5,490

64) The bank statement for Tetra Company contained the following items: a bank service charge of $80; a credit memo for interest earned, $85; and a $190 NSF check from a customer. The company had outstanding checks of $450 and a deposit in transit of $1,000. Assuming that the unadjusted bank balance was $2,000, what is the unadjusted book balance? A) $2,550 B) $1,815 C) $2,735 D) $3,000

65) The bank statement for Tetra Company contained the following items: a bank service charge of $10; a credit memo for interest earned, $15; and a $50 NSF check from a customer. The company had outstanding checks of $100 and a deposit in transit of $300. Assuming that the unadjusted bank balance was $500, what is the unadjusted book balance? A) $745 B) $455 C) $700 D) $800

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66) The bank statement for Tetra Company contained the following items: a bank service charge of $10; a credit memo for interest earned, $15; and a $50 NSF check from a customer. The company had outstanding checks of $100 and a deposit in transit of $300. Which of the following will be caused by recording the customer’s NSF check? A) Accounts receivable increases. B) Cash decreases. C) Stockholders’ equity decreases. D) Accounts receivable increases and cash decreases.

67) Keatts Company's bank statement included a NSF check written by one of its customers. What effect will recognizing the NSF check have on the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + − N/A N/A + N/A + + OA B.

+ −

N/A

− OA

+ −

N/A

−

N/A

−

N/A

−

N/A

A) Option A B) Option B C) Option C D) Option D

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68) On September 30 the bank statement of Fine Company showed a balance of $13,250. The following information was revealed by comparing the bank statement to the cash balance in Fine’s accounting records: ● Deposits in transit amounted to $5,415 ● Outstanding checks amounted to $9,710 ● A $780 check was incorrectly drawn on Fine's account ● NSF checks returned by the bank were $1,280 ● The bank service charge was $45 ● Credit memo for $190 for the collection of one of the company's account receivable What is the true cash balance? A) $9,735 B) $9,880 C) $8,600 D) $10,135

69) On September 30 the bank statement of Fine Company showed a balance of $7,800. The following information was revealed by comparing the bank statement to the cash balance in Fine's accounting records: ● Deposits in transit amounted to $3,150 ● Outstanding checks amounted to $6,200 ● A $550 check was incorrectly drawn on Fine's account ● NSF checks returned by the bank were $750 ● The bank service charge was $29 ● Credit memo for $75 for the collection of one of the company's account receivable What is the true cash balance? A) $5,346 B) $5,300 C) $4,596 D) $7,096

70) The owner of Barnes Company established a petty cash fund amounting to $400. What is the effect on the financial statements of recording this transaction? Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net of Cash Equity Income Flows A. N/A N/A N/A N/A N/A N/A (400) OA B. (400)

N/A

(400)

N/A

400

(400)

(400) OA

N/A

D. (400)

(400)

N/A

(400) OA

A) Option A B) Option B C) Option C D) Option D

71)

How are cash overages reported on the financial statements? A) Petty Cash Payable B) Petty Cash Receivable C) Petty Cash Expense D) Miscellaneous revenue

72)

Which of the following occurs when a company replenishes its petty cash fund? A) Cash decreases B) Petty cash decreases C) Expenses decrease D) Cash increases

73) Which of the following procedures are typically used when a petty cash fund is established?

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A) Assigning a petty cash custodian B) Use of petty cash vouchers C) Physical control over the petty cash fund D) All of these procedures are used when a petty cash fund is established

74) On April 30, Midwest Company established a petty cash fund of $1,000. On May 1, a disbursement of $355 was made from the fund for payment of delivery expense. The petty cash account has not been replenished. How would the disbursement affect the financial statements on May 1? A) Delivery expense increases and cash decreases by $355 B) Petty cash increases and cash decreases by $355 C) Delivery expense increases and petty cash decreases by $355 D) The disbursement has no effect on the financial statements

75) Peterson Company's petty cash fund was established on January 1 with $500. On January 31, a count of the fund revealed: $105 in cash remaining and vouchers for miscellaneous expenses totaling $400. If the company records both the disbursements and the replenishments to the fund, what is the overall effect on Peterson’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (400) N/A (400) N/A 400 (400) (395) OA B. (400)

N/A

(400)

N/A

400

(400)

(400) OA

C. (500)

N/A

(500)

N/A

500

(500)

(500) FA

D. (395)

N/A

(395)

400

(395)

(395) OA

A) Option A B) Option B C) Option C D) Option D

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76) Gross Company established a $250 petty cash fund on January 1. On March 1, the fund contained $160 in receipts for miscellaneous expenses and $85 in cash. If the company records both the disbursements and replenishments to the fund, what effect will it have on the elements of the financial statements? A) No effect on total assets B) Decrease stockholders’ equity by $160 C) Increase stockholders’ equity by $165 D) Decrease total assets by $165

77) Blake Company established a petty cash fund in the amount of $400. At the end of the accounting period, the petty cash box contained receipts for expenditures amounting to $180 and $215 in cash. If the company records both the disbursements and replenishments to the fund, what effect will replenishing the fund have on total assets and expenses?

A. B. C. D.

Total Assets

Expenses

−$ 180 −$ 185 −$ 185 −$ 180

+$ 185 +$ 185 +$ 180 +$ 180

A) Option A B) Option B C) Option C D) Option D

78)

Which of the following is not a primary role of an independent auditor? A) Assume legal and professional responsibilities to the public. B) Advise client on tax strategies. C) Determine whether a company's financial statements are materially correct. D) All of these answer choices are correct.

79)

Which of the following statements regarding the SEC is not true?

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A) SEC rules frequently require disclosures in addition to those required by GAAP. B) The SEC has the authority to establish and enforce accounting rules for public companies. C) The SEC is a private professional organization. D) Public companies must register with the SEC.

80) What is the most favorable audit opinion that a company can receive on its financial statements? A) Adverse opinion B) Unqualified opinion C) Disclaimer of opinion D) Qualified opinion

81)

Which of the following statements about the materiality concept is not true?

A) Materiality is different for each company. B) A material error would change the opinion of the average prudent investor. C) Any error greater than $5,000 is considered material in a financial statement audit. D) Material misstatements should not exist in order for a company to receive an unqualified audit opinion.

82) If the financial statements cannot be relied upon because they contain one or more material departures from GAAP, what type of opinion will the auditor issue? A) Qualified opinion B) Disclaimer of opinion C) Adverse opinion D) Unqualified opinion

83)

Which of the following statements is true with regards to financial statement audits?

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A) The auditors guarantee that the financial statements are accurate and correct. B) Financial audits are directed toward the discovery of fraud. C) Auditors provide reasonable assurance that statements are free from material misstatements, whether caused by errors or fraud. D) Auditors will not disclose information that they have acquired as a result of their accountant-client relationship.

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Answer Key Test name: Chap 06_2e_Test Bank_MCQs_TF 1) FALSE No system can prevent all fraud. However, a good system of internal controls minimizes illegal or unethical activities by reducing temptation and increasing the likelihood of early detection. 2) TRUE Administrative controls are designed to evaluate performance and the degree of compliance with company policies and public laws. 3) TRUE Segregation of duties helps to prevent theft by having the work of one employee act as a check of the work of another employee. 4) FALSE When duties are segregated, the work of one employee can act as a check on the work of another employee. 5) TRUE Collusion means that two or more employees work together to hide embezzlement by covering for each other. No system can prevent all fraud. However, a good system of internal controls minimizes illegal or unethical activities by reducing temptation and increasing the likelihood of early detection. 6) TRUE If a savings account imposes a substantial penalty for early withdrawal, it should be classified as an investment. 7) TRUE

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For financial reporting purposes, cash generally includes currency and other items that are payable on demand, such as checks, money orders, bank drafts, and certain savings accounts. Savings accounts that impose substantial penalties for early withdrawal should be classified as investments rather than cash. 8) FALSE The duties of approving disbursements, signing checks, and recording transactions should be segregated. By separating these duties, the check signer reviews the documentation provided by the approving individual before signing the check. Likewise, the recording clerk reviews the work of both the approving person and the check signer when the disbursement is recorded in the accounting records. 9) FALSE A bank statement debit memo describes a transaction that reduces the customer’s account balance. 10) FALSE A bank reconciliation normally begins with the cash balance reported by the bank, which is called the unadjusted bank balance. The adjustments necessary to determine the amount of cash that the depositor actually owns as of the date of the bank statement are then added to and subtracted from the unadjusted bank balance. The final total is the true cash balance. 11) TRUE These are typical adjustments to the bank balance. 12) FALSE

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Typical adjustments to the book balance on a bank reconciliation include account receivable collection, interest earned, service charges, and NSF checks. A certified check is deducted from the customer’s account when the bank certifies that the check is good. Certified checks, therefore, have been deducted by the bank in determining the unadjusted bank balance, whether they have cleared the bank or remain outstanding as of the date of the bank statement. Thus, certified checks do not affect the unadjusted book or bank balance on the bank reconciliation. 13) TRUE Control activities, the activities usually thought of as “the internal controls,” include such things as account reconciliations. 14) TRUE The adjustments bring the book balance in agreement with the true cash balance. 15) FALSE A bank reconciliation normally begins with the cash balance reported by the bank, which is called the unadjusted bank balance. The adjustments necessary to determine the amount of cash that the depositor actually owns as of the date of the bank statement are then added to and subtracted from the unadjusted bank balance. The final total is the true cash balance. The true cash balance is independently reached a second time by making adjustments to the unadjusted book balance. 16) TRUE The company is advised of NSF checks through debit memos that appear on the bank statement. 17) TRUE A shortage of cash would be treated as an expense. An overage of cash represents revenue. 18) FALSE

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Companies frequently establish a petty cash fund to maintain effective control over small cash disbursements. 19) TRUE Establishing a petty cash fund increases one asset, petty cash, and decreases another asset, cash. 20) TRUE There is no effect on the financial statements when petty cash funds are disbursed. The effects on the financial statements are recorded only when the petty cash fund is replenished. 21) TRUE A petty cash fund should be controlled by one employee, called the petty cash custodian. 22) TRUE Most audits result in unqualified opinions because companies correct any material reporting deficiencies the auditors find before the financial statements are released. 23) FALSE An error is material if knowing about it would influence the opinion of the average prudent investor. 24) TRUE The SEC is authorized to establish and enforce the accounting rules for public companies. 25) FALSE Financial audits are not directed toward the discovery of fraud. Auditors are, however, responsible for providing reasonable assurance that statements are free from material misstatements, whether caused by errors or fraud. 26) A Administrative controls are designed to evaluate performance and the degree of compliance with company policies and public laws. Version 1

27) B Strong internal controls provide reasonable, but not absolute, assurance that the objectives of a company will be accomplished. 28) B Accounting controls are composed of procedures designed to safeguard company assets and ensure the accounting records contain reliable information. Objectives 2 and 3 relate to accounting controls. On the other hand, administrative controls are composed of procedures designed to safeguard the assets and ensure that the accounting records contain reliable information. Objectives 1 and 4 relate to administrative controls. 29) D While customer service comment cards are helpful in monitoring company performance, they are not one of the nine features of an internal control system. 30) C A fidelity bond provides insurance that protects a company from losses caused by employee dishonesty. 31) D While the mechanics of internal control systems vary from company to company, the more prevalent features include the following: segregation of duties, quality of employees, bonded employees, required absence, a procedures manual, authority and responsibility, prenumbered documents, physical control, and performance evaluations. Internal controls do not relate to effective marketing plans. 32) B Internal controls can be circumvented by collusion among employees. 33) A

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The likelihood of fraud or theft is reduced if employees must work together to accomplish it. Clear segregation of duties is frequently used as a deterrent to corruption. When duties are segregated, the work of one employee can act as a check on the work of another employee. 34) C Expected change in cash = Cash sales of $1,031.50 Actual change in cash = Ending cash on hand of $1,150.25 − Beginning cash on hand of $125.00 = $1,025.25 Shortage = Expected change in cash (actual cash sales) of $1,031.50 − Actual change in cash of $1,025.25 = $6.25 When the company records the day’s sales and the shortage, it will increase assets (cash) by $1,025.25 and increase stockholders’ equity (retained earnings) by the same amount. It will increase revenue by the cash sales of $1,031.50 and increases expenses by the amount of the shortage of $6.25; resulting in an increase to net income of $1,025.25. A cash inflow for operating activities of $1,025.25 will be reported on the statement of cash flows. 35) D This describes an internal control procedure that would be implemented with regards to cash payments rather than cash receipts. 36) D All of these are controls that help safeguard a company’s assets, including cash. 37) A The fact that cash is the common unit of measurement is not a motive for embezzlement. 38) C A cash register tape records the total cash receipts for the day. 39) D Version 1

All of the procedures relate to controlling cash. 40) A Bank service charges (item 2) and non-sufficient-funds (NSF) checks (item 4) are subtracted from the unadjusted book balance to determine the true cash balance. Outstanding checks (item 1) are subtracted from and deposits in transit (item 3) are added to the unadjusted bank balance to determine the true cash balance. Because certified checks (item 5) are deducted both from bank and depositor records immediately, they do not cause differences between the depositor and bank balances and are not listed on the bank reconciliation. A credit memo reflecting interest earned (item 6) would be added to the unadjusted book balance to determine the true cash balance. 41) D Deposits in transit (item 3) are added to the unadjusted bank balance to determine the true cash balance. Bank service charges (item 2) and NSF checks (item 4) are subtracted from the unadjusted book balance to determine the true cash balance. Outstanding checks (item 1) are subtracted from the unadjusted bank balance to determine the true cash balance. Because certified checks (item 5) are deducted both from bank and depositor records immediately, they do not cause differences between the depositor and bank balances and are not listed on the bank reconciliation. A credit memo reflecting interest earned (item 6) would be added to the unadjusted book balance to determine the true cash balance. 42) A Bank statement credit memos describe activities that increase the customer’s account balance. 43) B

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True cash balance = Unadjusted bank balance of $35,851 + Deposits in transit of $4,530 − Outstanding checks of $11,680 = $28,701 Alternatively: True cash balance = Unadjusted book balance of $29,750 − Service charge of $74 + Interest revenue of $295 − NSF check of $1,270 = $28,701. 44) A True cash balance = Unadjusted bank balance of $34,351 + Deposits in transit of $4,240 − Outstanding checks of $10,935 = $27,656 Alternatively: True cash balance = Unadjusted book balance of $28,250 − Service charge of $39 + Interest revenue of $95 − NSF check of $650 = $27,656 45) B True cash balance = Unadjusted book balance of $10,500 − Service charge of $40 − NSF check of $225 = $10,235 46) B True cash balance = Unadjusted book balance of $10,400 − Service charge of $20 − NSF check of $200 = $10,180 47) A Providing written copies of receipts to customers is an internal control procedure relating to cash receipts rather than cash payments. 48) A Recording the receipt of the receivable, less the bank's collection fee, increases assets (Cash) by $625 and decreases assets (Accounts Receivable) by $650; thus, total assets decrease by $25. Stockholders' equity (Retained Earnings) decreases by the same amount. The transaction increases expenses by $25, which decreases net income. The net cash received of $625 is reported as a cash inflow from operating activities. Version 1

49) B Here, advertising expense was understated by $180, which is the difference between the actual amount of the check of $421 and the amount recorded of $241, and cash was overstated by the same amount. Correcting this error will decrease assets (Cash) and stockholders' equity (Retained Earnings). It will increase expenses, which decreases net income. The $180 decrease to cash is reported on the statement of cash flows as a cash outflow from operating activities. 50) C Here, cash was understated by $90, which is the difference between the actual amount of the receipt of $990 and the amount recorded of $900, and accounts receivable was overstated by the same amount. Correcting this error will increase assets (cash) and decrease assets (accounts receivable); thus, total assets do not change. The $90 increase to cash is reported as a cash inflow from operating activities. 51) D The adjustment to record the service charge will decrease assets (Cash) and stockholders' equity (Retained Earnings). It increases expenses, which decreases net income. It is reported as a cash outflow from operating activities on the statement of cash flows. 52) B A bank statement debit memo describes a transaction that reduces the customer's account balance, for example due to bank service charges. 53) A The NSF check was unknown to the company prior to receiving the bank statement, so it should be subtracted from the unadjusted book balance to arrive at the true cash balance. 54) D

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A certified check is guaranteed for payment by a bank. Whereas a regular check is deducted from the customer's account when it is presented for payment, a certified check is deducted from the customer's account when the bank certifies that the check is good. Certified checks, therefore, have been deducted by the bank in determining the unadjusted bank balance, whether they have cleared the bank or remain outstanding as of the date of the bank statement. Thus, a certified check has already been recorded by both the bank and the company and does not appear on a bank reconciliation. 55) D Because deposits in transit have been recorded in the depositor’s accounting records but have not yet been added to the depositor’s account by the bank, they must be added to the unadjusted bank balance. 56) A Outstanding checks are disbursements that have been properly recorded as cash deductions on the depositor’s books. However, the bank has not deducted the amounts from the depositor’s bank account because the checks have not yet been presented by the payee to the bank for payment; that is, the checks have not cleared the bank. 57) D Recording the NSF check increases one asset (Accounts Receivable) and decreases another asset (Cash). This results in no overall effect on total assets. There is no effect on stockholders’ equity (Retained Earnings) since net income is not affected. 58) B True cash balance = Unadjusted book balance of $15,200 − Service charge of $130 + Accounts Receivable Collection of $1,570 + Interest revenue of $220 = $16,860 59) D

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True cash balance = Unadjusted book balance of $9,700 − Service charge of $45 + Accounts Receivable Collection of $900 + Interest revenue of $50 = $10,605 60) D True cash balance = Unadjusted bank balance of $4,180 + Deposits in transit of $460 − Outstanding checks of $620 = $4,020 61) A True cash balance = Unadjusted bank balance of $2,300 + Deposits in transit of $400 − Outstanding checks of $500 = $2,200 62) C True cash balance of $5,030 = Unadjusted book balance (the unknown) − Service charge of $105 + Collection of the accounts receivable of $1,150 − NSF check of $690 Unadjusted book balance = $5,030 + $105 − $1,150 + $690 = $4,675 63) B True cash balance of $5,710 = Unadjusted book balance (the unknown) − Service charge of $90 + Collection of the accounts receivable of $1,000 − NSF check of $600 Unadjusted book balance = $5,710 + $90 − $1,000 + $600 = $5,400 64) C True cash balance = Unadjusted bank balance of $2,000 + Deposits in transit of $1,000 − Outstanding checks of $450 = $2,550 True cash balance of $2,550 (calculated above) = Unadjusted book balance (the unknown) − Service charge of $80 + Interest earned of $85 − NSF check of $190 Unadjusted book balance = $2,550 + $80 − $85 + $190 = $2,735 65) A

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True cash balance = Unadjusted bank balance of $500 + Deposits in transit of $300 − Outstanding checks of $100 = $700 True cash balance of $700 (calculated above) = Unadjusted book balance (the unknown) − Service charge of $10 + Interest earned of $15 − NSF check of $50 Unadjusted book balance = $700 + $10 − $15 + $50 = $745 66) D Recording the customer’s NSF check will increase the accounts receivable balance and decrease cash. 67) B Recording the NSF check increases one asset (Accounts Receivable) and decreases another asset (Cash). This results in no overall effect on total assets. There is no effect on stockholders’ equity or net income. Since the company must reduce its Cash account, this transaction is reported as a cash outflow from operating activities on the statement of cash flows. 68) A True cash balance = Unadjusted bank balance of $13,250 + Deposits in transit of $5,415 − Outstanding checks of $9,710 + Error correction of $780 = $9,735 69) B True cash balance = Unadjusted bank balance of $7,800 + Deposits in transit of $3,150 − Outstanding checks of $6,200 + Error correction of $550 = $5,300 70) C Establishing a petty cash fund increases one asset (Petty Cash) and decreases another asset (Cash). This asset exchange transaction has no overall effect on total assets. There is no effect on stockholders’ equity or net income. It does not affect the statement of cash flows. 71) D

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Cash overages are treated as revenue. If overages do not occur frequently and are of insignificant amounts, companies are likely to include them in miscellaneous revenue. 72) A Replenishing a petty cash fund decreases the Cash account and increases the Petty Cash account. It is an asset exchange transaction. 73) D The fund is established for a specified dollar amount and is controlled by the petty cash custodian. The custodian normally keeps the currency under lock and key (which are physical controls). When money is disbursed from the petty cash fund, the custodian completes a petty cash voucher. 74) D When petty cash is used to pay an expense, there is no effect on the financial statements. The expense will be recorded when the petty cash account is replenished. 75) D Since the amount of petty cash on hand is $105, it will take $395 to replenish the petty cash fund to its imprest balance of $500. Because the miscellaneous expenses paid by the fund totaled $400, there is a cash overage of $5. (Note that an overage of cash represents revenue.) Replenishing the fund will cause total assets (Cash) and stockholders' equity (Retained Earnings) to decrease by $395. Revenues will increase by $5 and expenses will increase by $400, resulting in a decrease in net income of $395. The replenishment is reported as a cash outflow from operating activities. 76) D

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Since the amount of petty cash on hand is $85, it will take $165 to replenish the petty cash fund to its imprest balance of $250. Because the miscellaneous expenses paid by the fund totaled $160, there is a cash shortage of $5 (Note that a cash shortage is an expense). Recording the petty cash fund will cause total assets (cash) and stockholders’ equity (retained earnings) to decrease by $165. Expenses will increase by $5 and net income will decrease by that same amount. 77) B Since the amount of petty cash on hand is $215, it will take $185 to replenish the petty cash fund to its imprest balance of $400. Because the miscellaneous expenses paid by the fund totaled $180, there is a cash shortage of $5 (Note that a cash shortage is an expense). Replenishing the petty cash fund will cause total assets (Cash) and stockholders' equity (Retained Earnings) to decrease by $185. Expenses will increase by $185 ($5 due to the shortage). 78) B The primary roles of an independent auditor CPA are summarized below: 1.Conducts a financial audit (a detailed examination of a company’s financial statements and underlying accounting records). 2.Assumes both legal and professional responsibilities to the public, as well as to the company paying the auditor. 3.Determines if financial statements are materially correct rather than absolutely correct. 4.Presents conclusions in an audit report that includes an opinion as to whether the statements are prepared in conformity with GAAP. In rare cases, the auditor issues a disclaimer. 5.Maintains professional confidentiality of client records. 79) C Version 1

The SEC is a government agency authorized to establish and enforce the accounting rules for public companies. 80) B An unqualified opinion is the most favorable opinion auditors can express. It means the auditor believes the financial statements are in compliance with GAAP without material qualification, reservation, or exception. 81) C The concept of materiality is very subjective. An error, or other reporting problem, is material if knowing about it would influence the decisions of an average prudent investor. Thus, materiality is different for each company and $5,000 is not necessarily a threshold for materiality. 82) C An adverse opinion indicates that the independent auditor found one or more material departures from GAAP and the departures from GAAP are so material that the financial statements do not present a fair picture of the company’s status. 83) C Auditors do not guarantee that financial statements are absolutely correct—only that they are materially correct. Financial audits are not directed toward the discovery of fraud. Auditors are, however, responsible for providing reasonable assurance that financial statements are free from material misstatements, whether caused by errors or fraud. The confidentiality rules in the code of ethics for CPAs prohibit auditors from voluntarily disclosing information they have acquired as a result of their accountant–client relationships. However, accountants may be required to testify in a court of law.

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CHAPTER 7: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Sparkes Company estimated it had $12,000 of uncollectible accounts related to credit sales it made during the year. Sparkes, which uses the allowance method, made the necessary adjustment to record this estimate.

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Sparkes Company estimated it had $12,000 of uncollectible accounts related to credit sales it made during the year. Sparkes, which uses the allowance method, made the necessary adjustment to record this estimate.

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3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Garrison Company recognized $4,000 of service revenue earned on account.

5) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Furs Company uses the allowance method. On June 20, Furs wrote off an uncollectible account in the amount of $2,000. On September 1, the company collected the receivable that it had previously written off. How would reinstating the receivable (not the collection) affect the financial statements?

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7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On November 1, Year 1, Gable Company accepted a credit card as payment for $1,500 of services rendered to one of its customers. The credit card company charges a 3% fee for handling the transaction. Show the effect of this transaction on Gable's financial statements.

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8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Gable Company collected a receivable due from a credit card company; the credit card fee had previously been recognized when the sale was recorded. Show the effect of the collection of the receivable on Gable's financial statements.

On September 1, Year 1, Diaz Company loaned $10,000 to Ace Company. Show the effect of this transaction on Diaz's financial statements.

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On September 1, Year 1, Ruiz Company loaned $10,000 to Alpha Company. Show the effect of the December 31, Year 1 adjustment to accrue interest on Ruiz's financial statements.

On March 1, Year 2, King Co. collected a note receivable and related interest from Havilland Co. The note had been issued one year earlier. Indicate the effects of this event on King's financial statements.

12)

What is meant by the net realizable value of accounts receivable?

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13)

Li Company has the following account balances:

Cash Accounts receivable Allowance for doubtful accounts Uncollectible accounts expense Credit sales

$ 25,000 76,000 5,100 6,200 115,000

Determine the net realizable value of Li's accounts receivable.

14)

What type of account is the Allowance for Doubtful Accounts?

15) After the accounts are adjusted at the end of the year, Accounts Receivable has a balance of $235,000, Uncollectible Accounts Expense has a balance of $17,500, and Allowance for Doubtful Accounts has a balance of $12,500. What is the net realizable value of the accounts receivable?

16) During its first year of operation, John's Repair Service recognized $220,000 of service revenue on account. The ending accounts receivable balance was $15,100. Jake estimates that 3% of sales on account will not be collected; no accounts receivable had been written off by year end. Assume there were no other transactions affecting accounts receivable. 1.a) What amount of cash was collected during the year? b) What amount of uncollectible accounts expense was recognized during the year?

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17) What is aging of accounts receivable, and how is it used to account for uncollectible accounts? 1.

18)

Under what condition is the direct write-off method acceptable under GAAP? 1.

19) What type of transaction is the write-off of an uncollectible account using the allowance method? (asset source, asset use, asset exchange, or claims exchange) 1.

20)

What are some of the costs a business incurs in making credit sales to customers?

21) Assuming the direct write-off method is used, when is uncollectible accounts expense recognized?

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22) How do the percent of revenue method and the percent of receivables method to estimate uncollectible accounts expense differ?

23) When the direct write-off method is used, what is the effect on the accounting equation of writing off an uncollectible account receivable?

24) If Kettler Company loans $24,000 to Beam Company on March 1, Year 1, and the oneyear note carries an interest rate of 7%, how much interest revenue will Kettler recognize in Year 1? How much interest revenue will Kettler recognize in Year 2?

25) Vales Services Company loaned $6,000 on August 1, Year 1 to an individual who issued Vales a promissory note with 6% interest. The issuer of the note repaid the principal and interest on July 30, Year 2. How did the event on August 1, Year 1 affect the statement of cash flows? How did the event on July 30, Year 2 affect the statement of cash flows?

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26) How does accepting a credit card payment for services rendered affect the financial statements?(Assume the credit card company charges a fee for handling a credit card transaction.)

27) How is the accounts receivable turnover computed? What information does this ratio provide?

28) How is the accounts receivable turnover computed? What information does this ratio provide?

29)

Discuss briefly the costs of making sales on account.

30) Which financial statement ratios facilitate the measurement of a company's effectiveness in collecting cash from customers?What is measured by each of these ratios? How should each of these ratios be interpreted?

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31) Why would cash sales companies, such as Wendy's, Domino's, and Krispy Kreme have accounts receivables on their financial statements?

32)

Explain the computation of the length of the operating cycle.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 33) Indicate whether each of the following statements is true or false assuming use of the allowance method. 1.a) The Allowance for Doubtful Accounts is a contra asset account. 2.b) The net realizable value of receivables is the difference between the ending balance of accounts receivable and the ending balance in the allowance for doubtful accounts. 3.c) The recognition of uncollectible accounts expense at the end of an accounting period does not affect the net realizable value of accounts receivable. 4.d) The write-off of an uncollectible account reduces the net realizable value of accounts receivable. 5.e) The write-off of an uncollectible account does not affect the amount of stockholders' equity.

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34)

Indicate whether each of the following statements is true or false.

1.a) Most companies expect to receive the full amount of their receivables. 2.b) The estimated amount of uncollectible accounts is called the net realizable value. 3.c) The direct write-off method does not require the computation of the net realizable value of accounts receivable. 4.d) The practice of reporting the net realizable value of receivables is the result of using the allowance method. 5.e) The materiality principle requires the computation of net realizable value for a company's liabilities.

35) On December 31, Year 1, the West Corporation estimated that $6,000 of its receivables might not be collected. At the end of Year 1, the unadjusted balances of Accounts Receivable and Allowance for Doubtful Accounts were $150,000 and zero. On February 1, Year 2, West wrote-off a delinquent account from one of its customers. West Corporation uses the allowance method. Indicate whether each of the following statements is true or false. 1.a) The net realizable value of accounts receivable (after the appropriate adjustment at the end of Year 1) was $144,000. 2.b) The write-off of the account on February 1 Year 2 did not affect the net realizable value of West's accounts receivable. 3.c) The adjustment to record uncollectible account expense at the end of Year 2 had no effect on West's total assets. 4.d) The February 1 write-off had no effect on West's Year 2 total assets. 5.e) The February 1 write-off decreased Year 2 net income.

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36) One of the methods for recognizing uncollectible accounts is the direct write-off method. Indicate whether each of the following statements is true or false. 1.a) The direct write-off method is not permitted by GAAP if uncollectible accounts expense is immaterial. 2.b) The direct write-off method is allowed for some companies because of the going concern concept. 3.c) The direct write-off method requires an advance estimate of anticipated uncollectible accounts. 4.d) The direct write-off method is easier to use than the allowance method. 5.e) The direct write-off method does not require the use of an allowance account.

37) Barton Corporation uses the percent of receivables method. As of December 31, Year 1, prior to estimating uncollectible accounts expense, Barton's balance of accounts receivable was $68,900, the balance of allowance for doubtful accounts was $2,500, and total sales for Year 1 were $875,000. On December 31, Barton aged its receivables and determined the following: Number of Days Past Due Current 0-30 31-60 61-90 Over 90 Total

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Receivables Amount $ 29,500 16,700 11,000 9,400 2,300

% Likely to be Uncollectible 1% 5% 10% 25% 50%

$ 68,900

Indicate whether each of the following statements is true or false. 1.a) Barton will report a net realizable value of accounts receivable equal to $63,170 on its December 31, Year 1 balance sheet. 2.b) Barton will report uncollectible accounts expense of $5,730 on its Year 1 income statement. 3.c) The December 31 adjustment related to uncollectible accounts will increase total liabilities and decrease stockholders' equity by $3,230. 4.d) The method Barton uses to account for uncollectible accounts is known as the balance sheet approach. 5.e) Write-offs of uncollectible accounts in Year 2 will reduce Barton's net realizable value of receivables.

38)

Indicate whether each of the following statements is true or false.

1.a) Loaning cash to another company is considered a financing activity on the statement of cash flows. 2.b) The major difference between treating the extension of credit to a customer as accounts receivable and treating it as notes receivable is the existence of interest. 3.c) In a promissory note, the payee issues the note to the maker. 4.d) Interest rates are always stated on an annual basis, regardless of the length of the note. 5.e) Accruing interest on a note receivable is considered an asset use transaction.

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39) The Griffin Corporation accepted a credit card for a sale of $3,000 on December 16, Year 1. The credit card company charges a fee of 4%. On January 5, Year 2, Griffin received payment from the credit card company. Indicate whether each of the following statements is true or false. 1.a) Griffin should record $2,880 of revenue in Year 1 when the sale is made. 2.b) Griffin should increase the balance of the accounts receivable by $3,000 on December 16, Year 1. 3.c) The sale has no impact on the statement of cash flows in Year 1. 4.d) The collection of cash increases total assets in Year 2. 5.e) The December 16 transaction increases total revenues and total expenses on the Year 1 income statement.

40)

Indicate whether each of the following statements is true or false.

1.a) A benefit of making credit card sales is that there is no cost to the merchant. 2.b) A benefit of accepting credit cards is that increased sales may be generated. 3.c) Recording a credit card sale increases total assets and increases total liabilities. 4.d) Recording the collection of cash from the credit card company increases cash and increases revenue. 5.e) The income statement is not affected at the time the cash receipt is recorded.

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41) Indicate whether each of the following statements is true or false. 1.a) Other things being equal, an operating cycle of 49 days is more desirable than an operating cycle of 120 days. 2.b) The operating cycle is longer for a winery than a fast-food restaurant. 3.c) The length of an operating cycle is not relevant to the profitability of a business. 4.d) The length of an operating cycle equals the average days to collect accounts receivable. 5.e) The length of an operating cycle is computed by adding the sum of the average days in inventory and the average number of days to collect accounts receivable.

42)

Indicate whether each of the following statements is true or false.

1.a) The higher the accounts receivable turnover ratio, the longer is a company's cash collection period. 2.b) The accounts receivable turnover ratio is measured as the amount of sales divided by net accounts receivable. 3.c) The average days to collect accounts receivable is measured as 365 divided by the accounts receivable turnover ratio. 4.d) Longer collection periods decrease the costs of collecting from customers. 5.e) A higher average collection period is desirable.

43)

Lucas Company has the following account balances at the end of Year 1:

Cash Accounts receivable Allowance for doubtful accounts

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$ 50,000 152,000 8,200

Required: Compute the net realizable value of the above accounts receivable.

44) After the accounts are adjusted at the end of the year, Accounts Receivable has a balance of $225,000, Uncollectible Accounts Expense for the year was $17,500, and Allowance for Doubtful Accounts has a balance of $12,500. What is the net realizable value of the accounts receivable?

45) In the first year of operation, Ralph's Repair Service recognized $480,000 of service revenue on account. The ending accounts receivable balance was $88,000. Ralph estimates that 2% of sales on account will not be collected. During Year 1, Ralph wrote off a $200 receivable that was determined to be uncollectible. Assume there were no other transactions affecting accounts receivable. Required: 1.a) What amount of cash was collected in Year 1? 2.b) What amount of uncollectible accounts expense was recognized in Year 1? 3.c) What is the net realizable value of accounts receivable that will be reported on the balance sheet as of December 31, Year 1?

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46) The following information is available for Phoenix Corporation, which uses the allowance method. Phoenix expects 3% of sales on account to be uncollectible. ● Sales on account: $490,000 ● Collections on account: $440,000 Required: a) Compute the amount of uncollectible accounts expense for Year 1.

47) The following information is available for Plains Company, which uses the allowance method. Beginning accounts receivable Beginning allowance for doubtful accounts Services on account during current year Collections on account during current year

$ 200,000 4,000 1,764,800 1,840,800

Plains estimated that 1% of sales on account will be uncollectible. After several attempts at collection, Plains wrote off an account of $900 that could not be collected. Required: 1.a) Compute the amount of uncollectible accounts expense for Year 1.

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48) On January 1, Year 2, Burton Company had a balance in Accounts Receivable of $90,000 and a balance in the Allowance for Doubtful Accounts account of $2,400. Burton had credit sales of $244,000 during Year 2 and ended the year with a balance in Accounts Receivable of $48,000. Burton also wrote off $1,100 of receivables during Year 2. Burton uses the allowance method and assumes that 2% of the sales on account will not be collected. Required: a) After adjustments at the end of Year 2, what will be the balance in the Allowance for Doubtful Accounts? b) What was the decrease in the net realizable value of accounts receivable in Year 2 as a result of the write-off of the receivable? c) What amount of cash was collected from customers during Year 2?

49) Larsen Company began the current year with balances in accounts receivable and allowance for doubtful accounts of $45,700 and $1,280, respectively. The company reported credit sales of $475,250 during the year, collected $480,200, and wrote off $800 of uncollectible accounts. Larsen Company estimates that 12% of its accounts receivable balance will be uncollectible. Required: 1.Determine the balance in the allowance for doubtful accounts as of the end of the current year. 2.Compute Larsen Company's uncollectible accounts expense for the current year. 3.Determine Larsen's net realizable value of accounts receivable as of the end of the current year.

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50) Vancouver Company began Year 2 with balances in accounts receivable and allowance for doubtful accounts of $92,800 and $9,280, respectively. The company reported credit sales of $875,550 during the year, collected $870,200, and wrote off $6,800 of uncollectible accounts. Vancouver estimates that 10% of its accounts receivable balance will be uncollectible. Required: 1.What will Vancouver report as its allowance for doubtful accounts on December 31, Year 2? 2.Compute uncollectible accounts expense for Year 2. 3.Calculate Vancouver's net realizable value of accounts receivable on December 31, Year 2.

51) Chico Company began Year 2 with balances in accounts receivable and allowance for doubtful accounts of $44,300 and $1,675, respectively. The company reported credit sales of $490,250 during the year and wrote off $1,400 of uncollectible accounts. Chico Company prepared the following aging schedule on December 31, Year 2: Number of Days Past Due Current 0-30 31-60 61-90 Over 90 Total

Receivables Amount $ 24,750 8,300 9,000 2,150 1,750 $ 45,950

%Likely to be Uncollectible 1% 5% 10% 25% 50%

Required: 1.Compute the amount of cash collected from accounts receivable. 2.Compute the uncollectible accounts expense. 3.Determine the net realizable value of accounts receivable.

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52) Perez Company began the current year with a balance of $148,000 in accounts receivable and $8,600 in allowance for doubtful accounts. During the year, it provided $656,000 in services to customers on account and collected $580,000 in cash from its accounts receivable. Perez wrote off $6,500 of uncollectible accounts during the year. At the end of the year, the company prepared an aging schedule and adjusted its accounts based on the estimate that $12,600 of receivables would not be collected. Required: 1.Compute the uncollectible accounts expense 2.Determine the net realizable value of accounts receivable at the end of the current year.

53) Kona Espresso Machine Company makes many of its sales on account. For Year 2, its beginning balance in Accounts Receivable was $190,000. Sales on account for the year were $904,000, and the amount of cash collected from its accounts receivable was $829,900. During the year, uncollectible accounts of $10,100 were written off. What was the ending balance in Accounts Receivable?

54) During Year 2, Oklahoma Trucking Company had service revenue on account of $350,000. Oklahoma had a beginning balance in Accounts Receivable of $35,000 and an ending balance of $42,500. During the year Oklahoma wrote-off $8,750 of receivables. Oklahoma uses the direct write-off method. Required: a) Determine the amount of cash that Oklahoma collected from customers during Year 1

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55) On October 1, Year 1, Blake Company loaned $18,000 to Jimenez for 8 months at 6% interest. Required: 1.How will Blake report the note and interest on its Year 1 income statement, balance sheet, and statement of cash flows? 2.How will Blake report the note and interest on its Year 2 income statement and statement of cash flows?

56) On September 1, Year 1, Vincent Company loaned $24,000. The note had a 7% interest rate and a one-year term. Required: 1.Calculate the amount of interest revenue recognized by Vincent Company during Year 1. 2.Calculate the amount of interest revenue recognized by Vincent Company during Year 2. 3.Calculate the amount of cash collected by Vincent Company on August 31, Year 2.

57)

Geary, Incorporated had the following sales during Year 1:

Cash sales Credit sales

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$ 240,000 $ 1,200,000

Credit card sales

$ 4,000,000

Geary also had the following beginning and ending balances in the following accounts:

Accounts Receivables Account Receivables - Credit Card Company

Beginning

Ending

$ 240,000 $ 800,000

$ 180,000 $ 840,000

Geary, who uses the allowance method, estimated that 3% of the credit sales will go uncollected. The credit card company charges Geary a 4% fee for handling credit card transactions. Required: 1.Compute the uncollectible accounts expense for Year 1. 2.Compute the credit card expense during Year 1. 3.Determine the amount of net cash flows from operating activities during Year 1.

58) Green Acres Lawn Care provided $600,000 of services to customers during Year 1. All customers paid for the services with credit cards. The company submitted the credit card receipts to the credit card company immediately, and the credit card company paid cash in the amount of face value less a 4 percent service charge. Required: Record the (1) credit card sales and (2) collection of the receivables in the horizontal statements model, below. Show dollar amounts of increases and decreases. For cash flows, indicate whether the item is an operating activity (OA), investing activity (IA), or financing activity (FA). Use NA to indicate that an element is not affected by an event. Assets

Cash

= Liabilities + Stockholders’ Revenue − Expense = Net Statement Equity Income of Cash Flows

ARCr.Card

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59) The following information is taken from the adjusted trial balance of the Studio Art Supply Company at the end of Year 1: Cash Accounts receivable Allowance for doubtful accounts Sales Cost of goods sold Operating expenses

$ 18,000 48,500 2,000 355,000 198,200 84,000

Required: 1.Compute the accounts receivable turnover. 2.Compute the average number of days to collect accounts receivable.

60) Old Dominion Antiques Shop reported the following income statement and balance sheet for Year 1: Old Dominion Antiques Shop Income Statement For the Year Ended December 31, Year 1 Sales Less: Cost of goods sold Gross margin Selling and administrative expenses

$ 495,000 234,400 260,600 152,500

Net Income

$ 108,100 Old Dominion Antiques Shop Balance Sheet As of December 31, Year 1

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Assets Cash Accounts receivable Inventory Property,plant, and equipment,net Total Assets Liabilities

$ 28,600 58,720 62,400 199,750 $ 349,470

Accounts payable Stockholders’ Equity

$ 44,680

Common stock Retained earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

$ 200,000 104,790 304,790 $ 349,470

During Year 1, the company's inventory turnover was 3.76 times and its average number of days to days to sell inventory was 97.1 days. Required: 1.Determine the accounts receivable turnover ratio and the average number of days to collect accounts receivable. 2.Determine the length of the operating cycle.

61)

The following information is available from Avalon, Incorporated for the current year:

Sales (all on account) Cost of goods sold Accounts receivable Jan. 1 Accounts receivable Dec. 31 Inventory Jan. 1 Inventory Dec. 31

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$ 375,000 215,000 42,350 37,500 40,900 42,400

During the year, the average number of days to sell inventory was 71.6 days. Required: Calculate the following. 1.Accounts receivable turnover ratio 2.Average number of days to collect accounts receivable 3.Length of operating cycle 4.Net cash flow from sales

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Answer Key Test name: Chap 07_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D N/A D N/A I D NA

The estimated amount of uncollectible accounts expense is recognized in a year-end adjusting entry. The adjusting entry reduces assets (Net Realizable Value of Receivables), stockholders’ equity (Retained Earnings), and net income. The statement of cash flows is not affected. The accounts receivable account is not reduced directly because none of the receivables have actually been determined to be uncollectible. The decrease in the net realizable value of receivables represents an estimate of what will be uncollectible at some time in the future. To distinguish the actual balance in accounts receivable from the Net Realizable Value, accountants use a contra asset account called Allowance for Doubtful Accounts. It’s called a contra account because it is subtracted from the balance in the Accounts Receivable account to determine the Net Realizable Value of Receivables that is shown on the balance sheet (i.e. Net Realizable Value = Accounts Receivable – Allowance for Doubtful Accounts). 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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I/D

This is an asset exchange transaction. Writing off an uncollectible account using the allowance method decreases assets (accounts receivable) and increases assets (by decreasing the allowance for uncollectible accounts, a contra asset account). Total assets remain unchanged. There is no effect on the income statement or the statement of cash flows. 3) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I NA I I NA I NA

Recognizing revenue earned on account increases assets (Accounts Receivable) and stockholders' equity (Retained Earnings). It increases revenue, which increases net income. Because the revenue was earned on account, there is no effect on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA I

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Collecting cash from accounts receivable is an asset exchange transaction. It increases the asset account, Cash, and decreases the asset account, Accounts Receivable. Thus, there is no net effect on total assets and no effect on total liabilities and stockholders’ equity. There is an inflow from operating activities on the statement of cash flows. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA NA

This is an asset exchange transaction. The reinstatement of the receivable increases assets (accounts receivable) and decreases assets (by increasing the allowance for doubtful accounts, a contra asset account). Since one asset increases and another asset decreases by the same amount, there is no effect on total assets. There is no effect on the income statement. The statement of cash flows is not affected because 6) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D NA

When a company uses the direct write-off method, a write-off decreases assets (Accounts Receivable) and Stockholders' equity (Retained Earnings). It increases expenses (uncollectible accounts expense), which decreases net income. It does not affect the statement of cash flows. Version 1

7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I NA I I I I NA

The transaction increases assets (Accounts Receivable—credit card) and stockholders' equity (Retained Earnings) by the amount due from the credit card company. It increases revenue and increases expenses (credit card expense). Because the increase to revenue is greater than the increase to expense, net income increases. The statement of cash flows is not affected. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA I

The collection from the credit card company will increase assets (Cash) and decrease assets (Accounts Receivable—credit card company), resulting in no net effect on assets. It is reported as a cash inflow from operating activities on the statement of cash flows. 9) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I/D NA NA NA NA NA D

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When a company loans money to another party, assets (Notes Receivable) increase and assets (Cash) decrease, resulting in no net change to assets. It is reported as a cash outflow from investing activities. 10) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I NA I I NA I NA

The adjustment to recognize interest on the note receivable will increase assets (Interest Receivable) and stockholders' equity (Retained Earnings). It increases revenue (interest revenue), which increases net income. It does not affect the statement of cash flows. 11) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I NA I I NA I I

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Collecting the note on March 1, Year 2, increases total assets (Cash) by the amount collected (that is, the principal plus all interest), decreases total assets (Note Receivable) by the principal, decreases total assets (Interest Receivable) by the amount of interest that had been accrued at the end of Year 1, and increases stockholders' equity (Retained Earnings) by the amount of interest earned in Year 2. It increases revenue (interest revenue) by the amount of interest earned in Year 2, which increases Year 2 net income. The cash received on the principal is reported as a cash inflow from investing activities, and the cash received from interest is reported as a cash inflow from operating activities. 12) Net realizable value of accounts receivable represents the amount of receivables a company estimates it will actually collect. Net realizable value = Accounts receivable− Allowance for doubtful accounts 13) $70,900 Net realizable value = Accounts receivable of $76,000− Allowance for doubtful accounts of $5,100 = $70,900 14) The Allowance for Doubtful Accounts is a contra asset account. 15) $222,500 Net realizable value = Accounts receivable of $235,000− Allowance for doubtful accounts of $12,500 = $222,500

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16) a) Ending accounts receivable of $15,100 = Beginning accounts receivable of $0 + Services on account of $220,000− Cash collected (the unknown) - Write-offs of $0 Cash collected = $0 + $220,000 − $15,100 = $204,900 b) Uncollectible accounts expense = Services on account of $220,000 × 3% = $6,600 John's estimates uncollectible accounts expense at the end of the year as a percentage of revenue. Recognizing the $6,600 uncollectible accounts expense will also increase the allowance for doubtful accounts. 17) Aging of accounts receivable is the process of assigning a percentage of likelihood that receivables will be uncollectible based on their ages. The resulting estimate is used to establish the ending balance in Allowance for Doubtful Accounts using the percent of receivables method. 18) The direct write-off method is only acceptable if uncollectible accounts expense is immaterial to the company's financial statements. 19) Asset exchange The write-off increases assets (decrease to allowance for doubtful accounts) and decreases assets (accounts receivable). 20) Costs include the cost of clerical tasks such as running background checks and maintaining customer records as well as the cost of uncollectible accounts. Further, there is an implicit interest cost associated with credit sales because cash is not immediately available for other needs. 21) Under the direct write-off method, a company simply recognizes uncollectible accounts expense in the period in which it identifies and writes off uncollectible accounts. Version 1

22) The percent of revenue method estimates uncollectible accounts expense by taking a percentage of revenue. The percentage used to make the estimate is usually based on the company's past collection experiences. However, the percentage may be adjusted, as needed. On the other hand, the percentage of receivables method estimates the amount of uncollectible expense by basing the estimate on a percentage of accounts receivable (rather than a percentage of revenue). This approach focuses on estimating the most accurate balance for the Allowance for Doubtful Accounts that appears on the year-end balance sheet. 23) With the direct write-off method, the write-off reduces the asset (accounts receivable) and decreases stockholders' equity (retained earnings). Expenses (uncollectible accounts expense) increase, which decreases net income. The statement of cash flows is not affected by the write-off. Under the direct write-off method, a company simply recognizes uncollectible accounts expense in the period in which it identifies and writes off uncollectible accounts. 24) Kettler will recognize $1,400 in interest revenue in Year 1 and $280 in Year 2. Interest revenue = Principal × Annual interest rate × Time outstanding Year 1: Interest revenue = $24,000 × 7% × 10/12 = $1,400 Year 2: Interest revenue = $24,000 × 7% × 2/12 = $280 25) Vales would show a $6,000 outflow from investing activities on August 1, Year 1. The company would show a $6,000 inflow from investing activities and a $360 inflow from operating activities on July 30, Year 2. Cash inflow for interest revenue = Principal of $6,000 × Annual interest rate of 6% × Time outstanding of 12/12 = $360

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26) The event increases assets (Accounts Receivable—credit card company) and increases stockholders' equity (Retained Earnings). It increases revenue (service revenue) and increases expenses (credit card expense). Because the increase to revenue is greater than the increase to expense, it increases net income. The statement of cash flows is not affected. 27) Accounts receivable turnover ratio = Sales ÷ Accounts receivable Dividing a company's sales by its net accounts receivable tells how many times the net accounts receivable balance is "turned over" (converted into cash) each year. The higher the turnover, the shorter the collection period. Higher turnovers are preferable. 28) Average number of days to collect accounts receivable = 365 ÷ Accounts receivable turnover ratio This ratio measures how many days, on average, it takes a company to collect its accounts receivable. Because longer collection periods increase costs, shorter periods are obviously more desirable. 29) A major cost is the possibility of encountering uncollectible accounts. Also, there is the cost of clerical tasks such as running background checks and maintaining customer records. In addition, there is an implicit interest rate as measured by the money that could be earned if the firm had sold the goods for cash. 30) Two ratios help management, or other users, measure a company's collection period. The accounts receivable turnover ratio tells how many times the net accounts receivable balance is "turned over" (converted into cash) each year. The higher the turnover, the shorter the collection period. The average number of days to collect accounts receivable measures how many days, on average, it takes a company to collect its accounts receivable. Because longer collection periods increase costs, shorter periods are obviously more desirable. Version 1

31) These companies have accounts receivable because they sell goods to restaurants that are independent franchisees. 32) The length of the operating cycle is computed by adding the number of days to sell inventory to the average number of days to collect accounts receivable. The simplest explanation of the operating cycle is "cash to cash." 33) a) T b) T c) F d) F e) T 1.a) This is true. Allowance for doubtful accounts is a contra asset account that decreases assets. 2.b) This is true. The net realizable value of receivables is the difference between the ending balance of accounts receivable and the ending balance in the allowance for doubtful accounts. 3.c) This is false. Recognition of uncollectible accounts expense increases allowance for doubtful accounts. 4.d) This is false. The write-off decreases both accounts receivable and allowance for doubtful accounts, so it does not affect the net realizable value of receivables. 5.e) This is true. There is no expense involved in writing off an uncollectible receivable when the allowance method is used.

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34) a) F b) F c) T d) T e) F 1.a) This is false. Most companies that extend credit to customers expect that some of those customers will fail to pay their obligations. 2.b) This is false. The estimated amount of uncollectible accounts is called uncollectible accounts expense (for a particular accounting period) or allowance for doubtful accounts (for the accounts receivable balance). 3.c) This is true. Net realizable value is not computed when the direct write-off method is used. 4.d) This is true. Net realizable value is the amount reported that is net of an allowance for uncollectible amounts. 5.e) This is false. The materiality concept requires computation of net realizable value of a company's receivables (rather than its liabilities). 35) a) T b) T c) F d) T e) F 1.a) This is true. The net realizable value of accounts receivable after the adjustment is $144,000, calculated as $150,000 accounts receivable minus $6,000 allowance for doubtful accounts. 2.b) This is true. The write-off decreased accounts receivable and allowance for doubtful accounts equally, so it did not affect net realizable value. 3.c) This is false. The adjustment decreased assets by increasing the allowance for doubtful accounts, a contra asset account. 4.d) This is true. The write-off decreased assets (accounts receivable) and increased assets (by decreasing the allowance for doubtful accounts, a contra asset account), resulting in no net change in assets. 5.e) This is false. The write-off would not decrease net income since the company uses the allowance method.

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36) a) F b) F c) F d) T e) T 1.a) This is false. GAAP permits the use of the direct write-off method if uncollectible accounts expense is immaterial. 2.b) This is false. The going concern concept does not allow for the use of the direct write-off method. 3.c) This is false. Only the allowance method requires an advance estimate of anticipated uncollectible accounts. 4.d) This is true. The direct write-off method is easier to use than the allowance method because it does not require estimates. 5.e) This is true. There is no allowance account if a company uses the direct write-off method.

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37) a) T b) F c) F d) T e) F 1.a) This is true. Adjusted balance in Allowance for Doubtful Accounts = ($29,500 × 1%) + ($16,700 × 5%) + ($11,000 × 10%) + ($9,400 × 25%) + ($2,300 × 50%) = $5,730; Net realizable value = Accounts receivable of $68,900 − Allowance of $5,730 = $63,170. 2.b) This is false. $5,730 adjusted allowance − $2,500 unadjusted allowance = $3,230 uncollectible accounts expense. 3.c) This is false. The allowance for doubtful accounts is a contra asset, not a liability. The adjustment will decrease assets (by increasing the allowance for doubtful accounts) and decrease stockholders' equity (retained earnings). 4.d) This is true. Aging of receivables is known as the balance sheet approach because it uses a percentage of one balance sheet account (accounts receivable) to estimate another balance sheet account (allowance for doubtful accounts). 5.e) This is false. Write−offs do not affect net realizable value when the allowance method is used because the write−off decreases both accounts receivable and allowance for doubtful accounts equally.

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38) a) F b) T c) F d) T e) F 1.a) This is false. Loaning cash to another company is considered an investing activity on the statement of cash flows. 2.b) This is true. Interest is charged on a note receivable, while it is not customary on accounts receivable. 3.c) This is false. The payee is the party that accepts the note, not the party that issues the note. 4.d) This is true. Interest rates are expressed on an annual basis, even if, for example, the term of the note is 18 months. 5.e) This is false. Accruing interest on a note receivable is an asset source, not use, transaction that increases assets (interest receivable) and increases stockholders' equity (retained earnings) by increasing interest revenue, which increases net income. 39) a) F b) F c) T d) F e) T 1.a) This is false. Revenue for the full amount of the sale of $3,000 is recorded when the sale is made. 2.b) This is false. The increase to the accounts receivable equals the amount due of $2,880 [or $3,000 − ($3,000 × 4%)]. 3.c) This is true. The cash flow is reported in Year 2 when cash is received from the credit card company. 4.d) This is false. The collection of cash has no net effect on total assets because the increase to assets (cash) in the amount of $2,880 [or $3,000 − ($3,000 × 4%)] is offset by a decrease in assets (accounts receivable) in the amount of $2,880. 5.e) This is true. The transaction on December 16 increases revenue by $3,000 and increases expense (credit card expense) by $120 (or $3,000 × 4%).

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40) a) F b) T c) F d) F e) T 1.a) This is false. The credit card company deducts its service fee from the gross amount of the sale and pays the merchant the net balance (gross amount of sale less credit card fee) in cash. 2.b) This is true. Merchants who accept credit cards typically sell more than merchants who do not accept credit cards. 3.c) This is false. Recording a credit card sale increases the asset (accounts receivable) and increases stockholders' equity (retained earnings). It increases revenue for the full amount, less credit card expense. 4.d) This is false. The transaction increases assets (cash) and decreases another asset (accounts receivable). 5.e) This is true. The income statement is affected when the credit card sale is recorded (see item c) rather than when the cash is collected from the credit card company. 41) a) T b) T c) F d) F e) T 1.a) This is true, if all other things are equal. 2.b) This is true. It takes a very long time to produce wine, so a winery would have a long operating cycle. 3.c) This is false. The faster a company is able to turn over its inventory and accounts receivable, the more profitable it will be. 4.d) This is false. The operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable into cash. 5.e) This is true. The operating cycle is the sum of average days in inventory plus average days in accounts receivable.

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42) a) F b) T c) T d) F e) F 1.a) This is false. The higher the accounts receivable turnover ratio, the lower the average number of days to collect accounts receivable. 2.b) This is true. 3.c) This is true. 4.d) This is false. The average number of days to collect accounts receivable measures how many days, on average, it takes a company to collect its accounts receivable. Because longer collection periods increase costs, shorter periods are more desirable. 5.e) This is false. The average collection period measures how many days, on average, it takes a company to collect its accounts receivable. Because longer collection periods increase costs, shorter periods are more desirable 43) $143,800 1.Net realizable value = Accounts receivable of $152,000− Allowance for doubtful accounts of $8,200 = $143,800 44) $212,500 Net realizable value = Accounts receivable of $225,000 − Allowance for doubtful accounts of $12,500 = $212,500 1.

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45) 1.a) $391,800 2.b) $9,600 3.c) $78,600 1.a) Ending accounts receivable of $88,000 = Beginning accounts receivable of $0 + Revenue on account of $480,000− Collections on account (the unknown) − Write-off of $2000 Cash collections = $0 + $480,000 − $200 − $88,000 = $391,800 2.b) Uncollectible accounts expense = Revenue on account of $480,000 × 2% = $9,600 3.c) Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $0 + Uncollectible accounts expense of $9,600 − Write-offs of $200 = $9,400 1.Net realizable value = Accounts receivable of $88,000 − Allowance for doubtful accounts of $9,400 = $78,600 46) 1.a) $14,700 1.a) $490,000 × 3% = $14,700 47) 1.a) $17,648 1.a) Uncollectible accounts expense = Service revenue of $1,764,800 × 1% = $17,648

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48) 1.a) $6,180 2.b) $0 3.c) $284,900 1.a) Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $2,400 + Uncollectible accounts expense of ($244,000 × 2%)− Write-off of $1,100 = $6,180 2.b) Net realizable value = Accounts receivable − Allowance for doubtful accounts Write-offs do not affect net realizable value because they decrease both accounts receivable and the allowance for doubtful accounts by the same amount. Beginning Accounts receivable Credit sales Less: Write-offa Less: Ending Accounts receivable

$ 90,000 244,000 (1,100) (48,000)

Cash collected

$ 284,900

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49) a) $4,794 b) $4,314 c) $35,156 a) Ending allowance for doubtful accounts = Accounts receivable of $39,950 × 12% = $4,794 b) Ending unadjusted allowance for doubtful accounts = Beginning credit balance in allowance for doubtful accounts of $1,280 - Write-offs of $800 = $480 Uncollectible accounts expense = Ending adjusted allowance for doubtful accounts of $4,794 (from part a) - Ending unadjusted allowance for doubtful accounts of $480 = $4,314 c) Ending accounts receivable = Beginning accounts receivable of $45,700 + credit sales of $475,250 - Collections on account of $480,200 - write-off of $800 = $39,950 Net realizable value = Accounts receivable of $39,950 (from part a) Allowance for doubtful accounts of $4,794 = $35,156

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50) a) $9,135 b) $6,655 c) $82,215 a) Ending accounts receivable = Beginning accounts receivable of $92,800 + Credit sales of $875,550 - Collections on account of $870,200 - Write-off of $6,800 = $91,350 Ending balance in allowance for doubtful accounts = Accounts receivable of $91,350 × 10% = $9,135 b) Ending balance of allowance for doubtful accounts of $9,135 = Beginning balance of allowance for doubtful accounts of $9,280 + Uncollectible accounts expense (the unknown) - Write-offs of $6,800 Uncollectible accounts expense = $9,135 - $9,280 + $6,800 = $6,655 c) Net realizable value = Accounts receivable of $91,350 - Allowance for doubtful accounts of $9,135 = $82,215

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51) a) $487,200 b) $2,700 c) $42,975 a) Ending accounts receivable of $45,950 = Beginning accounts receivable of $44,300 + Credit sales of $490,250 − Collections on account (the unknown) − Write-offs of $1,400 Cash collections on account = $44,300 + $490,250 − $1,400 − $45,950 = $487,200 Ending allowance for doubtful accounts balance = ($24,750 × 1%) + ($8,300 × 5%) + ($9,000 × 10%) + ($2,150 × 25%) + ($1,750 × 50%) = $2,975 b) Ending allowance for doubtful accounts of $2,975 = Beginning allowance for doubtful accounts of $1,675 + Uncollectible accounts expense (the unknown) - Write-offs of $1,400 Uncollectible accounts expense = $2,975 − $1,675 + $1,400 = $2,700 c) Net realizable value = Accounts receivable of $45,950 − Allowance for doubtful accounts of $2,975 = $42,975 52) a) $10,500 b) $204,900 a) Ending allowance for doubtful accounts of $12,600 = Beginning allowance for doubtful accounts of $8,600 + Uncollectible accounts expense (the unknown) - Write-offs of $6,500 Uncollectible accounts expense = $12,600 - $8,600 + $6,500 = $10,500 b) Net realizable value = Accounts receivable of $217,500 - Allowance for doubtful accounts of $12,600 = $204,900 Version 1

53) Ending balance in Accounts Receivable = $254,000 Ending balance of accounts receivable = Beginning balance of accounts receivable of $190,000 + Credit sales of $904,000 − Collections of $829,900 − Write-offs of $10,100 = $254,000 54) a) $333,750 a) Ending accounts receivable of $42,500 = Beginning accounts receivable of $35,000 + Revenue on account of $350,000 − Collections (the unknown) − $8,750 write-offs Collections = $35,000 + $350,000 − $8,750 − $42,500 = $333,750 55) a) In Year 1, Blake will report $270 of interest revenue on its income statement, an $18,000 note receivable and $270 interest receivable on its balance sheet, and an $18,000 cash outflow from investing activities on its statement of cash flows. b) In Year 2, Blake will report $450 of interest revenue on its income statement, and an $18,000 cash inflow from investing activities on its statement of cash flows, and a $720 cash inflow from operating activities on its statement of cash flows. a) At the end of Year 1, Blake will record accrued interest of $270, calculated as follows: Interest revenue = Principal of $18,000 × Annual interest rate of 6% × 3/12 = $270 b) $18,000 × 6% × 5/12 = $450 interest revenue. The note is due on June 1, Year 2, so Blake earns 5 months of interest revenue or $450, calculated as follows: Interest revenue = Principal of $18,000 × Annual interest rate of 6% × 5/12 = $450 Interest in the amount of $720 (or $270 + $450) will be collected in Year 2.

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56) a) $560 b) $1,120 c) $25,680 a) Interest revenue recognized during Year 1 = Principal of $24,000 × Annual interest rate of 7% × 4/12 = $560 b) Interest revenue recognized during Year 2 = Principal of $24,000 × Annual interest rate of 7% × 8/12 = $1,120 c) Cash collected at maturity = Principal of $24,000 + Interest of $1,680 (or $560 + $1,120) = $25,680 57) a) $36,000 b) $160,000 c) $5,300,000 a) The adjustment to recognize uncollectible accounts expense increases allowance for doubtful accounts, a contra asset account and increases uncollectible accounts expense by $36,000, calculated as follows: Uncollectible accounts expense = Credit sales of $1,200,000 × 3% = $36,000 b) The credit card expense equals $160,000 (or $4,000,000 × 4%) c) Net cash flow from operating activities: Cash sales Credit sales Credit card sales Total

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$ 240,000 (given) 1,260,000 (see below) 3,800,000 (see below) $ 5,300,000

Credit sales: Ending accounts receivable of $180,000 = Beginning accounts receivable of $240,000 + Credit sales of $1,200,000 − Collections on account (the unknown) Collections on account = $240,000 + $1,200,000 − $180,000 = $1,260,000 Credit card sales: Ending accounts receivable—credit card company of $840,000 = Beginning accounts receivable—credit card company of $800,000 + Credit card sales of $4,000,000 − Collections on account (the unknown) − Credit card fees of $160,000 (from part b) Collections on account = $800,000 + $4,000,000 − $160,000 − $840,000 = $3,800,000 58) Assets

Cash NA

ARCr.Card 576,000

576,00 (576,000 0 )

= Liabilitie + Stockholders Revenu − Expens = Net Statemen s ’ Equity e e Income t of Cash Flows

576,000

600,00 0 NA

24,000 NA

576,00 NA 0 NA 576,000 OA

(1) The credit card sale increases total assets (accounts receivable— credit card company) by $567,000 [or $600,000 - ($600,000 × 4%)]. It increases revenue by $600,000 and increases expenses (credit card expense) by $24,000 (or $600,000 × 4%). (2) The collection from the credit card company increases assets (cash) by $576,000 and decrease assets (accounts receivable—credit card company) by the same amount.

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59) a) 7.63 b) 48 days a) Accounts receivable turnover ratio = Sales of $355,000 ÷ Net accounts receivable of ($48,500 - $2,000) = 7.63 b) Average number of days to collect accounts receivable = 365 ÷ Accounts Receivable Turnover of ÷ 7.63 = 47.8 days (rounded to 48 days) 60) a) 8.43 times and 43.3 days b) 140.4 days a) Accounts receivable turnover = Sales of $495,000 ÷ Net accounts receivable of $58,720 = 8.43 times Average days to collect receivables = 365 ÷ 8.43 = 43.3 days b) Operating cycle = Average number of days to collect receivables of 43.3 days + Average number of days to sell inventory of 97.1 days = 140.4 days

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61) a) 10.0 times b) 36.5 days c) 108.1 days d) $379,850 a) Accounts receivable turnover ratio = Sales of $375,000 ÷ Net accounts receivable of $37,500 = 10.0 times b) Average number of days to collect accounts receivable = 365 ÷ Accounts receivable turnover ratio of 10.0 = 36.5 days c) Operating cycle = Average number of days to collect receivables of 36.5 days + Average number of days to sell inventory of 71.6 days = 108.1 days d) Cash inflow from sales = Sales on account of $375,000 + Decrease in accounts receivable of ($42,350 - $37,500) = $379,850

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CHAPTER 7 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The net realizable value of accounts receivable is the amount of receivables a company expects to collect. ⊚ true ⊚ false

2) The best estimate of the amount of cash a company expects to collect from its accounts receivable is the face value of the receivables. ⊚ true ⊚ false

Most companies report receivables on their balance sheets at the net realizable value. ⊚ true ⊚ false

4) The face value of Accounts Receivable plus the balance in the Allowance for Doubtful Accounts is equal to the net realizable value of the receivables. ⊚ true ⊚ false

The collection of an account receivable is an asset source transaction. ⊚ true ⊚ false

6) Using the allowance method of accounting for uncollectible receivables requires an estimate of the amount of receivables that will not be collected. ⊚ true ⊚ false

7) The direct write-off method does a better job of matching revenues and expenses than does the allowance method.

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⊚ ⊚

true false

8) Willis Company had $200,000 in credit sales for Year 1, and it estimated that 2% of the credit sales would not be collected. The balance in Accounts Receivable at the end of the year was $38,000. Willis had never used the allowance method to account for its receivables until Year 1. The net realizable value of its accounts receivable at the end of the year was $34,000. ⊚ true ⊚ false

9) The net realizable value of accounts receivable decreases when an account receivable is written off. ⊚ true ⊚ false

10) For a company that uses the allowance method, the write-off of an uncollectible account receivable is an asset use transaction. ⊚ true ⊚ false

11) When an uncollectible account receivable is written off under the allowance method, the amount of total assets is unchanged. ⊚ true ⊚ false

12) When a company receives payment from a customer whose account was previously written off, the customer's account should be reinstated. ⊚ true ⊚ false

13) When a company receives payment from a customer whose account was previously written off, the account is reinstated and the net realizable value of Accounts Receivable increases.

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⊚ ⊚

14)

true false

The adjustment to recognize uncollectible accounts expense is an asset use transaction. ⊚ true ⊚ false

15) The adjustment to recognize uncollectible accounts expense does not affect the net realizable value of receivables. ⊚ true ⊚ false

16) If a company estimates uncollectible accounts based on a percentage of receivables, the resulting estimate will be presented on the balance sheet as the ending balance in Allowance for Doubtful Accounts. ⊚ true ⊚ false

17)

The longer an account receivable has been outstanding, the less likely it is to be collected. ⊚ true ⊚ false

18) If a company uses the percent of receivables method to estimate uncollectible accounts, the company will first determine the required ending balance in Allowance for Doubtful Accounts; the Uncollectible Accounts Expense will be the difference between that amount and the balance in the Allowance for Doubtful Accounts. ⊚ true ⊚ false

19) A company that uses the direct write-off method must still prepare a year-end adjustment to estimate its uncollectible accounts. ⊚ true ⊚ false

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20)

The direct write-off method overstates assets on the balance sheet. ⊚ true ⊚ false

21) With the direct write-off method, writing off an account receivable is an asset use transaction. ⊚ true ⊚ false

22) The year-end adjustment to accrue interest on a note receivable is an asset source transaction. ⊚ true ⊚ false

23) On June 1, Year 2, Carolina Company collected a $24,000 note receivable that had been issued on June 1, Year 1. The note carried a 6% interest rate. On June 1, Year 2, the company will recognize interest revenue in the amount of $1,440. ⊚ true ⊚ false

24) Making a loan to another party is considered an investing activity on the statement of cash flows. ⊚ true ⊚ false

25) Many businesses find it more efficient to offer credit directly to customers rather than to accept third-party credit cards. ⊚ true ⊚ false

26) When a company accepts a credit card payment for a sale, the amount of sales revenue to be recorded is reduced by the amount of the credit card company's fee.

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⊚ ⊚

27)

true false

Collecting a credit card receivable is an asset source transaction. ⊚ true ⊚ false

28) Chadwick Company's sales for Year 1 were $8,700,000. The ending balance of accounts receivable was $801,000 at the end of the year. During Year 1, Chadwick collected $8,400,000 on its accounts receivable. The accounts receivable turnover ratio for the year was 10.5. ⊚ true ⊚ false

29) The longer it takes to collect accounts receivable, the greater the implicit interest cost that is incurred. ⊚ true ⊚ false

30) sell.

The operating cycle is the average time that a company spends acquiring inventory to ⊚ ⊚

true false

31) Other things being equal, the longer a company's operating cycle, the higher the company's operating costs are likely to be. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 32) How does the year-end adjustment to recognize uncollectible accounts expense affect the elements of the financial statements?

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A) Decrease total assets and decrease stockholders’ equity. B) Increase total assets and decrease stockholders’ equity. C) Increase total liabilities and increase stockholders’ equity. D) Decrease total liabilities and increase stockholders’ equity.

33) On January 1, Year 1, the Accounts Receivable balance was $23,300 and the balance in the Allowance for Doubtful Accounts was $2,300. On January 15, Year 1, an $670 uncollectible account was written-off. What is the net realizable value of accounts receivable immediately after the write-off? A) $22,630 B) $20,330 C) $21,000 D) $21,670

34) On January 1, Year 1, the Accounts Receivable balance was $37,000 and the balance in the Allowance for Doubtful Accounts was $2,800. On January 15, Year 1, an $800 uncollectible account was written-off. What is the net realizable value of accounts receivable immediately after the write-off? A) $36,200 B) $33,400 C) $35,000 D) $34,200

35) On January 1, Year 2 Grande Company had a $27,000 balance in the Accounts Receivable account and a zero balance in the Allowance for Doubtful Accounts account. During Year 2, Grande provided $90,000 of service on account. The company collected $86,500 cash from accounts receivable. Uncollectible accounts are estimated to be 2% of sales on account. What is the amount of cash flow from operating activities that would appear on the Year 2 statement of cash flows?

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A) $86,500 B) $84,770 C) $90,000 D) $63,540

36) On January 1, Year 2 Grande Company had a $16,000 balance in the Accounts Receivable account and a zero balance in the Allowance for Doubtful Accounts account. During Year 2, Grande provided $104,000 of service on account. The company collected $97,000 cash from accounts receivable. Uncollectible accounts are estimated to be 2% of sales on account. What is the amount of cash flow from operating activities that would appear on the Year 2 statement of cash flows? A) $97,000 B) $104,000 C) $89,520 D) $95,060

37) On January 1, Year 2 Grande Company had a $23,000 balance in the Accounts Receivable account and a zero balance in the Allowance for Doubtful Accounts account. During Year 2, Grande provided $82,000 of service on account. The company collected $78,500 cash from accounts receivable. Uncollectible accounts are estimated to be 2% of sales on account. What is the amount of uncollectible accounts expense recognized on the Year 2 income statement? A) $460 B) $8,000 C) $1,570 D) $1,640

38) On January 1, Year 2 Grande Company had a $16,000 balance in the Accounts Receivable account and a zero balance in the Allowance for Doubtful Accounts account. During Year 2, Grande provided $104,000 of service on account. The company collected $97,000 cash from accounts receivable. Uncollectible accounts are estimated to be 2% of sales on account. What is the amount of uncollectible accounts expense recognized on the Year 2 income statement? Version 1

A) $320 B) $1,000 C) $2,080 D) $1,940

39) The Miller Company earned $97,000 of revenue on account during Year 1. There was no beginning balance in the accounts receivable and allowance accounts. During Year 1, Miller collected $69,000 of cash from its receivables accounts. The company estimates that it will be unable to collect 3% of its sales on account. What is the amount of uncollectible accounts expense that will be recognized on the Year 1 income statement? A) $2,070 B) $840 C) $2,910 D) $28,000

40) The Miller Company earned $190,000 of revenue on account during Year 1. There was no beginning balance in the accounts receivable and allowance accounts. During Year 1, Miller collected $136,000 of cash from its receivables accounts. The company estimates that it will be unable to collect 3% of its sales on account. What is the amount of uncollectible accounts expense that will be recognized on the Year 1 income statement? A) $5,700 B) $1,320 C) $4,080 D) $54,000

41) The Miller Company earned $103,000 of revenue on account during Year 1. There was no beginning balance in the accounts receivable and allowance accounts. During Year 1, Miller collected $72,000 of cash from its receivables accounts. The company estimates that it will be unable to collect 3% of its sales on account. What is the net realizable value of Miller's receivables at the end of Year 1? Version 1

A) $27,910 B) $28,840 C) $34,090 D) $31,000

42) The Miller Company earned $190,000 of revenue on account during Year 1. There was no beginning balance in the accounts receivable and allowance accounts. During Year 1, Miller collected $136,000 of cash from its receivables accounts. The company estimates that it will be unable to collect 3% of its sales on account. What is the net realizable value of Miller's receivables at the end of Year 1? A) $54,000 B) $49,920 C) $59,700 D) $48,300

43) The balance in Accounts Receivable at the beginning of the year amounted to $2,560. During the year, $8,680 of credit sales were made to customers. If the ending balance in Accounts Receivable amounted to $1,660, and uncollectible accounts expense amounted to $700, what is the amount of cash inflow from customers that would appear in the operating activities section of the cash flow statement? A) $8,880 B) $8,680 C) $11,240 D) $9,580

44) The balance in Accounts Receivable at the beginning of the year amounted to $16,000. During the year, $64,000 of credit sales were made to customers. If the ending balance in Accounts Receivable amounted to $10,000, and uncollectible accounts expense amounted to $4,000, what is the amount of cash inflow from customers that would appear in the operating activities section of the cash flow statement?

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A) $66,000 B) $64,000 C) $80,000 D) $70,000

45) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $66,800 and $2,000, respectively. During Year 2, Kincaid reported $169,000 of credit sales, wrote off $1,450 of receivables as uncollectible, and collected cash from receivables amounting to $191,100. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What is the amount of uncollectible accounts expense that will be reported on the Year 2 income statement? A) $1,690 B) $668 C) $1,911 D) $1,450

46) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $31,000 and $500, respectively. During Year 2, Kincaid reported $72,500 of credit sales, wrote off $550 of receivables as uncollectible, and collected cash from receivables amounting to $74,550. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What is the amount of uncollectible accounts expense that will be reported on the Year 2 income statement? A) $310 B) $725 C) $745.50 D) $550

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47) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $76,000 and $4,000, respectively. During Year 2, Kincaid reported $215,000 of credit sales, wrote off $2,100 of receivables as uncollectible, and collected cash from receivables amounting to $271,100. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. Which of the following describes the effects of writing off the uncollectible accounts? A) Increase assets and stockholders’ equity B) Increase assets and decrease stockholders’ equity C) Decrease assets and stockholders’ equity D) Does not affect assets or stockholders’ equity

48) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $31,000 and $500, respectively. During Year 2, Kincaid reported $72,500 of credit sales, wrote off $550 of receivables as uncollectible, and collected cash from receivables amounting to $74,550. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. Which of the following describes the effects of writing off the uncollectible accounts? A) Increase assets and stockholders’ equity B) Increase assets and decrease stockholders’ equity C) Decrease assets and stockholders’ equity D) Does not affect assets or stockholders’ equity

49) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $64,800 and $1,600, respectively. During Year 2, Kincaid reported $159,000 of credit sales, wrote off $1,300 of receivables as uncollectible, and collected cash from receivables amounting to $173,500. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What effect will recognizing the uncollectible accounts expense for Year 2 have on the elements of the financial statements?

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A) Increase total assets and retained earnings B) Decrease total assets and increase retained earnings C) Decrease total assets and net income D) Increase total assets and decrease net income

50) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $31,000 and $500, respectively. During Year 2, Kincaid reported $72,500 of credit sales, wrote off $550 of receivables as uncollectible, and collected cash from receivables amounting to $74,550. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What effect will recognizing the uncollectible accounts expense for Year 2 have on the elements of the financial statements? A) Increase total assets and retained earnings B) Decrease total assets and increase retained earnings C) Decrease total assets and net income D) Increase total assets and decrease net income

51) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $72,400 and $3,200, respectively. During Year 2, Kincaid reported $197,000 of credit sales, wrote off $1,850 of receivables as uncollectible, and collected cash from receivables amounting to $239,900. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What is the net realizable value of receivables that will be reported on Kincaid's Year 2 balance sheet? A) $25,680 B) $24,330 C) $29,500 D) $27,650

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52) On January 1, Year 2, Kincaid Company's Accounts Receivable and the Allowance for Doubtful Accounts carried balances of $31,000 and $500, respectively. During Year 2, Kincaid reported $72,500 of credit sales, wrote off $550 of receivables as uncollectible, and collected cash from receivables amounting to $74,550. Kincaid estimates that it will be unable to collect one percent (1%) of credit sales. What is the net realizable value of receivables that will be reported on Kincaid's Year 2 balance sheet? A) $29,075 B) $27,725 C) $28,950 D) $28,400

53) Which of the following reflects the effect of the year-end adjustment to record estimated uncollectible accounts expense using the allowance method? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. − NA − NA − − −OA B.

−

−OA

−

A) Option A B) Option B C) Option C D) Option D

54) Hoff Company uses the allowance method. An account that had been previously writtenoff as uncollectible was recovered. How do the two parts of the recovery (reinstate receivable and collect the receivable) affect the elements of the financial statements when the two parts are considered together?

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A) Increase total assets and stockholders’ equity B) Increase total assets and decrease total liabilities C) Decrease total liabilities and increase stockholders’ equity D) Has no effect on total assets, total liabilities or stockholders’ equity

55) How would accountants estimate the amount of a company's uncollectible accounts expense? A) Consider new circumstances that are anticipated to be experienced in the future. B) Compute as a percentage of revenue. C) Consider industry averages. D) All of these answer choices are correct.

56) Domino Company ages its accounts receivable to estimate uncollectible accounts expense. Domino began Year 2 with balances in Accounts Receivable and Allowance for Doubtful Accounts of $38,630 and $2,930, respectively. During Year 2, the company wrote off $2,340 in uncollectible accounts. In preparation for the company's estimate of uncollectible accounts expense for Year 2, Domino prepared the following aging schedule: Number of Days Past Due Current 0-30 31-60 61-90 Over 90 Total

Receivables Amount $ 53,000 22,800 5,060 2,320 2,000

% Likely to be Uncollectible 1% 5% 10% 25% 50%

$ 85,180

What amount will be reported as uncollectible accounts expense on the Year 2 income statement? A) $3,166 B) $3,756 C) $826 D) $2,340

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57) Domino Company ages its accounts receivable to estimate uncollectible accounts expense. Domino began Year 2 with balances in Accounts Receivable and Allowance for Doubtful Accounts of $76,500 and $5,800, respectively. During Year 2, the company wrote off $4,640 in uncollectible accounts. In preparation for the company's estimate of uncollectible accounts expense for Year 2, Domino prepared the following aging schedule: Number of Days Past Due Current 0-30 31-60 61-90 Over 90 Total

Receivables Amount $ 104,000 45,000 9,920 4,440 3,800

% Likely to be Uncollectible 1% 5% 10% 25% 50%

$ 167,160

What amount will be reported as uncollectible accounts expense on the Year 2 income statement? A) $6,132 B) $1,512 C) $7,292 D) $4,640

58) Blain Company has $20,000 of accounts receivable that are current, $10,000 that are between 0 and 30 days past due, $6,000 that are between 30 and 60 days past due, and $1,600 that are more than 60 days past due. Blain estimates that 2% of the receivables that are current will be uncollectible, 5% of those between 0 and 30 days past due will be uncollectible, 10% of those between 30 and 60 days past due will be uncollectible, and 50% of those more than 60 days past due will be uncollectible. Just prior to recognizing uncollectible accounts expense, Blain’s allowance for doubtful accounts has a $200 positive balance. Assuming Blain uses the aging method to estimate uncollectible accounts expense, the amount of uncollectible expense will be A) $2,100 B) $2,500 C) $2,300 D) $1,900

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59) Blain Company has $20,000 of accounts receivable that are current, $10,000 that are between 0 and 30 days past due, $6,000 that are between 30 and 60 days past due, and $1,600 that are more than 60 days past due. Blain estimates that 2% of the receivables that are current will be uncollectible, 5% of those between 0 and 30 days past due will be uncollectible, 10% of those between 30 and 60 days past due will be uncollectible, and 50% of those more than 60 days past due will be uncollectible. At the beginning of Year 1, Blain had a $2,000 positive balance in its allowance for doubtful accounts. During Year 1, Blain wrote-off $2,200 of uncollectible receivables. Assuming Blain uses the aging method to estimate uncollectible accounts expense, the amount of uncollectible expense will be A) $2,000 B) $2,100 C) $2,300 D) $2,500

60) Ron Company experienced an accounting event that had the following effects on its financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income (6,000) = NA + (6,000) NA − 6,000 = (6,000) NA

Which of the following events could have caused these effects? A) Recognized uncollectible accounts expense under the aging method. B) Recognized uncollectible accounts expense under percent of receivables method. C) Recognized uncollectible accounts expense under the percent of revenue method. D) All of the answers describe events that could have caused the effects shown in the statements model.

61)

Which of the following statements is true regarding aging accounts receivable?

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A) An aging schedule is used to improve the estimate used in the percent of revenue method of determining the uncollectible accounts expense. B) The aging method of estimating uncollectible accounts is based on the assumption that the longer an account receivable remains outstanding, the less likely it is to be collected. C) The aging of accounts receivable involves applying lower uncollectible percentage estimates to older receivables. D) All of the statements are true.

62) Allegheny Company ended Year 1 with balances in Accounts Receivable and Allowance for Doubtful Accounts of $74,000 and $3,900, respectively. During Year 2, Allegheny wrote off $7,200 of Uncollectible Accounts. Using the percent of receivables method, Allegheny estimates that the ending Allowance for Doubtful Accounts balance should be $6,000. What amount will Allegheny report as Uncollectible Accounts Expense on its Year 2 income statement? A) $9,300 B) $6,000 C) $2,100 D) $7,200

63) Allegheny Company ended Year 1 with balances in Accounts Receivable and Allowance for Doubtful Accounts of $23,000 and $900, respectively. During Year 2, Allegheny wrote off $1,500 of Uncollectible Accounts. Using the percent of receivables method, Allegheny estimates that the ending Allowance for Doubtful Accounts balance should be $1,600. What amount will Allegheny report as Uncollectible Accounts Expense on its Year 2 income statement? A) $2,200 B) $1,500 C) $700 D) $1,600

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64) On December 31, Year 3, Alpha Company had an ending balance of $400,000 in its accounts receivable account and an unadjusted (current) balance in its allowance for doubtful accounts account of $600. Alpha estimates uncollectible accounts expense to be 1% of receivables. Based on this information, the amount of uncollectible accounts expense shown on the Year 3 income statement is

A) $3,400 B) $4,000 C) $4,400 D) $4,600

65) At the beginning of Year 3 Omega Company had a $60,000 balance in its accounts receivable account and a $3,000 balance in allowance for doubtful accounts. During Year 3, Omega experienced the following events. 1.(1) Omega earned $200,000 of revenue on account 2.(2) Collected $210,000 cash from accounts receivable 3.(3) Wrote-off $2,000 of accounts receivable as uncollectible Omega estimates uncollectible accounts to be 4% of receivables. Based on this information, the December 31, Year 3 balance in the accounts receivable account is

A) $50,000. B) $46,000. C) $48,000. D) $47,000.

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66) At the beginning of Year 3 Omega Company had a $60,000 balance in its accounts receivable account and a $3,000 balance in allowance for doubtful accounts. During Year 3, Omega experienced the following events. 1.(1) Omega earned $200,000 of revenue on account 2.(2) Collected $210,000 cash from accounts receivable 3.(3) Wrote-off $2,000 of accounts receivable as uncollectible Omega estimates uncollectible accounts to be 4% of receivables. Based on this information, the December 31, Year 3 unadjusted (current) balance in allowance for doubtful accounts account (balance before expense recognition) is

A) $1,920. B) $5,000. C) $1,000. D) $920.

67) At the beginning of Year 3 Omega Company had a $60,000 balance in its accounts receivable account and a $3,000 balance in allowance for doubtful accounts. During Year 3, Omega experienced the following events. 1.(1) Omega earned $200,000 of revenue on account 2.(2) Collected $210,000 cash from accounts receivable 3.(3) Wrote-off $2,000 of accounts receivable as uncollectible Omega estimates uncollectible accounts to be 4% of receivables. The December 31, Year 3 ending balance in allowance for doubtful accounts account (balance after expense recognition) is A) $2,080. B) $1,920. C) $1,000. D) $2,080. E) $920. F) $1,000. G) $920.

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68) At the beginning of Year 3 Omega Company had a $60,000 balance in its accounts receivable account and a $3,000 balance in allowance for doubtful accounts. During Year 3, Omega experienced the following events. 1.(1) Omega earned $200,000 of revenue on account 2.(2) Collected $210,000 cash from accounts receivable 3.(3) Wrote-off $2,000 of accounts receivable as uncollectible Omega estimates uncollectible accounts to be 4% of receivables. Based on this information, the amount of uncollectible accounts expense shown on the Year 3 income statement is

A) $1,920. B) $2,080. C) $1,000. D) $920.

69) At the beginning of Year 3 Omega Company had a $60,000 balance in its accounts receivable account and a $3,000 balance in allowance for doubtful accounts. During Year 3, Omega experienced the following events. 1.(1) Omega earned $200,000 of revenue on account 2.(2) Collected $210,000 cash from accounts receivable 3.(3) Wrote-off $2,000 of accounts receivable as uncollectible Omega estimates uncollectible accounts to be 4% of receivables. Based on this information, the amount of net realizable value of receivables shown on the Year 3 balance sheet is

A) $48,000. B) $46,080. C) $49,920. D) $50,000.

70) Which of the following is the term commonly used to describe the practice of reporting the net realizable value of receivables in the financial statements?

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A) Cash flow method. B) Allowance method. C) Direct write-off method. D) Accrual method.

71) What is the term used to describe the amount of accounts receivable that is actually expected to be collected? A) Allowance for doubtful accounts B) Uncollectible accounts expense C) The present value of accounts receivable D) Net realizable value

72) Which of the following is a true statement about a company that uses the allowance method? A) Uncollectible Accounts Expense is recorded when a receivable is written off. B) Uncollectible accounts are not recorded until the amount becomes significant. C) The net realizable value of its accounts receivable is shown on the balance sheet. D) None of these answer choices are correct.

73) Hancock Medical Supply Company, earned $84,000 of revenue on account during Year 1, its first year of operation. During Year 1, Hancock collected $66,800 of cash from its receivables accounts. The company did not write-off any uncollectible accounts. It estimates that it will be unable to collect 1% of revenue on account. What is the net realizable value of receivables that will be reported on the balance sheet at December 31, Year 1? A) $16,532 B) $16,360 C) $17,200 D) $17,028

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74) Hancock Medical Supply Company, earned $160,000 of revenue on account during Year 1, its first year of operation. During Year 1, Hancock collected $128,000 of cash from its receivables accounts. The company did not write-off any uncollectible accounts. It estimates that it will be unable to collect 1% of revenue on account. What is the net realizable value of receivables that will be reported on the balance sheet at December 31, Year 1? A) $30,400 B) $30,720 C) $32,000 D) $30,000

75) Which of the following is not an accurate description of the Allowance for Doubtful Accounts? A) The account is a contra account. B) The account is a liability. C) The amount of the Allowance for Doubtful Accounts decreases the net realizable value of a company's receivables. D) The account is increased by an estimate of uncollectible accounts expense.

76)

Which of the following best describes the percent of receivables method? A) Income statement approach B) Direct write-off approach C) Credit sales approach D) Balance sheet approach

77)

Which of the following is a cost of extending credit to customers? A) Uncollectible accounts expense B) Lost sales C) Fees paid to credit card companies D) Explicit interest

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78) If the allowance method is used, how does recording the recovery of an uncollectible account affect the elements of the financial statements?(Hint: Consider the effect of both the reinstatement and the collection of the receivable taken together.) A) No effect on total assets or stockholders’ equity B) Increase stockholders’ equity C) Decrease total assets D) Increase total assets and stockholders’ equity

79) On December 31, Year 1, the Loudoun Corporation estimated that 3% of its credit sales of $112,500 would be uncollectible. Loudoun uses the allowance method. On February 15, Year 2, one of Loudoun's customers failed to pay his $1,050 account and the account was written off. On April 4, Year 2, this customer paid Loudoun the $1,050. Which of the following correctly states the effect of the adjustment dated December 31, Year 1, on the financial statements of the Loudoun Corporation? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (3,375) 3,375 NA NA NA NA NA B. (3,375)

(3,375)

3,375

(3,375)

C. 3,375

3,375

(3,375)

3,375

3,375 OA

A) Option A B) Option B C) Option C D) Option D

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80) On December 31, Year 1, the Loudoun Corporation estimated that 3% of its credit sales of $112,500 would be uncollectible. Loudoun uses the allowance method. On February 15, Year 2, one of Loudoun's customers failed to pay his $1,050 account and the account was written off. On April 4, Year 2, this customer paid Loudoun the $1,050. Which of the following correctly states the effect of Loudoun Company writing off the customer's account? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cas + Net = Accounts + Commo + Retain Revenu − Expen = Net h Realizab Payable n ed e se Incom le Value Stock Earnin e gs a NA NA NA NA NA NA NA NA NA . b NA (1,050) NA NA (1,050 (1,050 NA (1,05 NA . ) ) 0) c NA (1,050) (1,050) NA NA NA NA NA NA . d NA NA 1,050 (1,05 NA NA (1,05 (1,05 NA . 0) 0) 0)

A) Option A B) Option B C) Option C D) Option D

81) On December 31, Year 1, the Loudoun Corporation estimated that 3% of its credit sales of $112,500 would be uncollectible. Loudoun uses the allowance method. On February 15, Year 2, one of Loudoun's customers failed to pay his $1,050 account and the account was written off. On April 4, Year 2, this customer paid Loudoun the $1,050. Which of the following correctly states the effect of Loudoun’s recording the reestablishment of the receivable on April 4, Year 2?

Assets Cas +

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Net

Balance Sheet Income Statement = Liabiliti + Stockholders’ es Equity = Accounts + Commo + Retain Revenu − Expen = Net

Stateme nt of Cash Flows

a . b . c . d .

Realizab le Value

Payable

n Stock

(1,050)

1,050

(1,05 0)

ed Earnin gs NA

Incom e

(1,05 0) NA

(1,05 0)

(1,050 (1,050 ) ) NA NA NA

A) Option A B) Option B C) Option C D) Option D

82) On December 31, Year 1, the Loudoun Corporation estimated that 3% of its credit sales of $112,500 would be uncollectible. Loudoun uses the allowance method. On February 15, Year 2, one of Loudoun's customers failed to pay his $1,050 account and the account was written off. On April 4, Year 2, this customer paid Loudoun the $1,050. Which of the following correctly states the effect of recording the collection of the reestablished receivable on April 4, Year 2? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income Flows A. 1,050 NA NA NA NA NA NA (1,050) B. 1,050 NA 1,050 1,050 NA 1,050 1,050 OA C. 1,050

1,050

(1,050)

D. 1,050 (1,050)

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1,050 1,050 OA NA

1,050 OA

A) Option A B) Option B C) Option C D) Option D

83)

The net effect of the entries to recognize the write-off under the allowance method is to: A) increase total stockholders’ equity only. B) have no effect on total assets or stockholders’ equity. C) decrease total assets. D) increase total assets and stockholders’ equity.

84)

Under the direct write-off method, uncollectible accounts expense is recognized A) in an adjusting entry at the end of the accounting period. B) when the allowance account has a zero balance. C) when an account is determined to be uncollectible. D) in a closing entry at the end of the accounting period.

85)

Which of the following statements is true?

A) The primary advantage of using the direct write-off method of recognizing uncollectible accounts expense is simplicity. B) Only banks are permitted to use the direct write-off method. C) The direct write-off method is used to assure the matching of expenses with revenue. D) Companies with large amounts of uncollectible accounts normally use the directwrite off method to account for uncollectible accounts expense.

86) Which of the following shows how recognizing uncollectible accounts expense under the direct write-off method would affect the financial statements? Balance Sheet

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Income Statement

Statemen

Assets

= Liabiliti + Stockholders’ es Equity Cas + Accounts = Accounts + Commo + Retaine Revenu − Expens = Net h Receivab Payable n d e e Incom le Stock Earning e s A NA − NA NA − NA + − . B NA − NA NA − NA + − . C + − NA NA − NA + − . D NA NA + NA − NA + − .

t of Cash Flows

−OA NA +OA NA

A) Option A. B) Option B. C) Option C. D) Option D.

87) The net realizable value of receivables is not shown on the balance sheet of a company using the A) percent of revenue method. B) direct write-off method. C) aging of accounts method. D) percent of receivables method.

88) The total amount of uncollectible accounts expense recognized over the life of a business will be the smallest under the A) percent of revenue method. B) percent of receivables method. C) direct write-off method. D) All methods produce the same amount of uncollectible accounts expense recognized over the life of a business.

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89) Which accounting concept can be used by some companies to justify the use of the direct write-off method? A) The entity concept B) The materiality concept C) The going concern concept D) The monetary principle

90)

When is it acceptable to use the direct write-off method? A) If the dollar amount of uncollectible accounts is not material. B) If most uncollectible accounts do not occur in the period of sale. C) If most sales are made to other businesses. D) All of these answer choices are correct.

91) Which of the following is not a significant difference between the allowance method and the direct write-off method? A) One method requires writing off uncollectible accounts and the other does not. B) One method conforms to GAAP and the other typically does not. C) One method reports net realizable value on the balance sheet and the other does not. D) One method requires the estimation of uncollectible accounts and the other does not.

92) What is the effect of recognizing $7,500 of uncollectible accounts expense under the direct write-off method? A) Assets and liabilities increase B) Assets and stockholders’ equity increase C) Assets and stockholders’ equity decrease D) There is no effect on total assets, liabilities or stockholders’ equity

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93) Rosewood Company made a loan of $10,200 to one of the company's employees on April 1, Year 1. The one-year note carried a 6% rate of interest. What is the amount of interest revenue that Rosewood would report in Year 1 and Year 2, respectively? A) $612 in Year 1 and $0 in Year 2 B) $0 in Year 1 and $612 in Year 2 C) $153 in Year 1 and $459 in Year 2 D) $459 in Year 1 and $153 in Year 2

94) Rosewood Company made a loan of $16,000 to one of the company's employees on April 1, Year 1. The one-year note carried a 6% rate of interest. What is the amount of interest revenue that Rosewood would report in Year 1 and Year 2, respectively? A) $960 in Year 1 and $0 in Year 2 B) $0 in Year 1 and $960 in Year 2 C) $240 in Year 1 and $720 in Year 2 D) $720 in Year 1 and $240 in Year 2

95) Which of the following is (are) the term(s) used to describe the person responsible for making payment on the due date of a promissory note? A) Lender or maker B) Maker or debtor C) Borrower D) Borrower or maker or debtor

96) On November 1, Year 1 Shelter Company loaned $4,000 cash to Cove Company. The one-year note carried a 5% rate of interest. Which of the following shows how the loan will affect Shelter’s financial statements on November 1, Year 1? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cash + Net = Accounts + Commo + Retain Revenu − Expen = Net Receivab Payable n ed e se Incom le Stock Earnin e gs

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A −4,00 . 0 B −4,00 . 0 C −4,00 . 0 D −4,00 . 0

4,000

−4,000

−4,000 IA −4,000 OA 4,000 IA −4,000 OA

A) Option A B) Option B C) Option C D) Option D

97) DeKalb Company made a loan of $10,000 to one of the company’s employees on May 1, Year 1. The one-year note carried a 6% rate of interest. The amount of interest revenue that DeKalb would report in Year 1 and Year 2, respectively would be A) $600, and $0. B) $0, and $600. C) $200, and $400. D) $400, and $200.

98) On October 1, Year 1 Hernandez Company loaned $60,000 cash to Acosta Company. The one-year note carried a 6% rate of interest. Which of the following shows how the December 31, Year 1 recognition of accrued interest will affect Hernandez’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 900 NA 900 900 NA 900 900 IA B.

900

C. 2,700

2,700

2,700 2,700 IA

D. 2,700

2,700

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A) Option A B) Option B C) Option C D) Option D

99) On October 1, Year 1 Hernandez Company loaned $60,000 cash to Acosta Company. The two-year note carried a 6% rate of interest. Which of the following shows the effect of Year 2 interest expense on Hernandez’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 900 NA 900 900 NA 900 900 IA B.

900

C. 2,700

2,700

2,700 IA

D. 2,700

2,700

A) Option A B) Option B C) Option C D) Option D

100) Forest Beach Company experienced an event that had the following effects on its financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA +IA

Which of the following events could have caused these effects?

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A) Accrued interest revenue. B) Loaned cash to an employee. C) Collected cash for the principal balance of a note receivable. D) Borrowed cash from a bank.

101) On August 1, Year 1 Western Company loaned $40,000 cash to Eastern Company. The one-year note carried a 6% rate of interest. The amount of interest revenue on the income statement and the amount of cash flow from operating activities shown on Western’s December 31, Year 1 financial statements would be A) $1,000 interest revenue and $2,400 cash flow from operating activities. B) $1,400 interest revenue and $2,400 cash flow from operating activities. C) $1,000 interest revenue and zero cash flow from operating activities. D) $1,400 interest revenue and zero cash flow from operating activities.

102) Buttercup Florist uses the allowance method to account for uncollectible accounts. Unable to collect a $150 account from a customer, Buttercup determined it was uncollectible. Which of the following statements is correct regarding the effect of writing-off a receivable? A) The net realizable value of receivables and total assets increase. B) The net realizable value of receivables and total assets decrease. C) The net realizable value of receivables decreases, and total assets increase. D) The net realizable value of receivables and total assets remains unchanged.

103) The Yankee Corporation has recently begun to accept credit cards. On July 7, Year 1, Yankee made a credit card sale of $600. Assume that the credit card fee is recorded on the date of sale and that the credit card company charges a fee of 3% for handling a credit card transaction. Which of the following correctly shows the effects of the sale on July 7? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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600

582

600

582

582 OA

582

600

582

600

A) Option A B) Option B C) Option C D) Option D

104) Which of the following correctly describes the effect of the collection of cash from the credit card company on the financial statements of Yankee Corporation? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 582 NA NA NA NA NA 582 OA (582) B. 582 NA NA 582 NA 582 582 OA C.

582 (582) D. 600

582

582 OA

A) Option A B) Option B C) Option C D) Option D

105) Which of the following is not an advantage of accepting credit cards from retail customers?

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A) The acceptance of credit cards tends to increase sales. B) The credit card company performs credit worthiness assessments. C) There are fees charged for the privilege of accepting credit cards. D) The credit card company assumes the cost of slow collections and write-offs.

106) Elliston Company accepted credit card payments for $10,000 of services provided to customers. The credit card company charges a 3% fee for handling the transaction. Which of the following describes the effect of this transaction? A) Increase revenue by $9,700 B) Increase assets by $10,000 C) Increase stockholders’ equity (retained earnings) by $9,700 D) Increase net income by $10,000

107) Alberta Company accepts a credit card as payment for $450 of services provided for the customer. The credit card company charges a 4% fee for handling the transaction. Select the answer that shows how the entry to record the sale would affect Alberta's financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 432 NA 432 432 NA 432 432 OA B.

432

450

432

432 OA

432

450

432

450

A) Option A B) Option B C) Option C D) Option D

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108) Glebe Company accepted a credit card as payment for $1,100 of services provided to a customer. The credit card company charges a 5% fee for handling the transaction. What effect will the collection of cash from the credit card company have on the elements of the financial statements? A) Increase assets by $1,045 B) Decrease assets and stockholders’ equity by $55 C) Increase assets by $1,100 D) None of these answer choices are correct

109) Zane Enterprises accepts a credit card as payment for $1,000 of services provided to a customer. The credit card company charges a 4% handling charge for its collection services. Based on this information A) Zane will collect $1,000 cash from the credit card company. B) Zane will pay the credit card company $1,000 cash. C) Zane will collect $960 cash from the credit card company. D) Zane will pay the credit card company $960 cash.

110) Barron Company accepts a credit card as payment for $2,400 of services provided to a customer. The credit card company charges a 5% handling fee for its collection services. Select the answer that shows how the entry to recognize the event would affect Barron’s financial statements. A) Assets will increase by $2,280. B) Revenue will increase by $2,400. C) Expenses will increase by $120. D) All of the answers describe effects that will occur as a result of recognizing this event.

111)

What does the accounts receivable turnover ratio measure?

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A) How quickly accounts receivable turn into cash B) How quickly the accounts receivable balance increases C) Average balance of accounts receivables D) How quickly inventory turns into accounts receivable

112)

Rhodes Company reports the following information for the Year 1 fiscal year:

Sales on account Accounts receivable Allowance for doubtful accounts

$ 650,000 $ 70,000 $ 4,000

Determine the average number of days it takes Rhodes to collect its accounts receivable. (Round intermediate calculations to 2 decimal places.) A) 37 B) 14 C) 39 D) 20

113) year.

The following information is available for Blankenship Company for the most recent

Sales Cost of goods sold Gross profit Net income Accounts receivable Inventory

$ 1,100,000 760,000 340,000 85,000 90,000 105,000

What was Blankenship's operating cycle for the most recent year? (Round to the nearest whole day.) A) 30 days B) 50 days C) 80 days D) 120 days

114)

How is a company’s operating cycle determined?

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A) Adding the inventory turnover ratio to the receivables turnover ratio divided into 365 days. B) Adding the average number of days to sell inventory to the average number of days to collect receivables. C) Dividing cost of goods sold by average inventory. D) Dividing 365 days by the difference in the inventory turnover and receivable turnover.

115)

Which of the following businesses would most likely have the longest operating cycle? A) A chain of coffee shops B) A national sporting goods chain C) An antiques dealer D) A Christmas tree farm

116)

Which of the following is not considered a "cost" of extending credit to customers? A) The opportunity cost of lost interest B) Keeping the records for accounts receivable C) The increased sales resulting from the extension of credit D) The possibility of unpaid accounts

117)

How is the accounts receivable turnover ratio computed? A) Sales ÷ Net accounts receivable B) Net accounts receivable ÷ Sales C) Cost of goods sold ÷ Inventory D) 365 days ÷ Net accounts receivable

118)

How is the average number of days to collect accounts receivable computed?

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A) Accounts Receivable ÷ Net income B) 365 ÷ Accounts receivable turnover ratio C) Accounts Receivable ÷ 365 D) Sales ÷ Net accounts receivable

119) The accounting records of the Harris and Schubert Companies contained the following account balances: Sales Harris Schubert

$ 300,000 180,000

Accounts receivable $ 60,000 40,000

Which of the following statements is true? A) Schubert Company has a lower likelihood of lost income resulting from credit costs. B) The company with the higher accounts receivable turnover ratio will also have the longer average number of days to collect accounts receivable. C) The accounts receivable for Schubert Company turns over 6 times each year. D) The average number of days to collect accounts receivable for Harris is 73 days.

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Answer Key Test name: Chap 07_2e_Test Bank_MCQs_TF 1) TRUE 2) FALSE The best estimate of the amount of cash a company expects to collect is the net realizable value of its accounts receivable. 3) TRUE GAAP requires the use of the allowance method, which results in the reporting of net realizable value (or accounts receivable minus the allowance for doubtful accounts) unless uncollectible accounts are immaterial. 4) FALSE Net realizable value = Accounts receivable − Allowance for doubtful accounts 5) FALSE Collection of an account receivable is an asset exchange transaction. Assets (cash) increase while assets (accounts receivable) decrease. 6) TRUE The estimate is made at the end of each accounting period. 7) FALSE The allowance method of accounting for uncollectible accounts is conceptually superior to the direct write-off method, in which uncollectible accounts expense is recognized when an account is determined to be uncollectible. The direct write-off method fails to match revenues with expenses and overstates accounts receivable on the balance sheet. It is easier to use, however, and is permitted by generally accepted accounting principles if the amount of uncollectible accounts expense is immaterial. Version 1

8) TRUE Uncollectible accounts expense (increase to allowance for doubtful accounts) = $200,000 × 2% = $4,000 Net realizable value = Accounts receivable of $38,000 − Allowance for doubtful accounts of $4,000 = $34,000 9) FALSE Net realizable value = Accounts receivable − Allowance for doubtful accounts The net realizable value is unaffected by a write-off because both accounts receivable and allowance for doubtful accounts decrease by the same amount. 10) FALSE The write-off is an asset exchange transaction that decreases assets (accounts receivable) and increases assets (because it decreases the allowance for doubtful accounts, a contra asset account). 11) TRUE The write-off is an asset exchange transaction that decreases assets (accounts receivable) and increases assets (because it decreases the allowance for doubtful accounts, a contra asset account). 12) TRUE The account receivable is reinstated because a complete record of the customer’s payment history may be useful if the customer requests credit again at some future date. 13) FALSE Reinstating an account receivable is performed by reversing the previous write-off; doing so increases the balances in Accounts Receivable and Allowance for Doubtful Accounts. Because the Allowance account is a contra asset account, the increase in it offsets the increase in the Accounts Receivable account, and the net realizable value is unchanged. 14) TRUE Version 1

Recognizing uncollectible accounts expense is an asset use transaction that decreases assets by increasing the allowance for doubtful accounts, a contra asset account. 15) FALSE Net realizable value = Accounts receivable − Allowance for doubtful accounts Recognizing uncollectible accounts expense decreases net realizable value because it increases allowance for doubtful accounts. 16) TRUE The percent of receivables method focuses on estimating the most accurate balance for the Allowance for Doubtful Accounts that appears on the year-end balance sheet. 17) TRUE History suggests that an account receivable that is past its due date is less likely to be collected than one that is not yet currently due. The longer an account receivable remains past due, the less likely it is to be collected. Accordingly, the accuracy of the amount of estimated uncollectible account expense can be improved by aging of accounts receivable, which involves applying higher uncollectible percentage estimates to older receivables. 18) TRUE This is the correct procedure for using percent of receivables to estimate uncollectible accounts. 19) FALSE No year-end adjustment is made to estimate uncollectible accounts using the direct write-off method; this method does not use an allowance account. 20) TRUE

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The direct write-off method overstates assets (accounts receivable) because receivables are reported at face value rather than net realizable value. 21) TRUE Using the direct write-off method, a write-off decreases assets (accounts receivable) and decreases stockholders’ equity (retained earnings). It increases expenses (uncollectible accounts expense), which decreases net income. 22) TRUE This is an asset source transaction. Accruing interest on a note receivable increases assets (interest receivable) and increases stockholders’ equity (retained earnings). It also increases interest revenue, which increases net income. 23) FALSE Only the interest earned during Year 2 of $600 (calculated below) should be recognized in Year 2. The interest earned during Year 1 of $840 (calculated below) should be accrued at the end of Year 1. Recognized in Year 1 (June through December): Interest revenue = $24,000 × 6% × 7/12 = $840 Recognized in Year 2 (January through May): Interest revenue = $24,000 × 6% × 5/12 = $600 24) TRUE Loaning cash is a cash outflow from investing activities. 25) FALSE

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Maintaining accounts and notes receivable is expensive. In addition to uncollectible accounts expense, companies extending credit to their customers incur considerable costs for such clerical tasks as running background checks and maintaining customer records. On the other hand, the credit card company deducts a service fee (usually between 1% and 5%) from the gross amount of the sale and pays the merchant the net balance (gross amount of sale less credit card fee) in cash. However, in return, the merchant avoids the risk of uncollectible accounts, as well as the cost of maintaining customer credit records. Many businesses find it more efficient to accept third-party credit cards instead of offering credit directly to their customers. 26) FALSE Revenue is recorded for the full amount of the sale, and the fee is recorded as a separate expense. Income increases by the amount of revenue and decreases by the amount of the credit card expense. Net income increases by the difference between the two amounts. 27) FALSE Collection of a credit card receivable is an asset exchange transaction that increases assets (cash) and decreases assets (accounts receivable). 28) FALSE Accounts receivable turnover ratio = Sales of $8,700,000 ÷ Accounts receivable of $801,000 = 10.9 29) TRUE There is an implicit interest cost associated with extending credit. When a customer is permitted to delay payment, the creditor forgoes the opportunity to invest the amount the customer owes. 30) FALSE The operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable into cash. Version 1

31) TRUE The length of the operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable into cash. The longer the operating cycle takes, the more it costs the company. 32) A The adjustment will decrease assets (by increasing the allowance for doubtful accounts, a contra asset account) and stockholders’ equity. It will increase expenses (uncollectible accounts expense), which decreases net income. 33) C Accounts receivable after the write-off = $23,300 − $670 = $22,630 Allowance for doubtful accounts after the write-off = $2,300 − $670 = $1,630 Net realizable value = Accounts receivable of $22,630 − Allowance for doubtful accounts of $1,630 = $21,000 34) D Accounts receivable after the write-off = $37,000 − $800 = $36,200 Allowance for doubtful accounts after the write-off = $2,800 − $800 = $2,000 Net realizable value = Accounts receivable of $36,200 − Allowance for doubtful accounts of $2,000 = $34,200 35) A The cash collected from accounts receivable in the amount of $86,500 will be reported as a cash inflow from operating activities. 36) A The cash collected from accounts receivable in the amount of $97,000 will be reported as a cash inflow from operating activities. 37) D

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Uncollectible accounts expense = Sales on account of $82,000 × 2% = $1,640 38) C Uncollectible accounts expense = Sales on account of $104,000 × 2% = $2,080 39) C Uncollectible accounts expense = Revenue on account of $97,000 × 3% = $2,910 40) A Uncollectible accounts expense = Revenue on account of $190,000 × 3% = $5,700 41) A Ending accounts receivable = Beginning accounts receivable of $0 + Revenue on account of $103,000 − Collections on account of $72,000 = $31,000 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $0 + Uncollectible accounts expense of $3,090 − Write-offs of $0 = $3,090 Net realizable value = Accounts receivable of $31,000 − Allowance for doubtful accounts of $3,090 = $27,910 42) D Ending accounts receivable = Beginning accounts receivable of $0 + Revenue on account of $190,000 − Collections on account of $136,000 = $54,000 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $0 + Uncollectible accounts expense of $5,700 − Write-offs of $0 = $5,700 Net realizable value = Accounts receivable of $54,000 − Allowance for doubtful accounts of $5,700 = $48,300 43) D Version 1

The $700 in uncollectible accounts expense does not affect accounts receivable, and does not affect cash flows. Ending accounts receivable of $1,660 = Beginning accounts receivable of $2,560 + Credit sales of $8,680 − Collections on account Collections on account (that is, cash inflow from customers) = $2,560 + $8,680 − $1,660 = $9,580 44) D The $4,000 in uncollectible accounts expense does not affect accounts receivable, and does not affect cash flows. Ending accounts receivable of $10,000 = Beginning accounts receivable of $16,000 + Credit sales of $64,000 − Collections on account Collections on account (that is, cash inflow from customers) = $16,000 + $64,000 − $10,000 = $70,000 45) A Uncollectible accounts expense = Credit sales of $169,000 credit sales × 1% = $1,690 46) B Uncollectible accounts expense = Credit sales of $72,500 credit sales × 1% = $725 47) D The write-off decreases assets (accounts receivable) and increases assets (by decreasing the allowance for doubtful accounts, a contra asset account. Therefore, there is no effect on total assets or stockholders’ equity. 48) D The write-off decreases assets (accounts receivable) and increases assets (by decreasing the allowance for doubtful accounts, a contra asset account. Therefore, there is no effect on total assets or stockholders’ equity. 49) C Version 1

Recognizing uncollectible accounts expense decreases assets (by increasing the allowance for doubtful accounts, a contra asset account) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. 50) C Recognizing uncollectible accounts expense decreases assets (by increasing the allowance for doubtful accounts, a contra asset account) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. 51) B Ending accounts receivable = Beginning accounts receivable of $72,400 + Credit sales of $197,000 − Collections on account of $239,900 − Write-offs of $1,850 = $27,650 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $3,200 + Uncollectible accounts expense of $1,970 − Write-offs of $1,850 = $3,320 Net realizable value = Accounts receivable of $27,650 − Allowance for doubtful accounts of $3,320 = $24,330 52) B Ending accounts receivable = Beginning accounts receivable of $31,000 + Credit sales of $72,500 − Collections on account of $74,550 − Writeoffs of $550 = $28,400 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $500 + Uncollectible accounts expense of $725 − Write-offs of $550 = $675 Net realizable value = Accounts receivable of $28,400 − Allowance for doubtful accounts of $675 = $27,725 53) D

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Recording uncollectible accounts expense decreases assets (increases allowance for doubtful accounts) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows. 54) D Hoff must first reinstate the receivable that was previously written off. The reinstatement increases assets (accounts receivable) and decreases assets (by increasing the allowance for doubtful accounts, a contra asset account), with no net effect on any of the elements of the financial statements. Next, Hoff records collection of the receivable, which increases assets (cash) and decreases assets (accounts receivable) with no net effect on total assets. 55) D Accountants use a variety of methods to estimate uncollectible accounts expense. There is no requirement that they use a particular approach. 56) A Estimated ending allowance balance = ($53,000 × 1%) + ($22,800 × 5%) + ($5,060 × 10%) + ($2,320 × 25%) + ($2,000 × 50%) = $3,756 Ending allowance for doubtful accounts of $3,756 = Beginning allowance for doubtful accounts of $2,930 + Uncollectible accounts expense (the unknown) − Write-offs of $2,340 Uncollectible accounts expense = $3,756 − $2,930 + $2,340 = $3,166 57) A Estimated ending allowance balance = ($104,000 × 1%) + ($45,000 × 5%) + ($9,920 × 10%) + ($4,440 × 25%) + ($3,800 × 50%) = $7,292 Ending allowance for doubtful accounts of $7,292 = Beginning allowance for doubtful accounts of $5,800 + Uncollectible accounts expense (the unknown) − Write-offs of $4,640 Uncollectible accounts expense = $7,292 − $5,800 + $4,640 = $6,132 58) A Version 1

Required ending balance in the allowance is determined as follows: Number of Days Past Due Current 0 - 30 30 - 60 Over 60 Total

Receivables Amount $ 20,000 10,000 6,000 1,600

Percentage Likely to be Uncollectible 0.02 0.05 0.10 0.50

$ 37,600

Required Allowance Account Balance $ 400 500 600 800 $ 2,300

Uncollectible accounts expense = Required ending balance − Current balance = $2,300 − $200 = $2,100. 59) D Number of Days Past Due Current 0 - 30 30 - 60 Over 60 Total

Receivables Amount $ 20,000 10,000 6,000 1,600 $ 37,600

Percentage Likely to be Uncollectible 0.02 0.05 0.10 0.50

Required Allowance Account Balance $ 400 500 600 800 $ 2,300

The current balance in the allowance account prior to recognizing uncollectible accounts expense is negative $200 ($2,000 beginning balance − $2,200 write-off). Uncollectible accounts expense = Required ending balance − Current balance = $2,300 − ($200) = $2,500. 60) D The percent of receivables, aging, and percent of revenue methods differ only in the way they determine the estimated amount of the uncollectible accounts expense. The recognition of the expense has the same effects on the financial statements regardless of which method is used to determine the amount of the expense. 61) B

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An aging schedule is used to improve the estimate used in the percent of receivables method not the percent of revenue method. The aging of accounts receivable involves applying higher uncollectible percentage estimates to older receivables (not lower). The only true statement is that the aging method of estimating uncollectible accounts is based on the assumption that the longer an account receivable remains outstanding, the less likely it is to be collected. 62) A Ending allowance for doubtful accounts of $6,000 = Beginning allowance for doubtful accounts of $3,900 + Uncollectible accounts expense (the unknown) − Write-offs of $7,200 Uncollectible accounts expense = $6,000 − $3,900 + $7,200 = $9,300 63) A Ending allowance for doubtful accounts of $1,600 = Beginning allowance for doubtful accounts of $900 + Uncollectible accounts expense (the unknown) − Write-offs of $1,500 Uncollectible accounts expense = $1,600 − $900 + $1,500 = $2,200 64) A Uncollectible accounts expense = Ending balance in allowance account − unadjusted balance in allowance account Ending balance in allowance account ($400,000 × 0.01) Less:Unadjusted (current) balance in allowance account

$ 4,000 (600)

Estimated uncollectible accounts expense

$ 3,400

65) C Balance in Accounts Receivable: Beginning accounts receivable balance Plus: Revenue earned on account Less:Collections of accounts receivable Less:Write-off of accounts receivable

$ 60,000 200,000 (210,000) (2,000)

Ending accounts receivable balance

$ 48,000

66) C Version 1

Beginning allowance account balance Less:Write-off of accounts receivable

$ 3,000 (2,000)

Current allowance account balance

$ 1,000

67) B Balance in Accounts Receivable: Beginning accounts receivable balance Plus:Revenue earned on account Less:Collections of accounts receivable Less:Write-off of accounts receivable

$ 60,000 200,000 (210,000) (2,000)

Ending accounts receivable balance

$ 48,000

Ending balance in the allowance for doubtful accounts account: $48,000 Ending accounts receivable × 0.04 Estimate of uncollectible accounts = $1,920 68) D Balance in Accounts Receivable: Beginning accounts receivable balance Plus:Revenue earned on account Less:Collections of accounts receivable Less:Write-off of accounts receivable

$ 60,000 200,000 (210,000) (2,000)

Ending accounts receivable balance

$ 48,000

Current (unadjusted) balance in the allowance for doubtful accounts account: Beginning allowance account balance Less:Write-off of accounts receivable

$ 3,000 (2,000)

Current allowance account balance

$ 1,000

Ending balance in the allowance for doubtful accounts account: $48,000 Ending accounts receivable × 0.04 Estimate = $1,920 Uncollectible accounts expense: $1,920 End balance in the allowance for doubtful accounts − $1,000 Current balance = $920 69) B Version 1

Balance in Accounts Receivable: Beginning accounts receivable balance Plus:Revenue earned on account Less:Collections of accounts receivable Less:Write-off of accounts receivable

$ 60,000 200,000 (210,000) (2,000)

Ending accounts receivable balance

$ 48,000

Ending balance in the allowance for doubtful accounts account: $48,000 Ending accounts receivable × .04 Estimate = $1,920 Net realizable value of accounts receivable: Ending accounts receivable balance Less:Ending allowance for doubtful accounts balance

$ 48,000 (1,920)

Net realizable value

$ 46,080

70) B Reporting accounts receivable in the financial statements at net realizable value is commonly called the allowance method of accounting for uncollectible accounts. 71) D The net realizable value of accounts receivable represents the amount of receivables a company estimates it will actually collect. 72) C A company that uses the allowance method estimates uncollectible accounts expense before they actually become uncollectible, using a contra asset account known as allowance for doubtful accounts, and reports the net realizable value of accounts receivable on the balance sheet. 73) B

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Ending accounts receivable = Beginning accounts receivable of $0 + Revenue on account of $84,000 − Collections on account of $66,800 = $17,200 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $0 + Uncollectible accounts expense of ($84,000 × 1%) − Write-offs of $0 = $840 Net realizable value = Accounts receivable of $17,200 − Allowance for doubtful accounts of $840 = $16,360 74) A Ending accounts receivable = Beginning accounts receivable of $0 + Revenue on account of $160,000 − Collections on account of $128,000 = $32,000 Ending allowance for doubtful accounts = Beginning allowance for doubtful accounts of $0 + Uncollectible accounts expense of ($160,000 × 1%) − Write-offs of $0 = $1,600 Net realizable value = Accounts receivable of $32,000 − Allowance for doubtful accounts of $1,600 = $30,400 75) B Allowance for doubtful accounts is a contra asset account and decreases the net realizable value of receivables. In addition, the account is increased by an estimate of uncollectible accounts expense. 76) D The percent of receivables method to estimate uncollectible accounts expense is frequently called the balance sheet approach because it uses a percentage of one balance sheet account (accounts receivable) to estimate another balance sheet account (allowance for doubtful accounts). 77) A

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Two costs of extending credit to customers are uncollectible accounts expense and clerical costs such as background checks and maintaining customer records. Additionally, there is an implicit cost associated with extending credit because the company forgoes the opportunity to invest the amount the customer owes. 78) A When a company receives payment on a previously written-off account, it must first reinstate the written-off account. The reinstatement increases assets (accounts receivable) and decreases assets (by increasing the allowance for doubtful accounts, a contra asset account), with no net effect onany of the elements of the financial statements. Then, the company records collection of the receivable, which increases assets (cash) and decreases assets (accounts receivable), again with no net effect on total assets, total liabilities, or stockholders’ equity. The event is reported as a cash inflow from operating activities on the statement of cash flows. 79) B Uncollectible accounts expense = Credit sales of $112,500 × 3% = $3,375 The adjustment decreases assets (by increasing the allowance for doubtful accounts which decreases the net realizable value of the receivable) and decreases stockholders’ equity (retained earnings). It increases expenses (uncollectible accounts expense), which decreases net income. It does not affect the statement of cash flows. 80) A The write-off increases assets by decreasing the allowance for doubtful accounts and decreases assets (accounts receivable), resulting in no net effect on total assets, total liabilities, or stockholders’ equity. 81) A

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Reestablishing the receivable increases assets (accounts receivable) and decreases assets (increase to allowance for doubtful accounts), resulting in no net effect on total assets, total liabilities, or stockholders’ equity. 82) D This is an asset exchange transaction. Once the receivable is reestablished, the collection of the receivable is recorded as an increase to assets (Cash) and a decrease to assets (Accounts Receivable), resulting in no net effect on total assets, total liabilities, or stockholders' equity. There is no impact on the income statement. It is reported as a cash inflow from operating activities. 83) B This is an asset exchange transaction. The amount of the uncollectible account is removed from the asset accounts receivable and from the contra asset allowance for doubtful accounts. The net realizable value of receivables remains unchanged. There is no effect on total assets or stockholders’ equity. 84) C Under the direct write-off method, a company simply recognizes uncollectible accounts expense in the period in which it identifies and writes off uncollectible accounts. 85) A The direct write-off method is only allowed under GAAP if uncollectible accounts are not material. It fails to match revenues with expenses. Revenues are recognized in one period and any related uncollectible accounts expense is recognized in a later period. If the amount of uncollectible accounts is immaterial, companies accept the minor reporting inaccuracies as a reasonable trade-off for recording convenience/simplicity. The direct write-off method is not limited to banks.

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86) B Under the direct write-off method, the recognition of uncollectible accounts expense is an asset use transaction. The balance in the asset account, accounts receivable, decreases. The expense recognition causes net income and ultimately stockholders’ equity to decrease. Since the event did not affect cash, the statement of cash flows is not affected. 87) B The direct write-off method does not estimate the amount of uncollectible accounts expense nor does it use an allowance for uncollectible accounts. Instead, it shows the gross amount of accounts receivable instead of the net realizable value of receivables on the balance sheet. 88) D The same total amount of expense is recognized regardless of which method is employed. It is the timing of the expense recognition rather than the total amount of expense recognized that differs between the different methods. More specifically, the percent of revenue and percent of receivables methods estimate and recognize the expense before receivables are determined to be uncollectible. In contrast, the direct write-off method recognizes the expense when accounts are determined to be uncollectible. 89) B The direct write-off method fails to match revenues with expenses and overstates accounts receivable on the balance sheet. It is easier to use, however, and is permitted by generally accepted accounting principles if the amount of uncollectible accounts expense is immaterial. 90) A

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The direct write-off method is permitted by generally accepted accounting principles only if the amount of uncollectible accounts expense is immaterial. 91) A Both methods require writing off uncollectible accounts. The difference is the timing of when uncollectible accounts expense is recognized. 92) C Using the direct write-off method, assets (accounts receivable) and stockholders’ equity (retained earnings) decrease. 93) D Interest revenue = Principal × Annual interest rate × Time outstanding Year 1 (April through December): Interest revenue = $10,200 × 6% × 9/12 months = $459 Year 2 (January through March): Interest revenue = $10,200 × 6% × 3/12 months = $153 94) D Interest revenue = Principal × Annual interest rate × Time outstanding Year 1 (April through December): Interest revenue = $16,000 × 6% × 9/12 months = $720 Year 2 (January through March): Interest revenue = $16,000 × 6% × 3/12 months = $240 95) D The maker is the person responsible for making payment on the due date. The maker may also be called the borrower or debtor. 96) A The event is an asset exchange. One asset account (Cash) decreases and another asset (Notes Receivable) increases. Total assets are not affected. Since no interest has been earned, there is no impact on the income statement. The cash outflow is an investing activity. 97) D Version 1

The amount of interest earned is computed as follows: Total annual interest = $10,000 × 0.06 = $600 Monthly interest = $600 annual interest ÷ 12 months = $50 Interest earned in Year 1 = $50 per month × 8 months = $400 Eight months of interest was accrued in Year 1. The remaining 4 months is earned in Year 2. Interest earned in Year 2 = $50 per month × 4 months = $200 98) B The amount of interest earned is computed as follows: Total annual interest = $60,000 × 0.06 = $3,600 Monthly interest = $3,600 annual interest ÷ 12 months = $300 Interest earned in Year 1 = $300 per month × 3 months = $900 Recognizing the accrued interest revenue increases assets (Interest Receivable) and stockholders’ equity (Retained Earnings). On the income statement, revenue increases which increases net income. Accrued interest means that the company has earned the interest but has not yet collected cash. Since no cash was collected, the statement of cash flows is not affected. 99) D

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The amount of interest earned is computed as follows: Total annual interest = $60,000 × 0.06 = $3,600 Monthly interest = $3,600 annual interest ÷ 12 months = $300 Interest earned in Year 2 = $300 per month × 9 months = $2,700 Recognizing the accrued interest revenue increases assets (Interest Receivable) and stockholders’ equity (Retained Earnings). On the income statement, revenue increases which increases net income Accrued interest means that the company has earned the interest but has not yet collected cash. Since no cash was collected, the statement of cash flows is not affected. 100) C Among other effects, accrued interest revenue would cause assets to increase. Cash loaned to an employee would have caused a cash outflow. Cash borrowed from a bank would have caused assets (cash) to increase. Since none of these effects are not shown in the statements model, these answers cannot be correct. Therefore, the correct answer is “collected cash for the principal balance of a note receivable”. Collecting the principal balance of a note receivable causes one asset account (cash) to increase and another asset (notes receivable) to decrease. Total assets are not affected. This is an asset exchange transaction that does not affect the income statement. The cash inflow from the collection of the note receivable would be classified as an investing activity. 101) C

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The amount of interest earned is computed as follows: Total annual interest = $40,000 × 0.06 = $2,400 Monthly interest = $2,400 annual interest ÷ 12 months = $200 Interest earned in Year 1 = $200 per month × 5 months = $1,000 Since the total amount of interest will be collected on the maturity date in Year 2, the cash flow associated with interest revenue in Year 1 is zero. 102) D This is an asset exchange transaction. The amount of the uncollectible accounts is removed from the asset accounts receivable and from the contra asset allowance for doubtful accounts. The net realizable value of receivables and therefore total assets remains unchanged. 103) C The sale increases assets (accounts receivable) by $582, the net amount that will be collected from the credit card company, increases revenue by $600, and increases expenses (credit card expense) by $18 (3% of $600). Net income and stockholders’ equity both increase by $582. The statement of cash flows is not affected. 104) A This is an asset exchange transaction. Collecting the amount due ($582) from the credit card company increases assets (Cash) and decreases assets (Accounts Receivable), resulting in no net effect on total assets, total liabilities, or stockholders' equity. It is reported as a cash inflow from operating activities. 105) C The fees associated with credit card sales are a disadvantage, not an advantage, of accepting credit cards. 106) C

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The credit card sale increases total assets (Accounts Receivable) and increases stockholders' equity (Retained Earnings) by $9,700 [or $10,000 − ($10,000 × 3%)]. It increases revenue by $10,000, increases expenses (credit card expense) by $300 (or $10,000 × 3%), and increases net income by $9,700 (or $10,000 − $300). The statement of cash flows is not affected. 107) C The sale increases assets (Accounts Receivable) and stockholders' equity (Retained Earnings) by $432 [or ($450 − ($450 × 4%)]. It increases revenue by $450, increases expenses (credit card expense) by $18 (or $450 × 4%), and increases net income by $432 (or $450 − $18). The statement of cash flows is not affected. 108) D Collecting the amount due from the credit card company increases assets (cash) and decreases assets (accounts receivable − credit card company), resulting in no net effect on total assets, total liabilities, or stockholders’ equity. 109) C The fee charged by the credit card company is $40 ($1,000 × 0.04). The customer will ultimately pay the credit card company $1,000, and the credit card company will pay Zane $960 ($1,000 − $40). 110) D The sales revenue is $2,400. The credit card expense charged by the credit card company is $120 ($2,400 × 0.05). The customer will pay the credit card company $2,400 and the credit card company will pay Barron $2,280 ($2,400 − $120). Therefore, Barron’s assets (Cash) increase by $2,280. 111) A

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Dividing a company’s sales by its net accounts receivable tells how many times the net accounts receivable balance is “turned over” (converted into cash) each year. The higher the turnover, the shorter the collection period. 112) A Accounts receivable turnover ratio = Sales of $650,000 ÷ Net accounts receivable of ($70,000 − $4,000) = 9.85 Average number of days to collect accounts receivable = 365 ÷ Accounts receivable turnover ratio of 9.85 = 37 days 113) C The length of the operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable into cash. Accounts receivable turnover ratio = Sales of $1,100,000 ÷ Net accounts receivable of $90,000 = 12.22 Average number of days to collect accounts receivable = 365 ÷ 12.22 = 30 days Inventory turnover = $760,000 cost of goods sold ÷ $105,000 of inventory = 7.24 Average number of days to sell inventory = 365 days ÷ 7.24 = 50 days Operating cycle = Average number of days to collect accounts receivable of 30 days + Average number of days to sell inventory of 50 days = 80 days 114) B Operating cycle = Average number of days to collect receivables + Average number of days to sell inventory 115) D

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The length of the operating cycle is the average time it takes a business to convert inventory to accounts receivable plus the time it takes to convert accounts receivable into cash. The Christmas tree farm would most likely have the longest operating cycle because it takes longer to grow Christmas trees than it takes the three types of other businesses to obtain merchandise inventory. 116) C Increased sales would be a benefit (rather than a cost) of extending credit to customers. 117) A Accounts receivable turnover ratio = Sales ÷ Net accounts receivable 118) B Average number of days to collect accounts receivable = 365 ÷ Accounts receivable turnover ratio 119) D

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Accounts receivable turnover ratio = Sales ÷ Net accounts receivable Average number of days to collect accounts receivable = 365 ÷ Accounts receivable turnover ratio Harris: Accounts receivable turnover ratio = $300,000 ÷ $60,000 = 5 times Average number of days to collect accounts receivable = 365 ÷ 5 = 73 days Schubert: Accounts receivable turnover ratio = $180,000 ÷ $40,000 = 4.5 times Average number of days to collect accounts receivable = 365 ÷ 4.5 = 81.11 days The two costs of extending credit to customers include uncollectible accounts expense and recordkeeping costs. The longer it takes to collect accounts receivable, the greater the opportunity cost of lost income.Schubert takes longer to collect its receivables and, as a result, has a greater likelihood of lost income as a result of credit costs.

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CHAPTER 8: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Belvedere Company recognized $2,500 of depreciation expense on a delivery van. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA The Fisher Company paid $28,000 to improve the quality of a manufacturing machine. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA The Greer Company purchased equipment on account on January 1, Year 1. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

4) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Jenkins Company purchased equipment for $25,000. The equipment had an estimated useful life of four years and an estimated salvage value of $5,000. Jenkins uses the straight-line method. At the beginning of Year 3, the equipment was sold for $8,000. Show how the sale affected the financial statements for Year 3, assuming Jenkins uses straight-line depreciation. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

5) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, the Baker Company purchased an asset for $200,000. The asset had a $50,000 salvage value and a 10-year life. Baker uses the straight-line method. At the beginning of Year 3, the asset was sold for $174,000. Show how the sale will affect Baker's financial statements, assuming that Baker uses straight-line depreciation. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

6) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA An asset purchased for $24,000 with a $6,000 salvage value and a 5-year life has been depreciated using the straight-line method for two years. At the beginning of Year 3, the useful life of the asset was revised to 4 years with no change in salvage value. Show how the revision of depreciation expense in the third year of the asset's life will affect the financial statements in year 3 (compared to the financial statements if the revision in estimate had not been made). Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Benitez Company purchased an asset for $50,000. The asset has an estimated salvage value of zero and an 8-year useful life. On January 1, Year 3, the company spent $2,400 cash on routine repairs and maintenance. What effect will the Year 3 expenditure have on the company's financial statements? Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Boothe Company paid $9,000 to extend the useful life of one of its assets. How will this expenditure affect Boothe's financial statements? Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

9) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Gulfshore Oil Company recognized $2,000,000 of depletion expense related to an oil reserve. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

10) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Shelton Robotics Company amortized $30,400 of patent cost. How does this event affect Shelton's financial statements? Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

11) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA Baltimore Company acquired Chesapeake Company for $650,000 cash. Chesapeake's assets had been appraised at $660,000. At the time of sale, Chesapeake's accounting records showed total assets of $590,000, liabilities of $180,000 and stockholders' equity of $410,000. How would the purchase affect Baltimore's financial statements? Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

12) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On May 16, Year 5, Zinke Corporation recognized an impairment loss of $50,000 of goodwill. The goodwill was originally recorded two years earlier in connection with the acquisition of another company. Show how the impairment loss affected the financial statements in Year 5. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

13)

Statement of Cash Flows

Why is land not depreciated?

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14)

Give three examples of property, plant and equipment.

15)

Give an example of an intangible asset with an identifiable useful life.

16) Give (1) an example of a type of industry in which a company would invest in a relatively small amount of property, plant, and equipment, and (2) an example of a type of industry that requires a heavy investment in property, plant, and equipment.

17) Give examples of three types of common cost components of a building that is purchased.

18) What is meant by a "basket purchase"? What method is commonly used to determine the cost of individual assets?

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19) Which method of depreciation generally allocates the largest amount of depreciation to the first year of the asset's life?

20)

What type of account is Accumulated Depreciation?

21)

Explain how the gain or loss is computed on the sale of a piece of equipment.

22) What is the name of the provision in the tax code that requires one-half year's depreciation to be charged in the year in which an asset is acquired and one-half year's depreciation in the final year of depreciation?

23) If a business chooses to use the straight-line method for tax purposes rather than MACRS, how will this choice affect the amount of income taxes paid in the first year of an asset's life?

24) Assume that the estimate of an asset's useful life is changed at the beginning of Year 2. Explain the implications of revising that estimate on previous, current, and future calculations of deprecation and how depreciation using the straight-line method would be computed in Year 2.

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25)

What accounts are affected by a capital expenditure that extends the life of a plant asset?

26) What term is used to describe the process of allocating the cost of natural resources to expense?

27)

Describe what is meant by the term "goodwill."

28)

For what type of assets is the recognition of expense called "amortization"?

29) Explain the meaning of the terms "tangible" and "intangible" and discuss how these terms are used in describing assets.

30) Explain how impairment losses for intangible assets with indefinite useful lives are determined.

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31)

Explain why goodwill is not amortized and what is required as a result.

32) Why do some say that the GAAP treatment of research and development puts the US at a competitive disadvantage compared to businesses in other countries?

33) Assume that two companies are in similar circumstances except for their choice of depreciation methods. Explain how the amounts of depreciation expense reported on the income statement of the company that uses the straight-line method will differ from the amounts reported by the company that uses the double-declining-balance method.

34) On January 1, Year 1, Jefferson Manufacturing Company purchased equipment for $212,000. Jefferson paid $4,000 to have the machine installed. The equipment is expected to have a 5-year useful life and a salvage value of $26,000. Required: 1.a) At what dollar amount should this equipment be recorded in Jefferson's accounting records? 2.b) Compute depreciation expense for Year 1 and Year 2 using the straight-line method. 3.c) What is the book value at the beginning of Year 3? 4.d) Assume the equipment was sold on January 1, Year 3, for $135,000. Compute the amount of gain or loss from the sale.

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ESSAY. Write your answer in the space provided or on a separate sheet of paper. 35) Indicate whether each of the following statements is true or false. 1.a) Plant assets are classified as long-term assets, while intangible assets are treated as current assets. 2.b) Intangible assets include patents, copyrights, and natural resources. 3.c) Intangible assets with indefinite useful lives will be not be amortized. 4.d) The cost of land should be depleted over its useful life. 5.e) The cost of a natural resource should be expensed (depleted) over its useful life.

36) Indicate whether each of the following statements is true or false. 1.a) Long-term assets having no physical substance are called intangible assets. 2.b) Trademarks are examples of an intangible asset. 3.c) Natural resources are examples of tangible long-term assets. 4.d) Land is never classified as a component of property, plant, and equipment. 5.e) Goodwill is classified as Property, Plant and Equipment.

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37) Indicate whether each of the following statements is true or false. 1.a) Sales taxes paid on the purchase of equipment would be expensed in the year of the purchase. 2.b) Real estate fees and attorney's fees related to the purchase of a building would be added to the cost of the building. 3.c) Payment of a fine for improper burning of a demolished building would be added to the land account. 4.d) Delivery charges on equipment would be expensed in the year of the purchase. 5.e) The matching concept requires that plant assets be recorded at the amount paid for the assets.

38) On January 1, Year 1, Warren Company purchased a machine for $120,000. Warren estimated the useful life of the machine to be 10 years and the salvage value to be $20,000. Indicate whether each of the following statements is true or false. 1.a) Depreciation expense for Year 1 under the straight-line method would be $12,000. 2.b) Depreciation expense for Year 1 under the double declining method would be $24,000. 3.c) The accumulated depreciation at the end of Year 2 under the straight-line method would be $20,000. 4.d) The accumulated depreciation at the end of Year 2 under the double declining method would be $48,000. 5.e) The book value of the machine under both the double declining method and the straightline method at the end of 10 years would be $20,000.

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39) Indicate whether each of the following statements regarding accounting for long-term assets is true or false. 1.a) Other things being equal, the lower a company estimates the salvage value of a plant asset to be, the higher the company's net income will be. 2.b) Depreciation expense is an example of a "non-cash" expense. 3.c) For tax purposes, the most desirable depreciation method is the one that produces the lowest amount of depreciation expense. 4.d) The book value of an asset is the amount a company believes it is worth (its fair value) as of the date of the balance sheet. 5.e) A company that uses the straight-line method for financial statement reporting and MACRS for tax reporting will show a deferred tax liability in an asset’s early life.

40) Indicate whether each of the following statements is true or false. 1.a) Straight-line depreciation is the most widely used method in the U.S. 2.b) An accelerated depreciation method provides a lower depreciation charge in the early years of an asset's life cycle than does the straight-line method. 3.c) The units-of-production method allocates the cost of a plant asset in proportion to the asset's usage. 4.d) Total depreciation expense recognized over the asset's life is not affected by the choice of depreciation methods. 5.e) Recording depreciation expense affects the income statement and the statement of cash flows but neither the balance sheet nor the statement of changes in stockholders' equity.

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41) Schubert Company owned equipment that originally cost $48,000. On January 1, Year 6, the company sold the equipment for $16,000 cash. Accumulated depreciation on the day of sale amounted to $34,000. Based on this information, indicate whether each of the following statements is true or false. 1.a) The sale will increase Schubert’s net income, but it will not affect the company's operating income. 2.b) Schubert would show a $16,000 cash inflow in the operating activities section of the cash flow statement. 3.c) The sale would result in a decrease in total assets. 4.d) The sale would increase Schubert’s stockholders' equity by $2,000. 5.e) The sale would increase cash by $16,000, increase gain on sale of equipment by $2,000, and decrease equipment by $14,000.

42) Rupert Company purchased a delivery van on January 1, Year 1 for $45,000. Rupert uses the straight-line method for the asset, which has a five-year estimated useful life and a salvage value estimated at $9,000. On January 1, Year 3, the asset was sold for $33,300 cash. Indicate whether each of the following items related to Rupert Company is true or false. 1.a) Annual depreciation for Rupert’s equipment was $9,000. 2.b) Accumulated depreciation at end of Year 2 was $14,400. 3.c) Book value at end of Year 2 was $30,600. 4.d) On the date of the sale, Rupert will record a loss of $2,400. 5.e) A gain or loss on the sale of a plant asset is reported on the balance sheet.

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43) Indicate whether each of the following statements is true or false. 1.a) MACRS is an accelerated depreciation method commonly used for tax purposes. 2.b) The half-year convention is a semiannual meeting of accountants and educators. 3.c) MACRS requires that the taxpayer estimate the salvage value of assets. 4.d) The use of MACRS provides tax benefits in the early years of an asset's life, compared to use of the straight-line method. 5.e) Most companies use the same depreciation method for both financial reporting and tax reporting.

44) Indicate whether each of the following statements is true or false. 1.a) A trademark has an identifiable legal lifetime. 2.b) U.S. GAAP requires that research and development costs be capitalized as assets and then expensed over a reasonable period of time. 3.c) A patent is amortized over the longer of its legal or useful life. 4.d) Recording the amortization of a patent includes increasing Amortization Expense and decreasing the Patent account. 5.e) The capitalized cost of a trademark includes the cost to develop the trademark and to defend it.

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45) Indicate whether each of the following statements is true or false. 1.a) Plant assets are classified as long-term assets, while intangible assets are treated as current assets. 2.b) Intangible assets include patents, copyrights, and natural resources. 3.c) Intangible assets with indefinite useful lives will be not be amortized. 4.d) The cost of land should be depleted over its useful life. 5.

46) Indicate whether each of the following statements is true or false. 1.a) A patent with a useful life of 5 years and a legal life of 10 years is amortized over 5 years. 2.b) Intangible assets with indefinite useful lives must be tested each year for impairment. 3.c) If it is determined that the original value recorded for goodwill is too high, then the income statement account, impairment loss, will be increased. 4.d) To recognize an impairment loss on goodwill, Amortization Expense will be increased, and the Goodwill account will be decreased. 5.e) The recognition of an impairment loss involves a cash outflow classified as a financing activity.

47) On May 4, Year 1, Steger Company purchased a tract of land as a factory site for $1,600,000. An existing building on the property was demolished, and construction was begun on a new factory building in July Year 1 and completed December 15, Year 1. Cost data are shown below. New building Cost of demolishing old building Proceeds from sale of salvaged materials from old

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$ 7,500,000 137,500 22,000

building Architect's fees Title insurance and attorney's fee for purchase of land

225,000 82,500

Required: 1.1) What is the capitalized cost of the land? 2.2) What is the capitalized cost of the factory building?

48) Pioneer Corporation purchased for $450,000 land and a building that will be used in farming operations. The appraised value of the land is $100,000 and the appraised value of the building is $400,000. Required: 1.1) What amount of the purchase price will be allocated to the land? 2.2) What amount of the purchase price will be allocated to the building?

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49) On January 1, Year 1, Golden Company purchased a new computer system for $50,000. Management estimates that the system will have a 5-year life and a salvage value of $7,500. Jane Golden, the company president, knows that the system can be depreciated using either the straight-line method or the double-declining-balance method. She is concerned as to the possible effect on various financial statement analyses if the company uses one method versus the other. Required: 1.a) Indicate which method will have the larger negative effect (in other words, the less favorable effect) on each of the following ratios in Year 1: 1.(1) Debt-to-equity ratio 2.(2) Return-on-sales 1.b) Indicate which method will have the larger negative effect on each of the following ratios in Year 4: 1.(1) Debt-to-equity ratio 2.(2) Return-on-sales

50) On January 1, Year 1, Scott Company purchased a new machine for $220,000. The machine is expected to have an eight-year life and a $20,000 salvage value. The machine is expected to produce 800,000 finished products during its eight-year life. Production during Year 1 was 70,000 units and during Year 2 was 110,000 units. Required: Determine the amount of depreciation expense to be recorded on the machine for Year 1 and Year 2, respectively, using each of the following methods: 1.1) Straight-line 2.2) Units-of-production 3.3) Double-declining-balance

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51) On January 1, Year 1, Phoenix Corporation purchased a delivery truck for $45,000. The estimated useful life of the truck is 5 years, with an estimated salvage value of $9,000. The truck is expected to be driven 200,000 miles during its useful life. Required: 1.a) Phoenix uses double-declining-balance depreciation. 1.(1) What is the amount of depreciation for Year 1? 2.(2) What is the balance of the accumulated depreciation account at the end of Year 2? 1.b) Refer to part a. Assume Phoenix used double-declining-balance depreciation and sold the truck at the beginning of Year 3 for $18,000. What is the amount of the gain or loss on the sale of the delivery van? 2.c) Assume that Phoenix used the units-of-production method instead. The delivery van was driven 50,000 miles the first year and 40,000 miles the second year. 1.(1) What is the amount of depreciation expense for Year 1? 2.(2) What is the amount of depreciation expense for Year 2? 3.(3) What is the book value of the van at the end of Year 2?

52) On January 1, Year 1, Sheffield Corporation purchased equipment for $100,000. Sheffield used the straight-line method of depreciation with a $12,000 salvage value and a useful life of 5-years. On January 1, Year 3, Sheffield sold this equipment for $70,000. Required: a) Calculate the gain or loss Sheffield should recognize from this sale.

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53) On January 1, Year 1, Rainey Company purchased a machine that cost $150,000. The equipment is estimated to have a 5-year life and a salvage value of $30,000. Required: 1.a) Compute the amount of depreciation expense using the double-decliningbalance method for: 1.(1) Year 1 2.(2) Year 2 1.b) Compute the amount of MACRS depreciation for the above equipment for Year 1 assuming the property is 5-year property and the MACRS percentage is 20%.

54) On July 1, Year 1, Glover Corporation purchased $80,000 of equipment. The equipment is expected to be used in the business for five years and has an estimated salvage value of $11,000. Partial MACRS tables are listed below: Year 1 2 3 4

5-Year, % 20.00 32.00 19.20 11.52

7-Year, % 14.29 24.49 17.49 12.49

Required: 1.a) Compute the amount of depreciation that is deductible under MACRS for Year 1 and Year 2 if the equipment is classified as 5-year property. 2.b) Compute the amount of depreciation that is deductible under MACRS for Year 1 and Year 2 if the equipment is classified as 7-year property.

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55) On January 1, Year 1, Stewart Corporation purchased equipment with a list price of $120,000. A discount of 2% was granted on the equipment; the shipping terms were FOB shipping point, and the transportation cost was $3,000. Installation and testing costs amounted to $4,000. The equipment had an estimated useful life of 4 years and salvage value of $10,000. At the beginning of Year 3, Stewart revised the expected life of the asset to six years and the salvage value to $12,000. Required: Compute the depreciation expense using straight-line method for each of the six years and in total.

56) On January 1, Year 3, Dartmouth Corporation paid $18,000 for major improvements on a two-year-old manufacturing machine. Although the expenditure did not change the expected useful life, it greatly increased the productivity of the machine. Prior to this transaction, the machine account in the general ledger was listed at $84,000, and the accumulated depreciation account was $20,000. Dartmouth uses the straight-line method. The estimated useful life was six years, and the estimated salvage value was $4,000. Required: 1.a) Immediately after the January 1, Year 3 transaction, what is the book value of the asset on Dartmouth books? 2.b) Compute the depreciation for the machine for Year 3.

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57) Mays Corporation purchased a new truck on January 1, Year 1 for $65,000 cash. The salvage value was estimated to be $10,000 at the end of the useful life of 5 years. On January 1, Year 3, Mays had to replace the engine of the truck paying $4,000 cash. At that time, Mays estimates that the truck will continue a productive life for another four years. The company uses the straight-line method. Required: a) Calculate the depreciation expense for Year 3.

58) Alaska Energy Corporation paid cash to acquire land to be used for oil production. The costs incurred by Alaska Energy were the following Exploration of proposed land Geologic surveys of land Estimated oil reserves Cost to purchase land

$ 150,000 250,000 870,000 6,500,000

The company estimated that 3,885,000 gallons of crude oil could be extracted from the site over the life of the asset. The company was able to extract 230,000 gallons in Year 1, 675,000 gallons in Year 2, and 554,000 gallons in Year 3. Required: 1.a) Calculate the depletion charge for: 1.(1) Year 1 2.(2) Year 2 3.(3) Year 3

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59) In Year 1, West Virginia Mining Company purchased a coal mine that contained an estimated 1,200,000 tons of coal, of which 1,000,000 tons can be profitably extracted, for a cash price of $58,500,000. The company mined 50,000 tons of coal in Year 1. Required: 1.a) What is the amount of depletion to be recorded per ton of coal? 2.b) What is the amount of depletion expense for Year 1?

60) In Year 1, Hinkle Corporation Company acquired a patent from a competitor for $275,000. At the time of purchase, it had 12 years of its legal life remaining; however, due to competition, Hinkle believes that the patent will only be useful for 8 years. Required: Calculate the amortization expense for Year 1.

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Answer Key Test name: Chap 08_2e_Problem Materials 1) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

Recognizing depreciation expense decreases assets (book value of asset because it increases accumulated depreciation, a contra asset account) and stockholders' equity (retained earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows. 2) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I/D NA NA NA NA NA

Statement of Cash Flows D

Paying cash to improve the quality of a machine decreases one asset (cash) and increases another asset (equipment), resulting in no net effect on total assets. It does not affect liabilities or stockholders' equity. There is no impact on the income statement. It is reported as a cash outflow from investing activities on the statement of cash flows. 3) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

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Statement of Cash Flows NA

Purchasing equipment on account increases assets (equipment) and increases liabilities (accounts payable). It does not affect stockholders' equity, the income statement or the statement of cash flows. 4) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows I

Annual depreciation expense = (Cost of $25,000 - Salvage value of $5,000) ÷ 4 years = $5,000 Accumulated depreciation at beginning of Year 3 = $5,000 per year × 2 years = $10,000 Book value at beginning of Year 3 = Cost of $25,000 − Accumulated depreciation of $10,000 = $15,000 Loss on sale = Book value of $15,000 − Proceeds of $8,000 = $7,000 The sale at a loss increases assets (cash) by $8,000, decreases assets (book value of equipment) by $25,000, increases assets (accumulated depreciation) by $10,000, and decreases stockholders' equity (retained earnings) by $7,000. It increases expenses (loss on sale of equipment) by $7,000, which decreases net income. The amount received of $8,000 is reported as a cash inflow from investing activities on the statement of cash flows. 5) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I NA I

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Statement of Cash Flows I

Annual depreciation expense = (Cost of $200,000 − Salvage value of $50,000) ÷ 10 years = $15,000 Accumulated depreciation at beginning of Year 3 = $15,000 per year × 2 years = $30,000 Book value at beginning of Year 3 = Cost of $200,000 − Accumulated depreciation of $30,000 = $170,000 Gain on sale = Proceeds of $174,000 − Book value of $170,000 = $4,000 The sale at a gain increases assets (cash) by $174,000, decreases assets (book value of equipment) by $200,000, increases assets (accumulated depreciation) by $30,000, and increases stockholders' equity (retained earnings) by $4,000. It increases revenues (gain on sale of equipment) by $4,000, which increases net income. The amount received of $174,000 is reported as a cash inflow from investing activities on the statement of cash flows. 6) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

Shortening the estimated useful life to two remaining years, compared to three, will increase depreciation expense. The increase in depreciation expense decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders' equity (retained earnings). It increases expenses (depreciation expense), which decreases net income. The revision does not affect the statement of cash flows. 7) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

Expenditures for routine repairs and maintenance are expensed when incurred and do not affect the asset or its depreciation. The routine repair and maintenance will decrease assets (cash) and stockholders' equity (retained earnings). It will increase expenses (repair and maintenance expense) and decrease net income. It will be reported as a cash outflow from operating activities on the statement of cash flows. 8) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I/D NA NA NA NA NA

Statement of Cash Flows D

An expenditure that extends an asset's useful life decreases assets (cash) and increases assets (by decreasing accumulated depreciation, a contra asset account), resulting in no net effect on total assets. The expenditure is reported as a cash outflow from investing activities on the statement of cash flows. 9) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

Recognizing depletion expense decreases assets (oil reserve) and stockholders' equity (retained earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows. 10) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

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Statement of Cash Flows NA

Amortizing the cost of an intangible asset decreases assets (patent) and stockholders' equity (retained earnings). It increases expenses (amortization expense), which decreases net income. It does not affect the statement of cash flows. 11) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows D

Goodwill = Acquisition price of $650,000 - Fair value of Chesapeake's net assets of $480,000 (or appraised value of assets of $660,000 − liabilities of $180,000) = $170,000 The purchase will decrease assets (cash) by $650,000, increase assets (various purchased assets) by $660,000, increase assets (goodwill) by $170,000, resulting in a net increase in assets of $180,000. It will also increase liabilities (various liabilities assumed) by $180,000. The cash paid of $650,000 will be reported as a cash outflow from investing activities on the statement of cash flows. 12) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

Impairment of goodwill decreases assets (goodwill) and stockholders' equity (retained earnings). It increases expenses (impairment loss), which decreases net income. It does not affect the statement of cash flows. 13) While land is normally classified as a component of property, plant, and equipment, it is not subject to depreciation. Land has an infinite life. It is not worn out or consumed as it is used. Version 1

14) Answers will vary (only three examples are required). Examples of property, plant, and equipment include, but are not necessarily limited to, furniture, cash registers, machinery, delivery trucks, computers, mechanical robots, buildings, or office equipment. Note that one company may include all office equipment in one account, whereas another company might divide office equipment into computers, desks, chairs, and so on. Land is normally classified as a component of property, plant, and equipment but it is not subject to depreciation. 15) Answers will vary (only one example is required). Intangible assets with identifiable useful lives include patents and copyrights. 16) Answers will vary. (1) Stock brokerage firms and insurance companies are examples of firms that invest in relatively small amounts of property, plant, and equipment. (2) Electric utility companies and automobile manufacturing companies are examples of firms that require heavy investment in property, plant, and equipment. Businesses in certain industries tend to rely on more property, plant, and equipment; businesses in other industries rely on more human capital. 17) Answers will vary (only three examples are required). Costs of newly purchased buildings include the purchase price, sales taxes, title search and transfer documents, realtor's fees, attorney's fees, and remodeling costs.

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18) A basket purchase is the acquisition of a group of assets in a single transaction. The total price of a basket purchase must be allocated among the assets acquired. Accountants commonly allocate the purchase price using the relative market value method. 19) Double-declining-balance Double-declining-balance, an accelerated method, produces more depreciation expense in the early years of an asset's life, with a declining amount of expense in later years. 20) The Accumulated Depreciation account is a contra asset account. 21) The gain or loss on the sale of an asset is normally computed by comparing the proceeds from the sale (or sales price) of the asset to the asset's book value. Book value = Cost − Accumulated deprecation 22) Half-year convention The half-year convention is designed to simplify computing taxable income. Instead of requiring taxpayers to calculate depreciation from the exact date of purchase to the exact date of disposal, the tax code requires one-half year's depreciation to be charged in the year in which an asset is acquired and one-half year's depreciation in the final year of depreciation.

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23) A company choosing the straight-line method will pay more taxes in the early years and less taxes in later years than a company choosing MACRS, depending on the useful life of the asset. A company choosing MACRS would reduce taxes in the early years of an asset's life because it would report higher depreciation charges on the tax return than in the financial statements. In later years, however, taxes will be higher because, under MACRS, the amount of depreciation declines as the asset becomes older. Taxes are delayed but not avoided. 24) Because revisions of such estimates are common, generally accepted accounting principles call for incorporating the revised information into present and future calculations. Prior reports are not corrected (or changed). Year 2 Depreciation charge = [Book value as of beginning of Year 2 − Estimated salvage value] ÷ Remaining useful life 25) Accumulated Depreciation If a capital expenditure extends the life of an asset rather than improving the asset's quality of service, accountants view the expenditure as canceling some of the depreciation previously charged to expense. The event is still an asset exchange; cash decreases, and the book value of the machine increases. However, the increase in the book value of the machine results from reducing the balance in the contra asset account, Accumulated Depreciation. 26) Depletion The term used to recognize expense for natural resources is depletion.

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27) Goodwill is the added value of a successful business that is attributable to factors such as reputation, location, and superior products. Goodwill enables a business to earn above-average profits. In other words, goodwill is the excess paid for an existing business over the appraised value of the net assets. 28) Intangible assets The costs of intangible assets with identifiable useful lives are normally expensed on a straight-line basis using a process called amortization. 29) Answers will vary. Tangible assets have a physical presence; they can be seen and touched. In contrast, intangible assets have no physical form. Although they may be represented by physical documents, intangible assets are, in fact, rights or privileges. They cannot be seen or touched. Tangible assets include land, natural resources, and buildings. Intangible assets include copyrights, patents, and goodwill. 30) Intangible assets with indefinite useful lives must be tested for impairment annually. The impairment test consists of comparing the fair value of the intangible asset to its carrying value (book value). If the fair value is less than the book value, an impairment loss must be recognized. 31) The costs of intangible assets with identifiable useful lives are normally expensed on a straight-line basis using a process called amortization. Goodwill is not amortized because it has an indefinite useful life. Intangible assets with indefinite useful lives must be tested for impairment annually.

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32) For many years, some thought the companies that followed U.S. GAAP were at a disadvantage when it came to research and development (R&D) costs, because these companies had to immediately expense such costs, while the accounting rules of some other countries allowed R&D costs to be capitalized. Recording costs as an asset– capitalizing it–means that net income is not immediately reduced. The global movement toward using IFRS is reducing, but not eliminating, the different accounting treatments for R&D. 33) During the early years of the asset's life, the straight-line method will report lower depreciation expense (and higher net income) than the double-declining-balance method. During the later years of the asset's life, the straight-line method will report higher depreciation expense (and lower net income) than the double-declining-balance method. 34) 1.a) $216,000 2.b) $38,000 3.c) $140,000 4.d) $5,000 Loss 1.a) Cost = $212,000 + $4,000 = $216,000 2.b) Annual deprecation = (Cost of $216,000 − Salvage value of $26,000) ÷ 5 years = $38,000 3.c) Book value at end of Year 2 = $216,000 − ($38,000 per year × 2 years) = $140,000 4.d) Gain (loss) = Proceeds from sale of $135,000 − Book value of $140,000 = ($5,000)

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35) a) F b) F c) T d) F e) T 1.a) This is false. Intangible assets are long-term assets. 2.b) This is false. Natural resources are not intangible assets. 3.c) This is true. Only intangible assets that have identifiable lives would be amortized. 4.d) This is false. Land is not depleted or expensed in any way. 5.e) This is true. Natural resources are depleted in order to match their expense with the revenue they produce. 36) a) T b) T c) T d) F e) F 1.a) This is true. Intangible assets derive their value from rights and privileges. 2.b) This is true. 3.c) This is true. Natural resources are tangible assets. 4.d) This is false. Land is normally classified as a component of property, plant, and equipment but is not subject to depreciation. 5.e) This is false. Goodwill is an intangible asset because it does not have physical substance.

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37) a) F b) T c) F d) F e) F 1.a) This is false. Sales tax is included in the cost of the asset purchased. 2.b) This is true. The cost of a building includes any one-time fee related to the purchase. 3.c) This is false. The fine would be expensed because it was not necessary to use the land. It was because of the company's own negligence. 4.d) This is false. The delivery charges are a necessary cost to obtain the equipment and prepare it for its initial use, so they would be added to the cost of the equipment. 5.e) This is false. That is a description of the historic cost concept. 38) a) F b) T c) T d) F e) T 1.a) This is false. Annual depreciation expense = ($120,000 − $20,000) ÷ 10 years = $10,000 2.b) This is true. Year 1 Depreciation expense = $120,000 × (2 × 10%) = $24,000 3.c) This is true. Accumulated depreciation at the end of Year 2 = $10,000 annual depreciation × 2 years = $20,000 4.d) This is false. Year 1 Depreciation expense = $120,000 × (2 × 10%) = $24,000; Year 2 Depreciation expense = ($120,000 − $24,000) × (2 × 10%) = $19,200; Accumulated depreciation at end of Year 2 = $24,000 + $19,200 = $43,200 5.e) This is true. Regardless of depreciation method, the book value of an asset will be equal to its salvage value at the end of its useful life.

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39) a) F b) T c) F d) F e) T 1.a) This is false. A lower salvage value will produce greater depreciation expense, and lower, not higher, net income. 2.b) This is true. Depreciation does not affect cash. 3.c) This is false. For tax purposes, greater depreciation expense produces lower income tax expense. 4.d) This is false. The book value of an asset is equal to the asset's historic cost minus its accumulated depreciation. 5.e) This is true. Using the MACRS depreciation method delays taxes, resulting in a deferred tax liability. 40) a) T b) F c) T d) T e) F 1.a) This is true. Most U.S. companies use the straight-line method for financial reporting. 2.b) This is false. An accelerated depreciation method provides a greater depreciation charge in an asset's early years of useful life than does straight-line. 3.c) This is true. Using the units-of-production method ties depreciation expense to use or output of an asset. 4.d) This is true. All depreciation methods produce the same total depreciation expense over an asset's useful life. 5.e) This is false. Recording depreciation expense affects the income statement and the balance sheet but does not affect the statement of cash flows.

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41) a) T b) F c) F d) T e) F 1.a) This is true. The $2,000 gain on the sale is reported on the income statement below operating income. 2.b) This is false. The $16,000 cash inflow is reported as an investing activity, not an operating activity. 3.c) This is false. The sale will result in an increase in total assets because the cash received is greater than the book value of the asset. 4.d) This is true. The $2,000 gain on the sale will increase retained earnings. 5.e) This is false. The sale would increase cash by $16,000, increase gain on sale of equipment by $2,000, decrease accumulated depreciation for $34,000, and decrease equipment by $48,000. 42) a) F b) T c) T d) F e) F 1.a) This is false. Annual depreciation = ($45,000 − $9,000 salvage) ÷ 5 years = $7,200 2.b) This is true. Accumulated depreciation at end of Year 2 = 2 years × $7,200 annual depreciation = $14,400 3.c) This is true. Book value at end of Year 2 = Cost of $45,000 cost − Accumulated depreciation of $14,400 = $30,600 4.d) This is false. Proceeds from sale of $33,300 price − Book value of $30,600 = Gain on sale of $2,700 5.e) This is false. Gains and losses are reported on the income statement (rather than on the balance sheet).

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43) a) T b) F c) F d) T e) F 1.a) This is true. MACRS is the accelerated depreciation method most companies use for income tax purposes. 2.b) This is false. The half-year convention refers to the practice of calculating depreciation in the asset's first year as if it had been purchased at mid-year, regardless of when the purchase was actually made. 3.c) This is false. Salvage values are not used in MACRS depreciation. 4.d) This is true. MACRS is an accelerated depreciation method that assigns greater depreciation expense in an asset's early life, resulting in lower income tax expense. 5.e) This is false. Most U.S. companies use the straight-line method for financial reporting and MACRS depreciation for tax reporting. 44) a) F b) F c) F d) T e) T 1.a) This is false. A trademark can be used indefinitely as long as the company that owns the trademark renews its registration. 2.b) This is false. U.S. companies must expense research and development costs. 3.c) This is false. A patent is amortized of the shorter, not longer, of its legal or useful life. 4.d) This is true. Typically, companies do not use a contra-asset account similar to accumulated depreciation to record amortization. Instead, the Patent account is decreased by the amount of amortization. 5.e) This is true. Development of a trademark is capitalized, as well as continuing expenditures related to defending the trademark against infringement.

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45) a) F b) F c) T d) T e) F 1.a) This is false. The transaction will increase assets by $730,000 (the fair value of the assets on Ernie's books plus the goodwill). 2.b) This is false. Liabilities will increase on Ernie's books by their carrying amount from Bert's books. 3.c) This is true. Goodwill = Price paid of $480,000 + Liabilities assumed of $250,000 − Fair value of assets acquired of $630,000 = $100,000 4.d) This is true. Goodwill is an intangible asset that does not have an identifiable life. 5.e) This is false. Goodwill is not amortized but is tested annually for impairment. 46) a) T b) T c) T d) F e) F 1.a) This is true. Intangible assets, such as patents, with identifiable lives are amortized over the shorter of their legal or useful lives. 2.b) This is true. If an intangible asset does not have an identifiable useful life, such as a trademark or goodwill, it is not amortized, but it is tested for impairment each year. 3.c) This is true. The income statement account Impairment Loss is increased if it is determined that the original value recorded for goodwill is too high. 4.d) This is false. The Impairment Loss account is increased, not Amortization Expense. 5.e) This is false. An impairment loss does not affect cash flows.

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47) 1) $1,798,000 2) $7,725,000 The cost of the building is limited to the actual construction and architect's costs of the building. All costs related to obtaining the land and preparing the land for construction, net of proceeds from the salvaged materials, are capitalized as the cost of the land. Land $ 1,600,000 137,500 (22,000) 82,500 $ 1,798,000

Building $ 7,500,000 225,000 — — $ 7,725,000

48) 1.1) $90,000 2.2) $360,000 Appraised value Land Building Total

$ 100,000 400,000 $ 500,000

% 20% 80% 100%

Allocation: Land $450,000 × 20% = $90,000 Building $450,000 × 80% = $360,000

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49) 1.a) 1.(1) Double-declining balance method 2.(2) Double-declining balance method 1.b) 1.(1) Straight-line method 2.(2) Straight-line method Double-declining-balance depreciation recognizes greater depreciation expense in an asset's early life and less expense in later years. That means that in Year 1, double-declining depreciation will result in lower stockholders' equity, thus a higher (less favorable) debt-to-equity ratio and lower (less favorable) return on sales. This will reverse itself in Year 4. 50) 1.1) $25,000 and $25,000 2.2) $17,500 and $27,500 3.3) $55,000 and $41,250 Year 1 Straight-line Units-of-production Units-of-production Double-decliningbalance Double-decliningbalance

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Year 2

($220,000 − $20,000)/8 years ($220,000 − $20,000)/800,000 × 70,000 ($220,000 − $20,000)/800,000 × 110,000 $220,000 × (2 × 12.5%)

$ 25,000 $ 25,000 17,500

($220,000 − $55,000) × (2 × 12.5%)

41,250

27,500 55,000

51) 1.a) 1.(1) $18,000 2.(2) $28,800 1.b) $1,800 gain 2.c) 1.(1) $9,000 2.(2) $7,200 3.(3) $28,800 1.a) 1.(1) Double-declining-balance rate = (1 ÷ 5) × 2 = 40% Year 1 depreciation expense = Book value at beginning of year of $45,000 × 40% = $18,000 2.(2) Book value at end of Year 1 = Cost of $45,000 − Accumulated depreciation of $18,000 = $27,000 Year 2 depreciation expense = Book value at beginning of year of $27,000 × 40% = $10,800 Accumulated Depreciation at end of Year 2 = $18,000 + $10,800 = $28,800 1.b) Gain on sale = Proceeds of $18,000 − Book value at end of Year 2 of $16,200 ($45,000 − $28,800) = $1,800 2.c) 1.(1) Depreciation expense = [(Cost of $45,000 − Salvage value of $9,000) ÷ Estimate of 200,000 miles × Miles driven of 50,000 = $9,000 2.(2) Year 2 Depreciation expense = [(Cost of $45,000 − Salvage value of $9,000) ÷ Estimate of 200,000 miles × Miles driven of 40,000 = $7,200 3.(3) Book value at the end of Year 2 = Cost of $45,000 − Accumulated depreciation of ($9,000 + $7,200) = $28,800

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52) a) $5,200 Gain a) Annual depreciation = (Cost of $100,000 − Salvage value of $12,000) ÷ 5 years = $17,600 Book value at January 1, Year 3 = Cost of $100,000 − Accumulated depreciation of ($17,600 per year × 2 years) = $64,800 Gain on sale = Proceeds from sale of $70,000 − Book value of $64,800 = $5,200 53) 1.a) 1.(1) $60,000 2.(2) $36,000 1.b) $30,000 1.a) Double-declining-balance rate = (1 ÷ 5) × 2 = 40% 1.(1) Depreciation for Year 1 = Book value at beginning of year of $150,000 40% = $60,000 2.(2) Depreciation for Year 2 = Book value of ($150,000 − $60,000) 40% = $36,000 1.b) Depreciation = Cost of $150,000 × 20% = $30,000

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54) 1.a) 1.(1) $16,000 2.(2) $25,600 1.b) 1.(1) $11,432 2.(2) $19,592 1.a) Five-Year Property: 1.(1) Year 1: Cost of 80,000 20% = $16,000 2.(2) Year 2: Cost of $80,000 32% = $25,600 1.b) Seven-Year Property: 1.(1) Year 1: Cost of $80,000 14.29% = $11,432 2.(2) Year 2: Cost of $80,000 24.49% = $19,592 55) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

$ 28,650 28,650 13,825 13,825 13,825 13,825 $ 112,600

Cost = List price of $120,000 - Discount of ($120,000 × 2%) + Transportation costs of $3,000 + Installation costs of $4,000 = $124,600 Years 1 and 2: Annual depreciation = (Cost of $124,600 − Salvage of $10,000) ÷ 4 years = $28,650 per year Book value at end of Year 2 = Cost of $124,600 − Accumulated depreciation of (28,650 per year × 2 years) = $67,300 Years 3, 4, 5, and 6: Annual depreciation = (Book value of $67,300 − Revised salvage value of $12,000) ÷ Remaining years of 4 = $13,825 per year Version 1

56) 1.a) 82,000 2.b) $19,500 1.a) Book value = Cost of $84,000 − Accumulated depreciation of $20,000 + Capital expenditure of $18,000 = $82,000 2.b) Year 3 Depreciation = (Book value of $82,000 − Estimated salvage value of $4,000) ÷ 4 years = $19,500 57) a) $9,250 a) Original cost

$ 65,000

Less: Accumulated depreciation

(22,000)

Book value on 1/1/2018

43,000

Add: Cost of engine

4,000 47,000

Less: Salvage value

(10,000) 37,000

Divided by remaining useful life

4 years $ 9,250

58) 1.a) 1.(1) $460,000 2.(2) $1,350,000 3.(3) $1,108,000 1.a) 2. Exploration of proposed land Geologic surveys of land Estimated oil reserves Cost to purchase land Total cost

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$ 150,000 250,000 870,000 6,500,000 $ 7,770,000 45

3. Depletion rate = $7,770,000 ÷ 3,885,000 gallons = $2.00 per gallon 1.(1) Year 1 Depletion expense: 230,000 gallons × $2.00 per gallon = $460,000 2.(2) Year 2 Depletion expense: 675,000 gallons × $2.00 per gallon = $1,350,000 3.(3) Year 3 Depletion expense: 554,000 gallons × $2.00 per gallon = $1,108,000 59) 1.a) $58.50 2.b) $2,925,000 1.a) Cost of $58,500,000 Estimated amount to be extracted of 1,000,000 tons = $58.50 per ton 2.b) Year 1 Depletion expense = Tons extracted of 50,000 × Depletion charge of $58.50 per ton $2,925,000 60) $34,375 Annual amortization expense = Cost of $275,000 ÷ Useful life of 8 years = $34,375

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CHAPTER 8 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Tangible assets include land, equipment, and goodwill. ⊚ true ⊚ false

Intangible assets include patents, copyrights, and franchises. ⊚ true ⊚ false

3) The term used to recognize expense for property, plant, and equipment assets is depletion. ⊚ true ⊚ false

Land differs from other property because it is not subject to depreciation. ⊚ true ⊚ false

5) When a building is purchased simultaneously with land, the purchase price must be allocated between the building and the land. ⊚ true ⊚ false

A copyright is an intangible asset with an indefinite useful life. ⊚ true ⊚ false

A trademark is a tangible asset with an indefinite useful life. ⊚ true ⊚ false

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8) Title search and transfer document costs incurred to purchase a building are expensed in the period the building is acquired. ⊚ true ⊚ false

9) The depreciable cost of a long-term asset is the difference between the amount paid for the asset and its salvage value. ⊚ true ⊚ false

10) Late in a plant asset's useful life, the amount of depreciation that would be recorded with the double-declining-balance method is less than the amount that would be recognized with the straight-line method. ⊚ true ⊚ false

11)

The purchase of a new delivery truck for cash is an asset use transaction. ⊚ true ⊚ false

12)

Recognizing depreciation expense on equipment or a building is an asset use transaction. ⊚ true ⊚ false

13)

Accumulated Depreciation is reported on the income statement. ⊚ true ⊚ false

14) When depreciation is recorded on equipment, Depreciation Expense is increased, and the Equipment account is decreased. ⊚ true ⊚ false

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15) With an accelerated depreciation method, an asset can be depreciated below its salvage value. ⊚ true ⊚ false

16) In choosing a depreciation method for financial reporting, a company should use the method that most closely approximates the amount of depreciation on the tax return. ⊚ true ⊚ false

17)

Gains and losses are reported as part of operating income on the income statement. ⊚ true ⊚ false

18) When using the modified accelerated cost recovery system (MACRS) the highest amount of depreciation expense will be recognized in the year the asset is acquired. ⊚ true ⊚ false

19)

The use of estimates and revision of estimates are uncommon in financial reporting. ⊚ true ⊚ false

20) Generally accepted accounting principles require that, when the estimated useful life of a long-term asset is changed, previously-issued financial statements should not be revised. ⊚ true ⊚ false

21) A substantial amount spent to improve the quality or extend the life of a long-term asset is called a revenue expenditure. ⊚ true ⊚ false

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22) An expenditure that improves the quality of service provided by a plant asset is added to the historical cost of the asset. ⊚ true ⊚ false

23) Expenditures that extend the useful life of a plant asset increase the accumulated depreciation on the asset. ⊚ true ⊚ false

24)

Depletion of a natural resource is usually calculated using the straight-line method. ⊚ true ⊚ false

25) The cost of natural resources includes the purchase price, as well as exploration costs and surveys. ⊚ true ⊚ false

26) Goodwill is the value attributable to favorable factors such as reputation, location, and superior products. ⊚ ⊚

true false

27) When Company X purchases Company Y, Company X should record Company Y's assets at their fair value at the time of the acquisition. ⊚ true ⊚ false

28) An impairment of an intangible asset decreases assets, stockholders' equity, and net income. ⊚ true ⊚ false

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 29) Which of the following would be classified as a tangible asset? A) Land B) Goodwill C) Copyright D) Trademark

30)

Which of the following would be classified as a long-term operational asset? A) Notes receivable B) Trademark C) Inventory D) Accounts receivable

31)

Which of the following would not be classified as a tangible long-term asset? A) Delivery truck B) Timber reserve C) Land D) Copyright

32)

Which of the following would not be classified as property, plant and equipment? A) Computers B) Buildings C) Inventory D) Office furniture

33) Which of the following terms is used to describe the process of expense recognition for property, plant and equipment? Version 1

A) Amortization B) Depreciation C) Depletion D) Revision

34) Which of the following intangible assets does not convey a specific legal right or privilege? A) Copyrights B) Franchises C) Goodwill D) Trademarks

35) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $1,520,000. Harding paid $385,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $407,000; Building, $1,210,000 and Equipment, $803,000. What value will be reported for the building on the balance sheet? A) $192,500 B) $760,000 C) $310,000 D) $1,210,000

36) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $1,900,000. Harding paid $350,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $374,000; Building, $1,100,000 and Equipment, $726,000. What value will be reported for the building on the balance sheet? A) $175,000 B) $950,000 C) $800,000 D) $1,100,000

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37) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $1,615,000. Harding paid $420,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $444,000; Building, $1,320,000 and Equipment, $876,000. What value will be reported for the land on the balance sheet? (Round intermediate percentage values to a whole percentage.) A) $448,800 B) $1,320,000 C) $274,550 D) $871,200

38) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $1,900,000. Harding paid $350,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $374,000; Building, $1,100,000 and Equipment, $726,000. What value will be reported for the land on the balance sheet? A) $370,000 B) $1,100,000 C) $323,000 D) $760,000

39) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $2,185,000. Harding paid $630,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $666,000; Building, $1,980,000 and Equipment, $1,314,000. What value will be reported for the land on the balance sheet? (Round intermediate percentage values to a whole percentage. Do not round other intermediate calculations.) A) $193,280 B) $131,700 C) $172,360 D) $348,210

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40) Harding Corporation acquired real estate that contained land, building and equipment. The property cost Harding $1,900,000. Harding paid $350,000 and issued a note payable for the remainder of the cost. An appraisal of the property reported the following values: Land, $374,000; Building, $1,100,000 and Equipment, $726,000. Assume that Harding uses the units-of-production method when depreciating its equipment. Harding estimates that the purchased equipment will produce 1,000,000 units over its 5-year useful life and has a salvage value of $34,000. Harding produced 265,000 units with the equipment by the end of the first year of purchase. Which amount below is closest to the amount Harding will record for depreciation expense for the equipment in the first year? A) $193,450 B) $125,200 C) $157,145 D) $165,890

41) On January 6, Year 1, Mount Jackson Corporation purchased a tract of land for a factory site for $825,000. An existing building on the site was demolished and the new factory was completed on October 11, Year 1. Additional cost data are shown below: Construction cost of new building Real estate and attorney fees Architect fees Cost to demolish old building Salvage recovery from old building

$ 1,000,000 18,200 84,000 77,100 (13,000)

Which of the following are the capitalized costs of the land and the new building, respectively? A) $907,300 and $1,084,000 B) $843,200 and $1,148,100 C) $920,300 and $1,071,000 D) $825,000 and $1,166,300

42) On January 6, Year 1, Mount Jackson Corporation purchased a tract of land for a factory site for $1,500,000. An existing building on the site was demolished and the new factory was completed on October 11, Year 1. Additional cost data are shown below: Construction cost of new building Real estate and attorney fees Architect fees Cost to demolish old building

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$ 1,760,000 15,400 138,000 133,200

Salvage recovery from old building

(11,000)

Which of the following are the capitalized costs of the land and the new building, respectively? A) $1,637,600 and $1,898,000 B) $1,515,400 and $2,020,200 C) $1,648,600 and $1,887,000 D) $1,500,000 and $2,035,600

43) Chico Company paid $560,000 for a basket purchase that included office furniture, a building and land. An appraiser provided the following estimates of the market values of the assets if they had been purchased separately: Office furniture, $140,000; Building, $460,000; and Land, $110,000. Based on this information, what is the cost that should be allocated to the office furniture? (Round intermediate percentage values to a whole percentage.) A) $112,000 B) $140,000 C) $211,707 D) $62,100

44) Chico Company paid $950,000 for a basket purchase that included office furniture, a building and land. An appraiser provided the following estimates of the market values of the assets if they had been purchased separately: Office furniture, $190,000; Building, $740,000; and Land, $132,000. Based on this information, what is the cost that should be allocated to the office furniture? (Round allocation percentage to two decimal places.) A) $171,000 B) $190,000 C) $316,667 D) $105,000

45) Anchor Company purchased a manufacturing machine with a list price of $97,000 and received a 2% cash discount on the purchase. The machine was delivered under terms free on board (FOB) shipping point, and transportation costs amounted to $4,600. Anchor paid $6,600 to have the machine installed and tested. Insurance costs to protect the asset from fire and theft amounted to $8,600 for the first year of operations. What is the cost of the machine?

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A) $95,060 B) $99,660 C) $114,860 D) $106,260

46) Anchor Company purchased a manufacturing machine with a list price of $160,000 and received a 2% cash discount on the purchase. The machine was delivered under terms free on board (FOB) shipping point, and transportation costs amounted to $2,400. Anchor paid $3,000 to have the machine installed and tested. Insurance costs to protect the asset from fire and theft amounted to $3,600 for the first year of operations. What is the cost of the machine? A) $156,800 B) $159,200 C) $165,800 D) $162,200

47) On March 1, Bartholomew Company purchased a new stamping machine with a list price of $69,000. The company paid cash for the machine; therefore, it was allowed a 5% discount. Other costs associated with the machine were: transportation costs, $1,200; sales tax paid, $2,920; installation costs, $950; routine maintenance during the first month of operation, $1,100. What is the cost of the machine? A) $69,670 B) $65,550 C) $71,720 D) $70,620

48) On March 1, Bartholomew Company purchased a new stamping machine with a list price of $34,000. The company paid cash for the machine; therefore, it was allowed a 5% discount. Other costs associated with the machine were: transportation costs, $550; sales tax paid, $1,360; installation costs, $450; routine maintenance during the first month of operation, $500. What is the cost of the machine?

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A) $34,210 B) $32,300 C) $35,160 D) $34,660

49) Laramie Company paid $1,600,000 for a purchase that included land, building, and office furniture. An appraiser provided the following estimates of the market values of the assets if they had been purchased separately: Land, $374,000, Building, $850,000, and Office Furniture, $476,000. What is the cost that should be allocated to the land? A) $352,000 B) $269,720 C) $374,000 D) $433,338

50) Laramie Company paid $800,000 for a purchase that included land, building, and office furniture. An appraiser provided the following estimates of the market values of the assets if they had been purchased separately: Land, $100,000, Building, $740,000, and Office Furniture, $160,000. What is the cost that should be allocated to the land? A) $80,000 B) $70,000 C) $100,000 D) $107,000

51) On January 1, Year 1, Phillips Company made a basket purchase including land, a building and equipment for $1,040,000. The appraised values of the assets are $74,000 for the land, $1,020,000 for the building and $216,000 for equipment. Phillips uses the doubledeclining-balance method for the equipment which is estimated to have a useful life of four years and a salvage value of $10,000. What is the depreciation expense for the equipment for Year 1? (Round your intermediate calculations to 4 decimal places.)

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A) $108,000 B) $54,000 C) $42,874 D) $85,748

52) On January 1, Year 1, Phillips Company made a basket purchase including land, a building and equipment for $380,000. The appraised values of the assets are $20,000 for the land, $340,000 for the building and $40,000 for equipment. Phillips uses the double-decliningbalance method for the equipment which is estimated to have a useful life of four years and a salvage value of $5,000. What is the depreciation expense for the equipment for Year 1? A) $17,000 B) $20,000 C) $9,500 D) $19,000

53) On January 1, Year 1, Milton Manufacturing Company purchased equipment with a list price of $29,000. A total of $2,400 was paid for installation and testing. During the first year, Milton paid $3,600 for insurance on the equipment and another $620 for routine maintenance and repairs. Milton uses the units-of-production method of depreciation. Useful life is estimated at 100,000 units, and estimated salvage value is $4,800. During Year 1, the equipment produced 14,000 units. What is the amount of depreciation for Year 1? A) $3,780 B) $4,228 C) $4,315 D) $4,900

54) On January 1, Year 1, Milton Manufacturing Company purchased equipment with a list price of $88,000. A total of $4,000 was paid for installation and testing. During the first year, Milton paid $6,000 for insurance on the equipment and another $2,200 for routine maintenance and repairs. Milton uses the units-of-production method of depreciation. Useful life is estimated at 100,000 units, and estimated salvage value is $8,000. During Year 1, the equipment produced 13,000 units. What is the amount of depreciation for Year 1?

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A) $10,920 B) $11,960 C) $11,700 D) $12,740

55)

The acronym MACRS stands for A) Modified Accelerated Cost Recovery System B) Management Accounting Cost and Revenue Streams C) Management Assurance Cost and Revenue System D) Modified Accounting of Cost and Revenue Streams

56)

Which of the following is considered an accelerated depreciation method?

A) Double-declining balance B) Units-of-production C) Modified accelerated cost recovery system (MACRS) D) Both double-declining-balance and MACRS

57) Which method of depreciation is used by most U.S. companies for financial reporting purposes? A) Straight-line B) Units-of-production C) Double-declining-balance D) Modified accelerated cost recovery system (MACRS)

58)

When reporting to the Internal Revenue Service companies are most likely to use

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A) an accelerated depreciation. B) straight-line depreciation. C) reverse accelerated depreciation. D) units-of-production depreciation.

59) Flagler Company purchased equipment that cost $90,000. The equipment had a useful life of 5 years and a $10,000 salvage value. Flagler uses the double-declining-balance method. Which of the following choices accurately reflects how the recognition of the first year's depreciation would affect the financial statements? Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders Revenue − Expens = Net Cash s ’ Equity e Income Flows A (32,000 Not (32,000) Not 32,000 (32,000 (32,000) . ) affected affecte ) Operatin d g activity B (16,000 Not (16,000) Not 16,000 (16,000 Not . ) affected affecte ) affected d C (36,000 Not (36,000) Not 36,000 (36,000 (36,000) . ) affected affecte ) Operatin d g activity D (36,000 Not (36,000) Not 36,000 (36,000 Not . ) affected affecte ) affected d

A) Option A B) Option B C) Option C D) Option D

60) On January 1, Year 1 Missouri Company purchased a truck that cost $49,000. The truck had an expected useful life of 10 years and a $5,000 salvage value. Missouri uses the double declining-balance method. What is the amount of depreciation expense recognized in Year 2?

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A) $7,840 B) $7,040 C) $4,900 D) $9,800

61) On January 1, Year 1 Missouri Company purchased a truck that cost $57,000. The truck had an expected useful life of 10 years and a $6,000 salvage value. Missouri uses the double declining-balance method. What is the amount of depreciation expense recognized in Year 2? A) $9,120 B) $11,400 C) $10,200 D) $8,160

62) At the end of the current accounting period, Ringgold Company recorded depreciation of $15,000 on its equipment. What is the effect of this event on the company's balance sheet? A) Decrease assets and increase liabilities B) Decrease stockholders’ equity and decrease assets C) Decrease assets and increase stockholders’ equity D) Decrease stockholders’ equity and increase liabilities

63) On January 1, Year 1, Friedman Company purchased a truck that cost $43,000. The truck had an expected useful life of 8 years and an $8,000 salvage value. Friedman uses the doubledeclining-balance method. What is the book value of the truck at the end of Year 1? A) $24,250 B) $34,250 C) $26,250 D) $32,250

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64) On January 1, Year 1, Friedman Company purchased a truck that cost $48,000. The truck had an expected useful life of 8 years and an $8,000 salvage value. Friedman uses the doubledeclining-balance method. What is the book value of the truck at the end of Year 1? A) $43,000 B) $38,000 C) $40,000 D) $36,000

65) On January 1, Year 1, Friedman Company purchased a truck that cost $58,000. The truck had an expected useful life of 200,000 miles over 8 years and an $9,000 salvage value. During Year 2, Friedman drove the truck 31,000 miles. Friedman uses the units-of-production method. What is depreciation expense in Year 2? (Round your intermediate calculations to 3 decimal places.) A) $8,990 B) $7,595 C) $6,125 D) $7,250

66) On January 1, Year 1, Friedman Company purchased a truck that cost $48,000. The truck had an expected useful life of 100,000 miles over 8 years and an $8,000 salvage value. During Year 2, Friedman drove the truck 18,500 miles. Friedman uses the units-of-production method. What is depreciation expense in Year 2? A) $8,880 B) $7,400 C) $6,000 D) $5,000

67) Emir Company purchased equipment that cost $110,000 cash on January 1, Year 1. The equipment had an expected useful life of six years and an estimated salvage value of $8,000. Emir depreciates its assets under the straight-line method. What are the amounts of depreciation expense during Year 3 and the accumulated depreciation at December 31, Year 3, respectively?

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A) $17,000 and $17,000 B) $17,000 and $68,000 C) $68,000 and $17,000 D) $17,000 and $51,000

68) Chubb Company paid cash to purchase equipment on January 1, Year 1. Select the answer that shows how the recognition of depreciation expense in Year 2 would affect the financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + Not + Not + Not affected affected affected B. Not affected + Not + +Operating affected activity C. Not Not + -Operating affected affected activity D. Not Not + Not affected affected affected

A) Option A B) Option B C) Option C D) Option D

69) On January 1, Year 1, Dinwiddie Company purchased a car that cost $45,000. The car has an expected useful life of 5 years and a $10,000 salvage value. Which of the following statements is true?

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A) The total amount of depreciation expense recognized over the six-year useful life will be greater under the double-declining-balance method than the straight-line method. B) The amount of depreciation expense recognized in Year 4 would be greater if Dinwiddie depreciates the car under the straight-line method than if the double-declining-balance method is used. C) At the end of Year 2, the amount in accumulated depreciation account will be less if the double-declining-balance method is used than it would be if the straight-line method is used. D) None of these statements is true.

70) On January 1, Year 1, Jing Company purchased office equipment that cost $34,375 cash. The equipment was delivered under terms free on board (FOB) shipping point, and transportation cost was $2,375. The equipment had a five-year useful life and a $12,210 expected salvage value. Assuming the company uses the double-declining-balance depreciation method, what are the amounts of depreciation expense and accumulated depreciation, respectively, that would be reported in the financial statements prepared as of December 31, Year 3? A) $0 and $24,540 B) $1,020 and $24,540 C) $8,820 and $23,520 D) $5,292 and $28,812

71) On January 1, Year 1, Jing Company purchased office equipment that cost $34,000 cash. The equipment was delivered under terms free on board (FOB) shipping point, and transportation cost was $2,000. The equipment had a five-year useful life and a $12,000 expected salvage value. Assuming the company uses the double-declining-balance depreciation method, what are the amounts of depreciation expense and accumulated depreciation, respectively, that would be reported in the financial statements prepared as of December 31, Year 3? A) $0 and $24,000 B) $960 and $24,000 C) $8,640 and $23,040 D) $5,184 and $28,224

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72) On January 1, Year 1, Jing Company purchased office equipment that cost $34,375 cash. The equipment was delivered under terms free on board (FOB) shipping point, and transportation cost was $2,375. The equipment had a five-year useful life and a $12,210 expected salvage value. Assume that Jing Company earned $30,300 cash revenue and incurred $19,300 in cash expenses in Year 3. The company uses the straight-line method. The office equipment was sold on December 31, Year 3 for $16,600. What is the company’s net income (loss) for Year 3? A) ($6,726) B) $6,726 C) $666 D) $5,574

73) On January 1, Year 1, Jing Company purchased office equipment that cost $34,000 cash. The equipment was delivered under terms free on board (FOB) shipping point, and transportation cost was $2,000. The equipment had a five-year useful life and a $12,000 expected salvage value. Assume that Jing Company earned $30,000 cash revenue and incurred $19,000 in cash expenses in Year 3. The company uses the straight-line method. The office equipment was sold on December 31, Year 3 for $16,000. What is the company’s net income (loss) for Year 3? A) ($6,600) B) $6,600 C) $600 D) $5,400

74) On January 1, Year 1, Jing Company purchased office equipment that cost $34,000 cash. The equipment was delivered under terms free on board (FOB) shipping point, and transportation cost was $2,000. The equipment had a five-year useful life and a $12,000 expected salvage value. At the end of Year 5, the equipment was still owned by Jing Company. What is the book value of the office equipment using the straight-line method and double-declining-balance method, respectively?

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A) $12,000 and $1,680. B) $12,000 and $12,000. C) $0 and $0. D) None of these answer choices are correct.

75) Tally Company paid cash to purchase a long-term operational asset. The cost of the asset will be expensed (depreciated) A) over the useful life of the asset. B) at the end of its useful life. C) on the day it is purchased. D) when the asset is sold.

76) On January 1, Year 1, Marino Moving Company paid $64,000 cash to purchase a truck. The truck was expected to have a four-year useful life and a $4,000 salvage value. If Marino uses the straight-line method, the amount of depreciation expense recognized on the Year 2 income statement is A) $16,000 B) $32,000 C) $15,000 D) $10,000

77) On January 1, Year 1, Marino Moving Company paid $64,000 cash to purchase a truck. The truck was expected to have a four year useful life and a $4,000 salvage value. If Marino uses the straight-line method, the accumulated depreciation shown on the Year 2 balance sheet is A) $16,000 B) $32,000 C) $45,000 D) $30,000

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78) On January 1, Year 1, Marino Moving Company paid $64,000 cash to purchase a truck. The truck was expected to have a four year useful life and a $4,000 salvage value. If Marino uses the straight-line method, the amount of book value shown on the Year 2 balance sheet is A) $32,000 B) $34,000 C) $28,000 D) $30,000

79) On January 1, Year 1, Marino Moving Company paid $64,000 cash to purchase a truck. The truck was expected to have a four year useful life and a $4,000 salvage value. If Marino uses the straight-line method, which of the following shows how the adjusting entry to recognize depreciation expense at the end of Year 3 will affect the Company’s financial statements? Balance Sheet Income Statement Stateme nt of Assets = Liabilit + Stockholders’ Cash ies Equity Flows Cash + Book = Accounts + Common + Retain Revenu − Expen = Net Value Payable Stock ed e se Income of Earnin Truck gs A Not (45,00 Not Not (45,00 Not 45,00 (45,00 Not . affect 0) affected affect 0) affect 0 0) affecte ed ed ed d B Not (45,00 Not Not (45,00 Not 45,00 (45,00 Not . affect 0) affected affect 0) affect 0 0) affecte ed ed ed d C Not (15,00 Not Not 15,000 Not 15,00 (15,00 (15,000 . affect 0) affected affect affect 0 0) ) ed ed ed Operati ng activit y D Not (15,00 Not Not (15,00 Not 15,00 (15,00 Not . affect 0) affected affect 0) affect 0 0) affecte ed ed ed d

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A) Option A B) Option B C) Option C D) Option D

80) Dinkins Company purchased a truck that cost $60,000. The company expected to drive the truck 100,000 miles over its 5-year useful life, and the truck had an estimated salvage value of $9,000. If the truck is driven 30,000 miles in the current accounting period, what would be the amount of depreciation expense for the year using the units-of-production method?

A) $18,000 B) $15,300 C) $24,000 D) $10,200

81) Dinkins Company purchased a truck that cost $46,000. The company expected to drive the truck 100,000 miles over its 5-year useful life, and the truck had an estimated salvage value of $8,000. If the truck is driven 26,000 miles in the current accounting period, what would be the amount of depreciation expense for the year using the units-of-production method?

A) $11,960 B) $9,880 C) $9,200 D) $7,600

82)

Which of the following statements is true regarding depreciation expense?

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A) Different companies in the same industry always depreciate similar assets by the same methods. B) A company using the straight-line method will show a smaller book value for assets than if the same company uses the double-declining-balance method. C) Choosing the double-declining balance method over the straight-line method will produce a greater total depreciation expense over the asset's life. D) A company should use the depreciation method that best matches expense recognition with the use of the asset.

83) A machine with a book value of $38,000 is sold for $32,000. Which of the following answers would accurately represent the effects of the sale on the financial statements? Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders Revenue/Gai − Expense = Net Cash s ’ Equity n Income Flows A 38,000 Not 38,000 38,000 Not 38,000 38,000 . affected affecte Investing d activity B (6,000 Not (6,000) Not 6,000 (6,000 6,000 . ) affected affected ) Operating activity C (6,000 Not (6,000) Not 6,000 (6,000 6,000 . ) affected affected ) Investing activity D (6,000 Not (6,000) Not 6,000 (6,000 32,000 . ) affected affected ) Investing activity

A) Option A B) Option B C) Option C D) Option D

84) Farmer Company sold a piece of equipment for $6,000. The equipment had an original cost of $34,000 and accumulated depreciation of $31,000 at the time of the sale. Which of the following correctly shows the effect of the sale on the financial statements? Balance Sheet

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Income Statement

Statemen

Assets = Liabilitie + Stockholders Revenue/Gai − Expense = Net s ’ Equity n Income A 3,000 .

Not affected

3,000

Not affecte d

B (3,000 . )

Not affected

(3,000)

Not affected

3,000

C 3,000 .

Not affected

3,000

Not affecte d

D 6,000 .

Not affected

6,000

Not affected

Not affecte d

t of Cash Flows 3,000 6,000 Operatin g activity (3,000 6,000 ) Investin g activity 3,000 6,000 Investin g activity 6,000 6,000 Investin g activity

A) Option A B) Option B C) Option C D) Option D

85) On January 1, Year 1, Raven Limo Service, Incorporated paid $74,000 cash to purchase a limousine. The limo was expected to have a five-year useful life and a $14,000 salvage value. On January 1, Year 3 the limo was sold for $54,000 cash. Assuming Raven uses straight-line depreciation, the Company would recognize a A) $4,000 loss B) $4,000 gain C) $6,000 loss D) $6,000 gain

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86) On January 1, Year 1, Raven Limo Service, Incorporated paid $74,000 cash to purchase a limousine. The limo was expected to have a five-year useful life and a $14,000 salvage value. On January 1, Year 3 the limo was sold for $46,000 cash. Assuming Raven uses straight-line depreciation, the Company would recognize a A) $4,000 loss B) $4,000 gain C) $22,000 loss D) $22,000 gain

87) Madison Company owned an asset that cost $44,000. The company sold the asset for $16,000. Accumulated depreciation on the day of sale amounted to $32,000. Which of the following statements is true? A) A $16,000 cash inflow in the investing activities section of the cash flow statement. B) A $16,000 increase in total assets. C) A $4,000 gain in the investing activities section of the statement of cash flows. D) A $4,000 cash inflow in the financing activities section of the cash flow statement.

88) Gillock, Incorporated uses modified accelerated cost recovery system (MACRS) for its income tax return and the straight-line method for its financial statements. On January 1, Year 1, the company purchased a long-term asset that cost $130,000 and has a $10,000 salvage value and an expected 8-year useful life. MACRS specifies a 5-year life for that asset and a depreciation rate of 20% for the first year of its life. Which of the following would the company show on its financial records?

A) Less depreciation expense on the tax return than on the income statement B) The same amount of depreciation expense for financial reporting as for income tax preparation C) Depreciation expense of $26,000 on the income statement and $15,000 on the tax return D) A deferred tax liability will be reported on the balance sheet

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89) Which of the following statements is true concerning the modified accelerated cost recovery system (MACRS) for the recognition of depreciation expense, for tax purposes?

A) 7-year property will be depreciated more rapidly than 10-year property under the MACRS depreciation method. B) Under MACRS more depreciation will be recorded in the second accounting period than in the first accounting period because of the half-year convention. C) MACRS is used for the determination of depreciation expense that is reported on an income tax return. D) All of these answer choices are true.

90) For Year 1, Oscar Company records depreciation expense of $12,000 on its income statement and $9,000 of modified accelerated cost recovery system (MACRS) depreciation on its tax return. Which of the following answers is correct regarding the difference between the two figures? A) Net income is understated by $3,000 on the Year 1 income statement. B) Deferred taxes of $3,000 are subtracted from taxable income of Year 1. C) The difference in depreciation expense is caused by differences between generally accepted accounting principles (GAAP) and the tax code. D) The amount of depreciation recorded on the income tax return must be incorrect.

91) On January 1, Year 1, the City Taxi Company purchased a new taxi cab for $45,000. The cab has an expected salvage value of $8,000. The company estimates that the cab will be driven 200,000 miles over its life. It uses the units-of-production method to determine depreciation expense. The cab was driven 54,000 miles the first year and 57,000 the second year. What is the amount of depreciation expense reported on the Year 2 income statement and the book value of the taxi at the end of Year 2, respectively? A) $12,825 and $20,025 B) $12,825 and $12,025 C) $10,545 and $24,465 D) $10,545 and $16,465

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92) On January 1, Year 1, the City Taxi Company purchased a new taxi cab for $36,000. The cab has an expected salvage value of $2,000. The company estimates that the cab will be driven 200,000 miles over its life. It uses the units-of-production method to determine depreciation expense. The cab was driven 45,000 miles the first year and 48,000 the second year. What is the amount of depreciation expense reported on the Year 2 income statement and the book value of the taxi at the end of Year 2, respectively? A) $8,640 and $19,260 B) $8,640 and $17,260 C) $8,160 and $20,190 D) $8,160 and $18,190

93) On January 1, Year 1, Li Company purchased an asset that cost $50,000. The asset had an expected useful life of five years and an estimated salvage value of $10,000. Li uses the straightline method for the recognition of depreciation expense. At the beginning of the fourth year, the company revised its estimated salvage value to $5,000. What is the amount of depreciation expense to be recognized during Year 4? A) $8,000 B) $10,500 C) $21,000 D) $13,000

94) On January 1, Year 1, Li Company purchased an asset that cost $80,000. The asset had an expected useful life of five years and an estimated salvage value of $16,000. Li uses the straightline method for the recognition of depreciation expense. At the beginning of the fourth year, the company revised its estimated salvage value to $8,000. What is the amount of depreciation expense to be recognized during Year 4? A) $12,800 B) $16,800 C) $33,600 D) $20,800

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95) Farmer Company purchased machine on January 1, Year 1 for $136,000. The machine is estimated to have a 5-year life and a salvage value of $21,000. The company uses the straightline method. At the beginning of Year 4, Farmer revised the expected life to eight years. What is the annual amount of depreciation expense for each of the remaining years in the machine's life? A) $9,200 B) $13,400 C) $8,375 D) $5,750

96) Farmer Company purchased machine on January 1, Year 1 for $82,000. The machine is estimated to have a 5-year life and a salvage value of $4,000. The company uses the straight-line method. At the beginning of Year 4, Farmer revised the expected life to eight years. What is the annual amount of depreciation expense for each of the remaining years in the machine's life? A) $6,240 B) $4,400 C) $7,040 D) $3,900

97) Farmer Company purchased machine on January 1, Year 1 for $82,000. The machine is estimated to have a 5-year life and a salvage value of $4,000. The company uses the straight-line method. If the original expected life remained the same (i.e., 5-years), but at the beginning of Year 4, the salvage value was revised to $8,000, what is the annual depreciation expense for each of the remaining years? A) $5,440 B) $27,200 C) $13,600 D) $14,800

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98) Renewable Energies, Incorporated (REI) paid $100,000 to purchase a windmill. The windmill was expected to have a 10-year useful life and a $30,000 salvage value. At the beginning of the fifth year of operation, REI changed the estimated useful life from 10 years to 14 years. Assuming the Company uses the straight-line method, the amount of depreciation expense on the Year 5 income statement would be

A) $3,000 B) $3,500 C) $4,200 D) $6,500

99) Renewable Energies, Incorporated (REI) paid $100,000 to purchase a windmill. The windmill was expected to have a 10-year useful life and a $30,000 salvage value. At the beginning of the fifth year of operation, REI changed the estimated useful life from 10 years to 14 years. Assuming the Company uses the straight-line method, the amount of accumulated depreciation on the Year 6 balance sheet would be

A) $28,000 B) $30,000 C) $32,200 D) $36,400

100) On January 1, Year 1, Ballard company purchased a machine for $40,000. On January 1, Year 2, the company spent $13,000 to improve its quality. The machine had a $7,600 salvage value and a 6-year life, which are unchanged. Ballard uses the straight-line method. What is the book value of the machine on December 31, Year 4? A) $23,600 B) $16,000 C) $8,000 D) $21,000

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101) On January 1, Year 1, Ballard company purchased a machine for $52,000. On January 1, Year 2, the company spent $12,000 to improve its quality. The machine had a $4,000 salvage value and a 6-year life, which are unchanged. Ballard uses the straight-line method. What is the book value of the machine on December 31, Year 4? A) $24,800 B) $20,800 C) $10,400 D) $24,000

102) Anton Company paid cash to extend the life of one of its assets. Which of the following choices accurately reflects how this event would affect the financial statements? Balance Sheet Income Statement Statement of Cash Asset = Liabilitie + Stockholders Revenue − Expense = Net Flows s s ’ Equity Income A +/− Not Not affected Not Not Not Not . affected affecte affecte affecte affected d d d B +/− Not Not affected Not Not Not −Investin . affected affecte affecte affecte g d d d activity C − Not − Not + − −Operatin . affected affecte g d activity D − Not − Not + − Not . affected affecte affected d

A) Option A B) Option B C) Option C D) Option D

103) On January 1, Year 2, Ruiz Company spent $850 on a plant asset to improve its quality. Which of the following correctly shows the effects of the Year 2 expenditure on the financial statements? Assets

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Balance Sheet = Liabilit + Stockholders’

Income Statement

Stateme nt of

ies Equity Cash Flows Cash + Book = Accounts + Common + Retain Revenu - Expens = Net Value Payable Stock ed e e Income of Earnin Equipme gs nt A (850 850 Not Not Not Not Not Not (850) . ) affected affect affect affect affect affect Investi ed ed ed ed ed ng activit y B (850 850 Not Not Not Not Not Not (850) . ) affected affect affect affect affect affect Operati ed ed ed ed ed ng activit y C (850 (850) Not Not Not Not Not Not (850) . ) affected affect affect affect affect affect Investi ed ed ed ed ed ng activit y D (850 Not Not Not (850) Not 850 (850) (850) . ) affecte affected affect affect Operati d ed ed ng activit y

A) Option A B) Option B C) Option C D) Option D

104) On January 1, Year 2 Boothe Company paid $12,000 cash to extend the useful life of a machine. Which of the following statements is true regarding the financial statement effects of this expenditure? A) Book value of machine decreases B) Retained earnings decreases C) Book value of machine increases D) Retained earnings increases

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105) On January 1, Year 1, Eller Company purchased an asset that had cost $24,000. The asset had an 8-year useful life and an estimated salvage value of $1,000. Eller depreciates its assets on the straight-line basis. On January 1, Year 5, the company spent $6,000 to improve the quality of the asset. How does the Year 5 depreciation expense impact the financial statements? A) Increase total assets by $4,375 B) Decrease stockholders’ equity by $4,375 C) Decrease total assets by $4,625 D) Increase stockholders’ equity by $4,625

106) Good Company paid cash to purchase mineral rights on a large parcel of land. Which of the following choices accurately reflects how this event would affect the horizontal financial statements model? Balance Sheet Income Statement Statement of Cash Asset = Liabilitie + Stockholders Revenue − Expense = Net Flows s s ’ Equity Income A +/− Not Not affected Not Not Not Not . affected affecte affecte affecte affected d d d B − Not − Not + − Not . affected affecte affected d C +/− Not Not affected Not Not Not −Investin . affected affecte affecte affecte g d d d activity D − Not − Not + − −Operatin . affected affecte g d activity

A) Option A B) Option B C) Option C D) Option D

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107) On April 1, Year 1, Fossil Energy Company purchased an oil producing well at a cash cost of $8,800,000. It is estimated that the oil well contains 740,000 barrels of oil, of which only 640,000 can be profitably extracted. By December 31, Year 1, 32,000 barrels of oil were produced and sold. What is depletion expense for Year 1 on this well? A) $586,667 B) $440,000 C) $146,667 D) $380,541

108) On April 1, Year 1, Fossil Energy Company purchased an oil producing well at a cash cost of $12,000,000. It is estimated that the oil well contains 600,000 barrels of oil, of which only 500,000 can be profitably extracted. By December 31, Year 1, 25,000 barrels of oil were produced and sold. What is depletion expense for Year 1 on this well? A) $800,000 B) $600,000 C) $480,000 D) $500,000

109)

How does the recognition of depletion expenseaffect the financial statements?

A) Decreases assets and stockholders’ equity and decreases cash flow from investing expenses under the direct approach. B) Decreases cash flow from operating activities, but does not affect the amount of total assets. C) Increases assets, stockholders’ equity, and cash flow from operating activities. D) Decreases assets and stockholders’ equity, but does not affect cash flow.

110) Glick Company purchased oil rights on July 1, Year 1 for $3,080,000. A total of 200,000 barrels of oil are expected to be extracted over the asset’s life, and 64,000 barrels are extracted and sold in Year 1. Which of the following correctly summarizes the effect of the Year 1 depletion expense on the financial statements?

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A) A decrease in stockholders’ equity of $200,000 B) A decrease in assets of $985,600 C) A decrease in assets of $640,000 D) An increase in stockholders’ equity of $1,025,600

111) Glick Company purchased oil rights on July 1, Year 1 for $2,400,000. A total of 200,000 barrels of oil are expected to be extracted over the asset’s life, and 30,000 barrels are extracted and sold in Year 1. Which of the following correctly summarizes the effect of the Year 1 depletion expense on the financial statements? A) A decrease in stockholders’ equity of $200,000 B) A decrease in assets of $360,000 C) A decrease in assets of $300,000 D) An increase in stockholders’ equity of $400,000

112) Which of the following would most likely not be expensed using the straight-line method? A) A copyright B) A building C) A timber reserve D) A patent

113) On January 1, Year 1, Monroe Minerals Company purchased a copper mine for $129,000,000. The mine was expected to produce 50,000 tons of copper over its useful life. During Year 1, the company extracted 7,800 tons of copper. The copper was sold for $6,300 per ton. Assume that the company incurred $9,030,000 in operating expenses during Year 1. What is the amount of net income for Year 1? A) $29,016,000 B) $19,986,000 C) $11,094,000 D) $20,124,000

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114) On January 1, Year 1, Monroe Minerals Company purchased a copper mine for $120,000,000. The mine was expected to produce 50,000 tons of copper over its useful life. During Year 1, the company extracted 6,000 tons of copper. The copper was sold for $4,500 per ton. Assume that the company incurred $8,040,000 in operating expenses during Year 1. What is the amount of net income for Year 1? A) $12,600,000 B) $4,560,000 C) $6,360,000 D) $14,400,000

115) On January 1, Year 1, Vanguard Company purchased a copyright for $12,000. Vanguard estimated the remaining useful life of the copyright to be 6 years. Which of the following correctly shows the effect of Vanguard's purchase of the copyright on the financial statements? Balance Sheet Income Statement Statement of Cash Asset = Liabilitie + Stockholders Revenue − Expense = Net Flows s s ’ Equity Income A +/− Not + + Not + +Financin . affected affecte g d activity B − Not − Not + − −Investin . affected affecte g d activity C +/− Not Not affected Not Not Not −Investin . affected affecte affecte affecte g d d d activity D + Not + Not Not Not −Operatin . affected affecte affecte affecte g d d d activity

A) Option A B) Option B C) Option C D) Option D

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116) On January 1, Year 1, Vanguard Company purchased a copyright for $12,000. Vanguard estimated the remaining useful life of the copyright to be 6 years. Which of the following correctly shows the effect of the first year's amortization of Vanguard's copyright? Balance Sheet Income Statement Statement of Cash Assets = Liabilitie + Stockholders Revenue − Expense = Net Flows s ’ Equity Incom e A + Not + Not + − +Operatin . affected affecte g d activity B − Not − Not + − Not . affected affecte affected d C Not + − − Not − Not . affecte affecte affected d d D − Not − Not + − . affected affecte Operating d activity

A) Option A B) Option B C) Option C D) Option D

117) Which of the following terms is used to describe long-term assets that have no physical substance and provide rights, privileges and special opportunities to businesses? A) Tangible assets B) Intangible assets C) Natural resources D) Property, plant and equipment

118)

Goodwill may be recorded in which of the following circumstances?

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A) When the property, plant and equipment of a business increase in value B) When a business earns a very high net income C) When a business sells property for more than its book value D) When one business acquires another business

119)

Which of the following is an asset that has an identifiable useful life? A) Goodwill B) Patents C) Renewable franchises D) Trademarks

120) What term is used to describe the situation where the value of an intangible asset may be significantly diminished? A) Amortization B) Impairment C) Depletion D) Depreciation

121) How will an impairment loss of $15,000 relating to goodwill affect the financial statements? A) Goodwill decreases B) Retained earnings decreases C) Impairment loss increases D) All of these answer choices are correct.

122)

Which of the following statements is correct regarding accounting treatment of goodwill?

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A) Goodwill is recorded as an asset and is not written off as an expense unless its value decreases. B) Goodwill is recorded as an asset and amortized over 5 years regardless of any change in value. C) Goodwill is recorded as an asset and amortized over 40 years unless its value decreases. D) Goodwill is expensed immediately in the year acquired.

123) Which of the following terms is used to identify the expense recognition associated with intangible assets? A) Allocation B) Depletion C) Depreciation D) Amortization

124) The balance sheet of Flo's Restaurant showed total assets of $620,000, liabilities of $208,000 and stockholders’ equity of $412,000. An appraiser estimated the fair value of the restaurant assets at $740,000. If Alice Company pays $1,025,000 cash for the restaurant, what is the amount of goodwill?

A) $285,000 B) $405,000 C) $493,000 D) $563,000

125) The balance sheet of Flo's Restaurant showed total assets of $600,000, liabilities of $160,000 and stockholders’ equity of $440,000. An appraiser estimated the fair value of the restaurant assets at $680,000. If Alice Company pays $770,000 cash for the restaurant, what is the amount of goodwill?

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A) $90,000 B) $170,000 C) $250,000 D) $230,000

126) On January 1, Year 1, Stiller Company paid $288,000 to obtain a patent. Stiller expected to use the patent for 5 years before it became technologically obsolete. The remaining legal life of the patent was 8 years. Based on this information, what is the amount of amortization expense during Year 3 and the book value of the patent as of December 31, Year 3, respectively? A) $36,000 and $108,000 B) $57,600 and $172,800 C) $36,000 and $180,000 D) $57,600 and $115,200

127) On January 1, Year 1, Stiller Company paid $80,000 to obtain a patent. Stiller expected to use the patent for 5 years before it became technologically obsolete. The remaining legal life of the patent was 8 years. Based on this information, what is the amount of amortization expense during Year 3 and the book value of the patent as of December 31, Year 3, respectively? A) $10,000 and $30,000 B) $16,000 and $48,000 C) $10,000 and $50,000 D) $16,000 and $32,000

128) Hoover Company acquired Burgess Company for $1,200,000 cash. The fair value of Burgess' assets was $1,040,000, and the company had liabilities of $60,000. How much goodwill did Hoover Company acquire in the purchase? A) $220,000 B) $1,040,000 C) $1,200,000 D) $60,000

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129) Byrd Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − Not − Not + − Not affected affected affected

Which of the following accounting events could have caused these effects? A) Recognized depletion expense under the units-of-production method. B) Recognized depreciation expense under the double-declining-balance method. C) Amortized patent cost under the straight-line method. D) All of these answer choices are correct.

130) Grant Company acquired Lee Company for $600,000 cash. The fair value of Lee's assets was $520,000, and the company had $40,000 in liabilities. Which of the following choices would reflect the acquisition on the horizontal financial statements model? Balance Sheet Income Statement Statem ent of Assets = Liabili + Stockholders Cash ties ’ Equity Cash + Lee’ + Goodw = Account + Commo + Retai Revenu − Expen = Net Flows s ill s n ned e se Incom Asse Payable Stock Earni e ts ngs a (600,0 520, 120,0 40,000 Not Not Not Not Not (600,0 . 00) 000 00 affec affec affect affec affec 00) ted ted ed ted ted Operat ing activi ty b (600,0 480, 120,0 Not Not Not Not Not Not (600,0 . 00) 000 00 affecte affec affec affect affec affec 00) d ted ted ed ted ted Operat ing activi ty c (600,0 520, 80,00 Not Not Not Not Not Not (600,0 . 00) 000 0 affecte affec affec affect affec affec 00) d ted ted ed ted ted Invest ing

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d (600,0 . 00)

520, 000

120,0 00

40,000

Not affec ted

Not Not Not affec affect affec ted ed ted

activi ty Not (600,0 affec 00) ted Invest ing activi ty

A) Option A B) Option B C) Option C D) Option D

131) Which of the following measurements would not be affected by the choice of depreciation methods? A) Debt-to-assets ratio B) Total assets C) Total cash flow from investing activities D) Return-on-equity ratio

132) Which of the following should be the main determinant for selection of the allocation method for long-term operational assets? A) The method that is most convenient to compute. B) The method that best matches the pattern of asset use. C) The method that provides the greatest return to the stockholders. D) The method that provides the best tax advantage.

133) Which of the following industries would most likely have the highest value for the ratio of sales to property, plant, and equipment?

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A) Airline B) Consumer product manufacturing company C) Electric utility D) Stock brokerage

134) Pierce Corporation, a U.S. business, is a direct competitor of Zeiss Company, a German firm. The two firms not only compete for customers, but also for investment capital. In Year 1, each company spent about $35,000 U.S. dollars or the equivalent on research and development. U.S. generally accepted accounting principles (GAAP) requires the entire amount to be expensed, while Germany requires its businesses to record research and development expenditures as an asset and then to expense it over its useful life. Assuming the treatment of research and development is the only difference between the two firms, which of the following is correct? A) Pierce will have higher total assets than Zeiss in Year 1. B) Pierce will have a higher debt-to-assets ratio than Zeiss in Year 1. C) Zeiss will have a lower net income for Year 1. D) This difference in accounting principles does not affect the total amount of assets reported by the two companies.

135) Tyler Company purchased equipment that cost $260,000 cash on January 1, Year 1. The equipment had an expected useful life of five years and an estimated salvage value of $10,000. Tyler depreciates its assets under the straight-line method. What is the amount of depreciation expense appearing on the Year 1 income statement? A) $26,000 B) $50,000 C) $52,000 D) $100,000

136) On January 1, Year 1, Dalen Company purchased office equipment that cost $3,500. The equipment had an estimated five-year useful life and an estimated salvage value of $750. The company uses the straight-line method. What is the depreciation expense shown on the income statement and the related cash flow from operating activities shown on the statement of cash flows, respectively, for Year 1? Version 1

A) $3,500 and $3,500 B) $550 and $3,500 C) $550 and $0 D) $0 and $550

137) On January 1, Year 1, Parker Company purchased an asset costing $20,000. The asset had an expected five-year life and a $2,000 salvage value. The company uses the straight-line method. What are the amounts of depreciation expense and accumulated depreciation, respectively, that will be reported in the Year 2 financial statements? A) $3,600 and $3,600 B) $3,600 and $7,200 C) $4,000 and $12,800 D) $4,000 and $7,200

138) Z Company purchased an asset for $24,000 on January 1, Year 1. The asset was expected to have a four-year life and a $4,000 salvage value. What is the amount of depreciation expense for Year 1 using the double-declining-balance method? A) $2,000 B) $3,000 C) $6,000 D) $12,000

139) On January 1, Year 1, XYZ Company paid $60,000 cash to purchase a truck. The truck has a $5,000 salvage value and a 4-year useful life. XYZ uses the double-declining-balance method. How much depreciation expense would XYZ report on its Year 2 income statement? A) $13,750 B) $15,000 C) $20,000 D) $30,000

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140) On January 1, Year 1, Zach Company purchased equipment that cost $50,000. The equipment had a useful life of 5 years and a $10,000 salvage value. Zach Company used the double-declining-balance method to depreciate its assets. What is the accumulated depreciation at the end of Year 2? A) $10,000 B) $12,000 C) $20,000 D) $32,000

141) On January 1, Year 1, Hardwick Company purchased a truck that cost $53,000. The company expected to drive the truck 200,000 miles over its 5-year useful life, and the truck had an estimated salvage value of $3,000. If the truck is driven 30,000 miles during Year 1, what would be the amount of depreciation expense for the year? A) $7,500 B) $10,000 C) $10,600 D) $12,000

142) On January 1, Year 1, Woolly Company purchased a truck that cost $64,000. The truck had an expected useful life of 120,000 miles over 8 years and a $4,000 salvage value. During Year 2, Woolly drove the truck 20,000 miles. Woolly uses the units-of-production method. What is the amount of depreciation expense recognized in Year 2? A) $8,000 B) $10,000 C) $11,000 D) $20,000

143) Jackson Incorporated purchased a truck for $36,000. The truck had a useful life of 150,000 miles over 4 years and a $6,000 salvage value. Jackson drove the truck 40,000 miles in Year 1 and 24,000 miles in Year 2. If Jackson uses the units-of-production method, what is the accumulated depreciation at the end of Year 2?

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A) $4,800 B) $8,000 C) $12,800 D) $16,000

144)

Which financial statement reports the amount of accumulated depreciation? A) Income statement B) Balance sheet C) Statement of cash flows D) Statement of stockholders’ equity

145)

How is depreciation expense reported in the financial statements? A) Long-term liabilities section of the statement of stockholders’ equity B) Financing activities section of the statement of cash flows C) Current assets section of the balance sheet D) Operating expenses section of the income statement

146) EFG Transportation Company uses the straight-line method to depreciate its delivery truck. Which of the following reflects how recognizing depreciation expense would affect the financial statements? Balance Sheet Income Statement Statement of Cash Asset = Liabilitie + Stockholders Revenue − Expense = Net Flows s s ’ Equity Income A +/− Not Not affected Not Not Not Not . affected affecte affecte affecte affected d d d B +/− Not Not affected Not + − −Operatin . affected affecte g d activity C − Not − Not + − Not . affected affecte affected d

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D .

Not affected

Not affecte d

Not affecte Operating d activity

A) Option A B) Option B C) Option C D) Option D

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Answer Key Test name: Chap 08_2e_Test Bank_MCQs_TF 1) FALSE Tangible assets have a physical presence; they can be seen and touched. Goodwill is an intangible asset. 2) TRUE Intangible assets are, in fact, rights or privileges. They cannot be seen or touched. 3) FALSE The term used to recognize expense for property, plant, and equipment is depreciation. The term used to recognize expense for natural resources is depletion. 4) TRUE Land is normally classified as a component of property, plant, and equipment but is not subject to depreciation. Land has an infinite life. It is not worn out or consumed as it is used. 5) TRUE Acquiring a group of assets in a single transaction is known as a basket purchase. The total price of a basket purchase must be allocated among the assets acquired. 6) FALSE A copyright protects writers’ works, musical compositions, works of art, and other intellectual property for the exclusive benefit of the creator or persons assigned the right by the creator. Copyrights granted by the federal government extend for the life of the creator plus 70 years. 7) FALSE

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A trademark is a name or symbol that identifies a company or a product and is an intangible asset. Trademarks are registered with the federal government and have an indefinite legal lifetime. 8) FALSE Title search and transfer document costs are included in the cost of the building and expensed over the building’s useful life. 9) TRUE The depreciable cost is the total amount of an asset’s cost that will be depreciated over its useful life. 10) TRUE Double-declining-balance depreciation recognizes greater amounts of expense in an asset’s early life and lesser amounts in its later life, while the straight-line method recognizes equal amounts of expense each year. 11) FALSE The purchase is an asset exchange transaction that increases one asset, delivery truck, and decreases another asset, cash. 12) TRUE Recognizing depreciation expense is an asset use transaction that decreases assets by increasing the Accumulated Depreciation account, a contra asset account. 13) FALSE Accumulated depreciation is reported on the balance sheet. It is a contraasset account. 14) FALSE When depreciation is recorded on equipment, Depreciation Expense is increased, and Accumulated Depreciation is increased. 15) FALSE An accelerated depreciation method such as the double-decliningbalance method depreciates an asset to its salvage value and no further. 16) FALSE Version 1

The method used to recognize depreciation expense should match the asset’s usage pattern. 17) FALSE Gains and losses are reported after operating income on the income statement. 18) FALSE Because of the half-year convention, the greatest amount of expense will be recognized in the second year of the asset’s life. 19) FALSE Estimates (for such things as useful life and salvage value) are used extensively in accounting, and revision of those estimates is not uncommon. 20) TRUE Only current and future financial statements change as the result of changes in estimates; previously-issued financial statements are not affected. 21) FALSE Substantial amounts spent to improve the quality or extend the life of an asset are described as capital expenditures. 22) TRUE An expenditure that improves a plant asset’s quality increases the plant asset account. 23) FALSE Expenditures that extend the useful life of a plant asset decrease the asset’s accumulated depreciation. 24) FALSE Depletion of a natural resource is usually calculated using the units-ofproduction method. 25) TRUE

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All costs associated with obtaining and readying an asset for its initial use are capitalized. 26) TRUE Goodwill is the value attributable to favorable factors such as reputation, location, and superior products. 27) TRUE Company X records the assets acquired at their fair value (rather than the original cost of the assets to Company Y) 28) TRUE An impairment loss decreases assets (the impaired asset’s account) and decreases stockholders’ equity (retained earnings). It increases expenses (impairment loss), which decreases net income. 29) A Tangible assets, such as land, have a physical presence; they can be seen and touched. The other answer choices are examples of intangible assets. Although they may be represented by physical documents, intangible assets are, in fact, rights or privileges. They cannot be seen or touched. Copyright, goodwill, and trademark are all examples of intangible assets, as they do not have physical existence. 30) B Long-term operational assets include assets, like equipment or buildings, that are used for extended periods of time (two or more accounting periods). Even though it is intangible, a trademark is a long-term operational asset. While a note receivable may be classified as longterm, it is not considered an operational asset. Inventory and accounts receivable are current assets. 31) D

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Tangible assets, such as delivery trucks, timber reserves, and land, have a physical presence; they can be seen and touched. Although they may be represented by physical documents, intangible assets, such as copyrights, are, in fact, rights or privileges. They cannot be seen or touched. 32) C Examples of property, plant, and equipment include furniture, cash registers, machinery, delivery trucks, computers, mechanical robots, buildings, and land. Inventory is a separate asset account. 33) B Depreciation is the process of expense recognition for property, plant and equipment. Amortization relates to intangible assets and depletion relates to natural resources. Although estimates may be revised, revision is not the name of a process of expense allocation. 34) C Intangible assets that provide rights and privileges include copyrights, franchises, and trademarks. On the other hand, goodwill is the value attributable to favorable factors such as reputation, location, and superior products. 35) B Accountants commonly allocate the purchase price of a basket purchase using the relative market value method. Relative market value of building = Market value of building of $1,210,000 ÷ Total market value of all assets acquired of $2,420,000 (or $407,000 + $1,210,000 + $803,000) = 50% Allocation to building = Purchase price of $1,520,000 × 50% = $760,000 36) B

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Accountants commonly allocate the purchase price of a basket purchase using the relative market value method. Relative market value of building = Market value of building of $1,100,000 ÷ Total market value of all assets acquired of $2,200,000 (or $374,000 + $1,100,000 + $726,000) = 50% Allocation to building = Purchase price of $1,900,000 × 50% = $950,000 37) C Total market value of all assets acquired = $444,000 + $1,320,000 + $876,000 = $2,640,000 Allocation to land = Purchase price of $1,615,000 × ($444,000 ÷ $2,640,000) = $1,615,000 × 17% = $274,550 38) C Total market value of all assets acquired = $374,000 + $1,100,000 + $726,000 = $2,200,000 Allocation to land = Purchase price of $1,900,000 × ($374,000 ÷ $2,200,000) = $1,900,000 × 17% = $323,000 39) C Total market value of all assets acquired = $666,000 + $1,980,000 + $1,314,000 = $3,960,000 Allocation to equipment = Purchase price of $2,185,000 × ($1,314,000 ÷ $3,960,000) = $2,185,000 × 33% = $721,050 Depreciation expense = [(Cost of $721,050 − Salvage value of $18,000) ÷ Estimate of 1,130,000 units] × Units produced of 278,000 units = $172,360 40) C

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Total market value of all assets acquired = $374,000 + $1,100,000 + $726,000 = $2,200,000 Allocation to equipment = Purchase price of $1,900,000 × ($726,000 ÷ $2,200,000) = $1,900,000 × 33% = $627,000 Depreciation expense = [(Cost of $627,000 − Salvage value of $34,000) ÷ Estimate of 1,000,000 units] × Units produced of 265,000 units = $157,145 41) A Cost of land = Purchase price of $825,000 + Realtor’s and attorney’s fees of $18,200 fees + Cost to demolish old building of $77,100 − Salvage recovery from old building of $13,000 = $907,300 Cost of building = Construction cost of $1,000,000 + Architect’s fees of $84,000 = $1,084,000 42) A Cost of land = Purchase price of $1,500,000 + Realtor’s and attorney’s fees of $15,400 fees + Cost to demolish old building of $133,200 − Salvage recovery from old building of $11,000 = $1,637,600 Cost of building = Construction cost of $1,760,000 + Architect’s fees of $138,000 = $1,898,000 43) A Total market value of all assets acquired = $140,000 + $460,000 + $110,000 = $710,000 Allocation to office furniture = Purchase price of $560,000 × ($140,000 ÷ $710,000) = $560,000 × 20% = $112,000 44) A Total market value of all assets acquired = $190,000 + $740,000 + $132,000 = $1,062,000 Allocation to office furniture = Purchase price of $950,000 × ($190,000 ÷ $1,062,000) = $950,000 × 18% = $171,000 45) D Version 1

Cost of machine = List price of $97,000 − Cash discount of $1,940 ($97,000 × 2% discount) + Freight costs of $4,600 + Installation and testing costs of $6,600 = $106,260. The insurance cost is not included in the cost of the machine; it is expensed. 46) D Cost of machine = List price of $160,000 − Cash discount of $3,200 ($160,000 × 2% discount) + Freight costs of $2,400 + Installation and testing costs of $3,000 = $162,200 The insurance cost is not included in the cost of the machine; it is expensed. 47) D Cost of machine = List price of $69,000 − Cash discount of $3,450 ($69,000 × 5%) + Transportation costs of $1,200 + Sales tax of $2,920 + Installation costs of $950 = $70,620. The routine maintenance is not included in the cost of the machine; it is expensed. 48) D Cost of machine = List price of $34,000 − Cash discount of $1,700 ($34,000 × 5%) + Transportation costs of $550 + Sales tax of $1,360 + Installation costs of $450 = $34,660 The routine maintenance is not included in the cost of the machine; it is expensed. 49) A Total market value of all assets acquired = $374,000 + $850,000 + $476,000 = $1,700,000 Allocation to land = Purchase price of $1,600,000 × ($374,000 ÷ $1,700,000) = $1,600,000 × 22% = $352,000 50) A Total market value of all assets acquired = $100,000 + $740,000 + $160,000 = $1,000,000 Allocation to land = Purchase price of $800,000 × ($100,000 ÷ $1,000,000) = $800,000 × 10% = $80,000 51) D Version 1

Total market value of all assets acquired = $74,000 + $1,020,000 + $216,000 = $1,310,000 Allocation to equipment = Purchase price of $1,040,000 × ($216,000 ÷ $1,310,000) = $1,040,000 × 16.49% = $171,496 Double-declining-balance rate = (1 ÷ 4) × 2 = 50% Year 1 depreciation expense = Book value at beginning of year of $171,496 × 50% = $85,748 52) D Total market value of all assets acquired = $20,000 + $340,000 + $40,000 = $400,000 Allocation to equipment = Purchase price of $380,000 × ($40,000 ÷ $400,000) = $380,000 × 10% = $38,000 Double-declining-balance rate = (1 ÷ 4) × 2 = 50% Year 1 depreciation expense = Book value at beginning of year of $38,000 × 50% = $19,000 53) A Cost of machine = List price of $29,000 + Installation costs of $2,400 = $31,400 Depreciation expense = [(Cost of $31,400 − Salvage value of $4,800) ÷ Estimate of 100,000 units] × Units produced during Year 1 of 14,000 = $3,780 54) A Cost of machine = List price of $88,000 + Installation costs of $4,000 = $92,000 Depreciation expense = [(Cost of $92,000 − Salvage value of $8,000) ÷ Estimate of 100,000 units] × Units produced during Year 1 of 13,000 = $10,920 55) A 56) D

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Because the double-declining-balance method recognizes depreciation expense more rapidly than the straight-line method does, it is called an accelerated depreciation method.The maximum depreciation currently allowed by tax law is computed using an accelerated depreciation method known as the MACRS. The units-of-production method bases depreciation expense on actual asset usage and is not an accelerated depreciation method. 57) A Approximately 87% of U.S. companies use the straight-line method. 58) A In general companies want to report the maximum amount of expense on their tax returns thereby reducing the amount of net income and the associated income tax expense. Since accelerated depreciation recognizes more expense in the early life of an asset, companies prefer to use this method to reduce taxation in the early years of an asset’s life. While it is true that the same total amount of depreciation expense is recognized over the life of an asset regardless of the depreciation method used, accelerated depreciation allows companies to report higher depreciation expense in the early years of an asset’s life, thereby deferring (delaying) the tax that must ultimately be paid. If you cannot avoid tax, the next best alternative is to defer (delay) paying it. 59) D Double-declining-balance rate = (1 ÷ 5) × 2 = 40% Year 1 depreciation expense = Book value at beginning of year of $90,000 × 40% = $36,000 Depreciation expense decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows. 60) A Version 1

Double-declining-balance rate = (1 ÷ 10) × 2 = 20% Depreciation expense = (Cost − Accumulated depreciation) × Doubledeclining-balance rate Year 1: $49,000 × 20% = $9,800 Year 2: ($49,000 − $9,800) × 20% = $7,840 61) A Double-declining-balance rate = (1 ÷ 10) × 2 = 20% Depreciation expense = (Cost − Accumulated depreciation) × Doubledeclining-balance rate Year 1: $57,000 × 20% = $11,400 Year 2: ($57,000 − $11,400) × 20% = $9,120 62) B Depreciation decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. 63) D Double-declining-balance rate = (1 ÷ 8) × 2 = 25% Year 1 depreciation expense = Book value at beginning of year of $43,000 × 25% = $10,750 Book value at end of Year 1 = Cost of $43,000 − Accumulated depreciation of $10,750 = $32,250 64) D Double-declining-balance rate = (1 ÷ 8) × 2 = 25% Year 1 depreciation expense = Book value at beginning of year of $48,000 × 25% = $12,000 Book value at end of Year 1 = Cost of $48,000 − Accumulated depreciation of $12,000 = $36,000 65) B

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Depreciation expense = [(Cost of $58,000 − Salvage value of $9,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 31,000 = $7,595 66) B Depreciation expense = [(Cost of $48,000 − Salvage value of $8,000) ÷ Estimate of 100,000 miles] × Miles driven during year of 18,500 = $7,400 67) D Annual depreciation expense = (Cost of $110,000 − Salvage value of $8,000) ÷ 6 years = $17,000 Accumulate deprecation at end of Year 3 = Depreciation expense of $17,000 per year × 3 years = $51,000 68) D Depreciation expense decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders’ equity (Retained Earnings). It increases expenses (depreciation expense) and decreases net income. It does not affect the statement of cash flows. 69) B Double-declining-balance depreciation produces a large amount of depreciation in the first year of an asset’s life and progressively smaller levels of expense in each succeeding year. Because the doubledeclining-balance method recognizes depreciation expense more rapidly than the straight-line method does, it is called an accelerated depreciation method. In the 4th year of the car’s 6-year useful life, straight-line depreciation will produce greater depreciation expense. 70) B

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Cost = $34,375 + $2,375 = $36,750 Double-declining-balance rate = (1 ÷ 5) × 2 = 40% Year 1 depreciation expense = Book value at beginning of year of $36,750 × 40% = $14,700 Book value at end of Year 1 = Cost of $36,750 − Accumulated depreciation of $14,700 = $22,050 Year 2 depreciation expense = Book value at beginning of year of $22,050 × 40% = $8,820 Book value at end of Year 2 = Cost of $36,750 − Accumulated depreciation of ($14,700 + $8,820) = $13,230 Recall that an asset cannot be depreciated below its salvage value. Initially, Year 3 depreciation expense would equal $5,292 (or $13,230 × 40%), which would reduce the book value to $7,938 (or $13,230 − $5,292), which is less than its salvage value of $12,210. Year 3 Depreciation expense = Salvage value of $12,210 − book value at beginning of Year 3 of $13,230 = $1,020 Accumulated depreciation at end of Year 3 = $14,700 + $8,820 + $1,020 = $24,540 71) B

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Cost = $34,000 + $2,000 = $36,000 Double-declining-balance rate = (1 ÷ 5) × 2 = 40% Year 1 depreciation expense = Book value at beginning of year of $36,000 × 40% = $14,400 Book value at end of Year 1 = Cost of $36,000 − Accumulated depreciation of $14,400 = $21,600 Year 2 depreciation expense = Book value at beginning of year of $21,600 × 40% = $8,640 Book value at end of Year 2 = Cost of $36,000 − Accumulated depreciation of ($14,400 + $8,640) = $12,960 Recall that an asset cannot be depreciated below its salvage value. Initially, Year 3 depreciation expense would equal $5,184 (or $12,960 × 40%), which would reduce the book value to $7,776 (or $12,960 − $5,184), which is less than its salvage value of $12,000. Year 3 Depreciation expense = Salvage value of $12,000 − book value at beginning of Year 3 of $12,960 = $960 Accumulated depreciation at end of Year 3 = $14,400 + $8,640 + $960 = $24,000 72) C Annual depreciation expense = (Cost of $36,750 − Salvage value of $12,210) ÷ 5 years = $4,908 Book value at end of Year 3 = Cost of $36,750 − Accumulated depreciation of (3 years × $4,908) = $22,026 Gain (loss) on sale = Proceeds from sale of $16,600 − Book value of $22,026 = ($5,426) Net income = Revenue of $30,300 − Cash expenses of $19,300 − Depreciation expense of $4,908 − Loss on sale of $5,426 = $666 73) C

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Annual depreciation expense = (Cost of $36,000 − Salvage value of $12,000) ÷ 5 years = $4,800 Book value at end of Year 3 = Cost of $36,000 − Accumulated depreciation of (3 years × $4,800) = $21,600 Gain (loss) on sale = Proceeds from sale of $16,000 − Book value of $21,600 = ($5,600) Net income = Revenue of $30,000 − Cash expenses of $19,000 − Depreciation expense of $4,800 − Loss on sale of $5,600 = $600 74) B At the end of Year 5, the end of the office equipment’s 5-year useful life, the book value will be equal to the $12,000 salvage value, regardless of which depreciation method is used. 75) A Purchasing a long-term asset is a deferral event. The cost of the purchase is placed in an asset account on the day of purchase. As the asset is used a portion of its cost will be expensed. Accordingly, the expense recognition is spread over the useful life of the asset. Since the company pays the cash before it recognizes the expense, the purchase is a deferral. 76) C

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Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($64,000 Cost − $4,000 Salvage) ÷ 4 Year life = $15,000 Straight-line depreciation recognizes the same amount of expense for each year of useful life. In this case, $15,000 will be recognized in Year 1, Year 2, Year 3, and Year 4. The depreciation expense account is a temporary account that is closed at the end of each accounting period. Therefore, the depreciation expense account for the truck has a zero balance at the beginning of each accounting period and a before closing balance that is equal to one year’s depreciation ($15,000) at the end of each accounting period. 77) D Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($64,000 Cost − $4,000 Salvage) ÷ 4 Year life = $15,000 The accumulated depreciation account is a permanent contra asset account. As its name implies, the balance accumulates each year. In this case the after closing (ending) balance in the accumulated depreciation account will be $15,000 in Year 1, $30,000 in Year 2, $45,000 in Year 3, and $60,000 in Year 4. 78) B Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($64,000 Cost − $4,000 Salvage) ÷ 4 Year life = $15,000 The book value is the amount of the cost of the asset minus the accumulated depreciation. At the end of Year 2, the book value is $34,000 ($64,000 Cost − $30,000 Accumulated depreciation). Version 1

79) D Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($64,000 Cost − $4,000 Salvage) ÷ 4 Year life = $15,000 The adjusting entry to recognize depreciation expense will cause the accumulated depreciation account to increase by $15,000 which decreases assets (Book Value of Equipment). Note that the question is not asking for the balance in the accumulated depreciation account but instead it is asking how the entry to recognize depreciation expense will affect the financial statements. The recognition of depreciation expense will cause net income to decrease and ultimately stockholders’ equity (retained earnings) to decrease. There is no impact on the statement of cash flows because the associated cash outflow would have been recognized previously when the truck was purchased. 80) B Depreciation expense = [(Cost of $60,000 − Salvage value of $9,000) ÷ Estimate of 100,000 miles] × Miles driven during year of 30,000 = $15,300 81) B Depreciation expense = [(Cost of $46,000 − Salvage value of $8,000) ÷ Estimate of 100,000 miles] × Miles driven during year of 26,000 = $9,880 82) D

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Expense recognition should match as closely as possible the benefit that was derived from the asset in a given period. Total depreciation over an asset’s useful life will be the same regardless of the depreciation method. Different companies in the same industry are free to choose whatever depreciation method they see fit. Because double-declining depreciation recognizes greater expense in an asset’s early years, the straight-line method will result in higher book value until the asset is fully depreciated, at which time the book values will be equal. 83) D The sale increases assets (cash) by $32,000, decreases assets (machine less its accumulated depreciation) by $38,000, for a net decrease in assets of $6,000. Because the machine is sold for $6,000 less than its book value, the company records a loss on the sale of $6,000, which decreases net income and stockholders’ equity (retained earnings). The $32,000 cash received is reported as a cash inflow from investing activities. 84) C The sale increases assets (cash) by $6,000, decreases assets (equipment) by $34,000, and increases assets (by decreasing accumulated depreciation, a contra asset account) by $31,000, resulting in a net increase in assets of $3,000. Because the selling price of $6,000 is greater than the equipment’s book value of $3,000 (or $34,000 − $31,000), Farmer reports a gain on the sale of $3,000, which increases revenue, net income, and stockholders’ equity (retained earnings). The $6,000 cash proceeds are reported as a cash inflow from investing activities. 85) B

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Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($74,000 Cost − $14,000 Salvage) ÷ 5 Year life = $12,000 Accumulated depreciation on January 1, Year 3 = $12,000 per year × 2 years = $24,000 Book value = $74,000 Cost − $24,000 Accumulated depreciation = $50,000 Gain on sale = $54,000 Sales price − $50,000 Book value = $4,000 86) A Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($74,000 Cost − $14,000 Salvage) ÷ 5 Year life = $12,000 Accumulated depreciation on January 1, Year 3 = $12,000 per year × 2 years = $24,000 Book value = $74,000 Cost − $24,000 Accumulated depreciation = $50,000 Loss on sale = $46,000 Sales price − $50,000 Book value = $4,000 87) A The sale results in a cash inflow from investing activities of $16,000, the cash received on the sale. The sale increases assets (cash) by $16,000, decreases assets (equipment) by $44,000, and increases assets (by decreasing accumulated depreciation, a contra asset account) by $32,000, resulting in a net increase in assets of $4,000. 88) D

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Depreciation deduction on Year 1 income tax return = 20% × $130,000 = $26,000 Straight-line method depreciation = ($130,000 − $10,000) ÷ 8 years = $15,000 Taxes will be reduced in Year 1 because the MACRS depreciation charge is higher than the straight-line amount. The amount of taxes delayed for future payment represents a deferred tax liability that will be reported on the balance sheet. 89) D 7-year property will be depreciated over 7 years, and 10-year property will be depreciated over 10 years. Because of the half-year convention, modified accelerated cost recovery system (MACRS) depreciation will be greater in an asset’s second year than its first. MACRS is used for tax reporting, but not for financial statement reporting. 90) C Modified accelerated cost recovery system (MACRS) will typically produce a different depreciation expense than any of the generally accepted accounting principles (GAAP) methods of calculating depreciation. It does not mean that net income is understated, it is just that net income for financial reporting is different than net income for tax reporting. Net income is not misstated as a result of the methods used for tax and financial reporting. 91) C

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Year 1 Depreciation expense = [(Cost of $45,000 − Salvage value of $8,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 54,000 = $9,990 Year 2 Depreciation expense = [(Cost of $45,000 − Salvage value of $8,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 57,000 = $10,545 Book value at end of Year 2 = Cost of $45,000 − Accumulated depreciation of ($9,990 + $10,545) = $24,465 92) C Year 1 Depreciation expense = [(Cost of $36,000 − Salvage value of $2,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 45,000 = $7,650 Year 2 Depreciation expense = [(Cost of $36,000 − Salvage value of $2,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 48,000 = $8,160 Book value at end of Year 2 = Cost of $36,000 − Accumulated depreciation of ($7,650 + $8,160) = $20,190 93) B Annual depreciation expense for Years 1 through 3 = (Cost of $50,000 − Salvage value of $10,000) ÷ 5 years = $8,000 Book value at end of Year 3 = Cost of $50,000 − Accumulated depreciation of ($8,000 × 3) = $26,000 Depreciation expense for Year 4 = (Book value of $26,000 − Revised salvage value of $5,000) ÷ Remaining years of 2 = $10,500 94) B

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Annual depreciation expense for Years 1 through 3 = (Cost of $80,000 − Salvage value of $16,000) ÷ 5 years = $12,800 Book value at end of Year 3 = Cost of $80,000 − Accumulated depreciation of ($12,800 × 3) = $41,600 Depreciation expense for Year 4 = (Book value of $41,600 − Revised salvage value of $8,000) ÷ Remaining years of 2 = $16,800 95) A Annual depreciation expense for Years 1 through 3 = (Cost of $136,000 − Salvage value of $21,000) ÷ 5 years = $23,000 Book value at end of Year 3 = Cost of $136,000 − Accumulated depreciation of ($23,000 × 3) = $67,000 The expected life is now 8 years and, so, there are 5 years remaining. Annual depreciation expense for Years 4 through 8 = (Book value of $67,000 − Salvage value of $21,000) ÷ Remaining years of 5 = $9,200 96) A Annual depreciation expense for Years 1 through 3 = (Cost of $82,000 − Salvage value of $4,000) ÷ 5 years = $15,600 Book value at end of Year 3 = Cost of $82,000 − Accumulated depreciation of ($15,600 × 3) = $35,200 The expected life is now 8 years and, so, there are 5 years remaining. Annual depreciation expense for Years 4 through 8 = (Book value of $35,200 − Salvage value of $4,000) ÷ Remaining years of 5 = $6,240 97) C Annual depreciation expense for Years 1 through 3 = (Cost of $82,000 − Salvage value of $4,000) ÷ 5 years = $15,600 Book value at end of Year 3 = Cost of $82,000 − Accumulated depreciation of ($15,600 × 3) = $35,200 Annual depreciation expense for Years 4 through 8 = (Book value of $35,200 − Revised salvage value of $8,000) ÷ Remaining years of 2 = $13,600 Version 1

98) C Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($100,000 Cost − $30,000 Salvage) ÷ 10 Year life = $7,000 Year 1 2

Depreciation Expense $ 7,000 $ 7,000

Accumulated Depreciation $ 7,000 $ 14,000

$ 7,000

$ 21,000

$ 7,000

$ 28,000

Book Value $ 100,000 − $ 7,000 = $ 93,000 $ 100,000 − $ 14,000 = $ 86,000 $ 100,000 − $ 21,000 = $ 79,000 $ 100,000 − $ 28,000 = $ 72,000

At the beginning of Year 5 the book value is $72,000 and the remaining useful life is 10 years (14 − 4). Revised depreciation expense per year = (Book value − Salvage value) ÷ Useful life Revised depreciation expense per year = ($72,000 Book value − $30,000 Salvage) ÷ 10 Year life = $4,200 99) D Depreciation expense per year = (Cost of the asset − Salvage value) ÷ Useful life Depreciation expense per year = ($100,000 Cost − $30,000 Salvage) ÷ 10 Year life = $7,000 Year 1

Depreciation Expense $ 7,000

Accumulated Depreciation $ 7,000

$ 7,000

$ 14,000

$ 7,000

$ 21,000

$ 7,000

$ 28,000

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Book Value $ 100,000 − $ 7,000 = $ 93,000 $ 100,000 − $ 14,000 = $ 86,000 $ 100,000 − $ 21,000 = $ 79,000 $ 100,000 − $ 28,000 = $ 72,000

Depreciation Expense $ 7,000

Accumulated Depreciation $ 7,000

$ 7,000

$ 14,000

$ 7,000

$ 21,000

$ 7,000

$ 28,000

$ 4,200

$ 32,200

$ 4,200

$ 36,400

Book Value $ 100,000 − $ 7,000 = $ 93,000 $ 100,000 − $ 14,000 = $ 86,000 $ 100,000 − $ 21,000 = $ 79,000 $ 100,000 − $ 28,000 = $ 72,000 $ 100,000 − $ 32,200 = $ 67,800

100) A Annual depreciation expense for Year 1 = (Cost of $40,000 − Salvage value of $7,600) ÷ 6 years = $5,400 Book value at end of Year 1 = Cost of $40,000 − Accumulated depreciation of $5,400 = $34,600 Annual depreciation expense for Years 2 through Year 6 = (Book value of $34,600 + Expenditure of $13,000 − Salvage value of $7,600) ÷ Remaining years of 5 = $8,000 Book value at end of Year 4 = Cost of $40,000 + Expenditure of $13,000 − Accumulated depreciation of ($5,400 + $8,000 + $8,000 + $8,000) = $23,600 101) A

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Annual depreciation expense for Year 1 = (Cost of $52,000 − Salvage value of $4,000) ÷ 6 years = $8,000 Book value at end of Year 1 = Cost of $52,000 − Accumulated depreciation of $8,000 = $44,000 Annual depreciation expense for Years 2 through Year 6 = (Book value of $44,000 + Expenditure of $12,000 − Salvage value of $4,000) ÷ Remaining years of 5 = $10,400 Book value at end of Year 4 = Cost of $52,000 + Expenditure of $12,000 − Accumulated depreciation of ($8,000 + $10,400 + $10,400 + $10,400) = $24,800 102) B The expenditure decreases assets (cash) and increases assets (by decreasing accumulated depreciation, a contra asset account). It is reported as a cash outflow from investing activities. 103) A The expenditure, which improves an asset’s quality, decreases assets (cash) by $850 and increases assets (Book Value of Equipment) by $850. It is reported as a cash outflow from investing activities. 104) C Capital expenditures that extend the useful life decrease accumulated depreciation and decrease cash. Decreasing accumulated depreciation has the effect of increasing the book value of the machine. Retained earnings is not affected. 105) B

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Annual depreciation expense for Years 1 through 4 = (Cost of $24,000 − Salvage value of $1,000) ÷ 8 years = $2,875 Book value at end of Year 4 = Cost of $24,000 − Accumulated depreciation of ($2,875 per year × 4 years) = $12,500 Annual depreciation expense for Years 5 through Year 8 = (Book value of $12,500 + Expenditure of $6,000 − Salvage value of $1,000) ÷ Remaining years of 4 = $4,375 Recognizing the new depreciation expense decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders’ equity (retained earnings) by $4,375. It also increases expenses (depreciation expense) and decreases net income by that amount. 106) C The purchase will decrease assets (Cash) and increase assets (Mineral Rights). It is reported as a cash outflow from investing activities. 107) B Unit depletion charge = Cost of $8,800,000 ÷ Estimate of 640,000 barrels = $13.75 per barrel Depletion expense = Barrels extracted during year of 32,000 × $13.75 per barrel = $440,000 108) B Unit depletion charge = Cost of $12,000,000 ÷ Estimate of 500,000 barrels = $24 per barrel Depletion expense = Barrels extracted during year of 25,000 × $24 per barrel = $600,000 109) D Recognition of depletion decreases assets (the natural resource) and stockholders’ equity (retained earnings). It increases expenses, which decreases net income. It does not affect cash flows. 110) B Version 1

Depletion rate = $3,080,000 ÷ 200,000 barrels = $15.40 per barrel Year 1 Depletion expense = $15.40 × 64,000 barrels = $985,600 Recognizing depletion decreases assets (oil rights) and stockholders’ equity (retained earnings) by $985,600. It also increases expenses, which decreases net income by the same amount. 111) B Depletion rate = $2,400,000 ÷ 200,000 barrels = $12 per barrel Year 1 Depletion expense = $12 × 30,000 barrels = $360,000 Recognizing depletion decreases assets (oil rights) and stockholders’ equity (retained earnings) by $360,000. It also increases expenses, which decreases net income by the same amount. 112) C Depletion of natural resources, such as a timber reserve, is recognized in a similar fashion to the units-of-production method. 113) B Unit depletion charge = Cost of $129,000,000 ÷ Estimate of 50,000 tons = $2,580 per ton Depletion expense = Tons extracted during year of 7,800 × $2,580 per ton = $20,124,000 Net income = Revenue of (7,800 tons × $6,300 per ton) − Depletion expense of $20,124,000 − Operating expenses of $9,030,000 = $19,986,000 114) B Unit depletion charge = Cost of $12,000,000 ÷ Estimate of 50,000 tons = $2,400 per ton Depletion expense = Tons extracted during year of 6,000 × $2,400 per ton = $14,400,000 Net income = Revenue of (6,000 tons × $4,500 per ton) − Depletion expense of $14,400,000 − Operating expenses of $8,040,000 = $4,560,000 Version 1

115) C Purchasing the copyright decreases assets (Cash) and increases assets (Copyright), resulting in no net effect on assets. It is reported as a cash outflow from investing activities. 116) B Amortization decreases assets (Copyright) and stockholders’ equity (Retained Earnings). It increases expenses, which decreases net income. It does not affect cash flows. 117) B Intangible assets, unlike the other assets listed, have no physical substance. They include assets such as copyrights, patents, trademarks, and goodwill. 118) D Goodwill is the value attributable to favorable factors such as reputation, location, and superior products. When one business acquires another business, goodwill is calculated as the excess of the acquisition price (comprised of the cash paid plus the liabilities assumed) over the fair value of the assets acquired. 119) B Intangible assets with identifiable useful lives include patents and copyrights. 120) B Intangible assets with indefinite useful lives must be tested for impairment annually. When the fair value of an intangible asset is less than its book value, an impairment loss must be recognized. 121) D Impairment of goodwill results in an impairment loss. The impairment loss reduces the intangible asset (goodwill), stockholders’ equity (retained earnings) and net income. The statement of cash flows is not affected. Version 1

122) A Because goodwill does not have an identifiable useful life, it is not amortized. Instead, it must be tested for impairment annually. 123) D The costs of intangible assets with identifiable useful lives are normally expensed on a straight-line basis using a process called amortization. 124) C Goodwill = Cash paid of $1,025,000 + Liabilities assumed of $208,000 − Fair value of assets acquired of $740,000 = $493,000 125) C Goodwill = Cash paid of $770,000 + Liabilities assumed of $160,000 − Fair value of assets acquired of $680,000 = $250,000 126) D Patents are amortized over the shorter of their legal or useful lives. Year 3 Amortization expense = Cost of $288,000 ÷ 5 years = $57,600 Book value at end of Year 3 = Cost of $288,000 − Amortization todate of ($57,600 × 3 years) = $115,200 127) D Patents are amortized over the shorter of their legal or useful lives. Year 3 Amortization expense = Cost of $80,000 ÷ 5 years = $16,000 Book value at end of Year 3 = Cost of $80,000 − Amortization to-date of ($16,000 × 3 years) = $32,000 128) A The acquisition will increase goodwill by $220,000. $1,200,000 + $60,000 = $1,260,000 the amount paid for the asset $1,260,000 the amount paid for the asset − $1,040,000 the fair value of the assets acquired = $220,000 the amount of goodwill. 129) D

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Depletion expense, amortization expense, and depreciation expense all decrease assets and stockholders’ equity (retained earnings). They also increase expenses, which decreases net income. They do not affect cash flows. 130) D The acquisition will decrease cash by $600,000, increase “Lee’s Assets” by $520,000 (the assets’ fair value), increase liabilities by $40,000 (the amount assumed), and increase goodwill for the difference of $120,000. The cash paid of $600,000 is reported as a cash outflow from investing activities. 131) C Recognizing depreciation decreases assets (by increasing accumulated depreciation, a contra asset account) and stockholders’ equity (retained earnings). It also increases expenses (depreciation expense), which decreases net income. Thus, the choice of depreciation methods impacts the debt-to-assets ratio (total liabilities ÷ total assets), total assets, and return-on-equity ratio (net income ÷ total equity). Depreciation does not affect cash flows. 132) B The method used to recognize depreciation expense should match the asset’s usage pattern. 133) D A stock brokerage, relative to the other industries listed, has little in property, plant, and equipment compared to revenue produced. The brokerage instead uses human capital, which does not appear on the balance sheet. 134) B

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Because Zeiss capitalizes research and development and expenses it over its useful life, Zeiss will report higher assets and lower expenses than Pierce. Therefore, Pierce, with lower assets, will have a higher debt-toassets ratio. 135) B Annual depreciation expense = (Cost of $260,000 − Salvage value of $10,000) ÷ 5 years = $50,000 136) C Annual depreciation expense = (Cost of $3,500 − Salvage value of $750) ÷ 5 years = $550 The $3,500 cash outflow to purchase the office equipment is shown as an investing activity on the statement of cash flows. There is no related cash flow from operating activities during Year 1. 137) B Annual depreciation expense = (Cost of $20,000 − Salvage value of $2,000) ÷ 5 years = $3,600 Accumulated depreciation at end of Year 2 = Depreciation expense of $3,600 per year × 2 Years = $7,200 138) D Double-declining-balance rate = (1 ÷ 4) × 2 = 50% Depreciation expense = Book value at beginning of year of $24,000 × 50% = $12,000 139) B Double-declining-balance rate = (1 ÷ 4) × 2 = 50% Year 1 depreciation expense = Book value at beginning of year of $60,000 × 50% = $30,000 Book value at end of Year 1 = Cost of $60,000 − Accumulated depreciation of $30,000 = $30,000 Year 2 depreciation expense = Book value at beginning of year of $30,000 × 50% = $15,000 Version 1

140) D Double-declining-balance rate = (1 ÷ 5) × 2 = 40% Year 1 depreciation expense = Book value at beginning of year of $50,000 × 40% = $20,000 Book value at end of Year 1 = Cost of $50,000 − Accumulated depreciation of $20,000 = $30,000 Year 2 depreciation expense = Book value at beginning of year of $30,000 × 40% = $12,000 Accumulated depreciation at end of Year 2 = $20,000 + $12,000 = $32,000 141) A Depreciation expense = [(Cost of $53,000 − Salvage value of $3,000) ÷ Estimate of 200,000 miles] × Miles driven during year of 30,000 = $7,500 142) B Depreciation expense = [(Cost of $64,000 − Salvage value of $4,000) ÷ Estimate of 120,000 miles] × Miles driven during year of 20,000 = $10,000 143) C Depreciation rate = (Cost of $36,000 − Salvage value of $6,000) ÷ Estimate of 150,000 miles = $0.20 per mile Year 1 Depreciation expense = 40,000 miles × $0.20 per mile = $8,000 Year 2 Depreciation expense = 24,000 miles × $0.20 per mile = $4,800 Accumulated depreciation at the end of Year 2 = $8,000 + $4,800 = $12,800 144) B Accumulated depreciation is a contra-asset account that is reported on the balance sheet. 145) D

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Generally, depreciation expense is reported as an operating expense on the income statement. 146) C Depreciation expense is an asset use transaction that decreases assets(Book Value of Delivery Truck) and stockholders’ equity (Retained Earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows.

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CHAPTER 9: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Warren Company recorded a year-end adjustment to recognize accrued interest expense on a note payable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Gilliam Company repaid a note payable on September 30, Year 1. The 8-month note had been issued on February 1, Year 1. The $20,800 cash payment included a $20,000 repayment of principal and a $800 payment for interest that had not been previously accrued. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Joseph Company issued a one-year, 6% note to Community Bank. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

4) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA On April 1, Year 2, Jenkins Company repaid a $20,000, one-year, 6% note and interest to Community Bank. Interest on the note had been accrued on December 31, Year 1. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

of Cash Flows

Statement of Cash Flows

7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Ping Company remitted the sales tax due (that is, paid cash to the tax authority). Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Sierra Mining is the defendant in a $3 million lawsuit involving damage to the environment. Sierra's attorneys have advised the company that the outcome of the lawsuit is reasonably possible, but not probable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

9) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Sierra Mining is the defendant in a $3 million lawsuit involving damage to the environment. Sierra's attorneys have advised the company that the outcome of the lawsuit is probable, and the likely settlement will be $750,000. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

10) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Kelly Company sells goods to customers with a three-year warranty. On December 31, Year 1, Kelly made the appropriate year-end adjustment to record the warranty expense related to the goods sold during the year. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

11) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Kelly Company sells goods to customers with a three-year warranty. Previously, Kelly made the appropriate year-end adjustment to record the warranty expense related to the goods sold during the preceding year. During the current year, Kelly paid $4,000 cash to satisfy warranty claims. Show the effects of the current year payments to satisfy warranty claims. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

12) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Charles Company paid salary expense for employees who are subject to tax withholding. The salaries had not been previously accrued. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

13) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Charles Company paid Jason Hewitt for work he performed as an independent contractor. The amount owed had not been previously accrued. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

14) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Charles Company submitted payments for withheld state and federal employment taxes. Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

of Cash Flows

15) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Charles Company recognized payroll tax expense for the employer portion of FICA tax and federal and state unemployment taxes. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

16) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA Charles Company recorded accrued vacation pay. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

17) On September 1, Year 1, Wiggins Company issued a $66,000 note payable that had a one-year term and an annual interest rate of 8%. What amount of interest expense will be recognized on the income statement for Year 1 and for Year 2, respectively?

18) How does the issuance of a note payable, accrual of interest, and repayment of the note's principal and interest each affect a company's statement of cash flows?

19) What accounting concept requires a company to accrue interest expense on a note payable?

20)

Why does the recording of a taxable sale increase a company's liabilities?

21) Under what conditions should a pending lawsuit be recognized in a company's financial statements? Under what conditions should the lawsuit be disclosed in the notes to the financial statements?

22) If a company pays cash to settle a customer's warranty claim, what is the effect on the accounting equation?

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23)

When is warranty expense usually recognized?

24)

What is the effect of the recognition of warranty expense on the statement of cash flows?

25) Ian Brown and Gayle Hubbard both perform work for Max Manufacturing. Ian Brown is an employee, and Gayle Hubbard is an independent contractor. How is this possible? How do these classifications affect payroll taxes?

26) Jack Grimes is hired by First Associates at a salary of $4,000 per month. He is shocked when his first monthly paycheck is only $3,150. Explain to Jack some of the factors that may have contributed to the difference.

27)

How does a classified balance sheet enhance the usefulness of accounting information?

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28) What is liquidity? What is the primary ratio used to evaluate a company's liquidity? How is this ratio calculated?

29) How is the current ratio calculated? What is its significance in analyzing financial statements?

30) The following transactions apply to Baird Corporation. 1) Issued common stock for $40,000 cash. 2) Provided services to customers for $32,000 on account. 3) Borrowed $30,000 on September 1 at 8% interest with a one-year term. 4) Purchased land for $32,000 cash. 5) Paid $22,000 for operating expenses. 6) Collected $28,000 cash from customers in partial settlement of its accounts receivable. 7) Recorded interest on the note payable at year end. 8) Paid $4,000 dividends to stockholders. Required: 1.a) Identify the effect on the statement of cash flows for each of the above transactions. Include the amount and the type of cash flow activity. Cash payments should be entered using parenthesis. 2.b) Classify the above accounting events into one of four types of transactions (asset source, asset use, asset exchange, claims exchange).

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31) On October 1, Year 1, Tankard Company borrowed $45,000 from the bank and issued a note for that amount. The note had a one-year term and an annual interest rate of 8%. Required: 1.a) Compute the amount of interest expense that will be shown on the Year 1 income statement. 2.b) What is the total amount of cash that will be paid to the bank at the maturity of the note on October 1, Year 2? 3.c) Prepare the liabilities section of the balance sheet at December 31, Year 1.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 32) Indicate whether each of the following is true or false. Perez Company borrowed money from its bank in July Year 1. The accrual of interest on the loan at the end of Year 1: 1.a) reduces cash flows. 2.b) involves recognition of interest expense. 3.c) does not affect income for Year 1. 4.d) involves recognition of a liability. 5.e) records a cash payment for interest.

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33)

Indicate whether each of the following statements is true or false.

1.a) An eight-month, 6% note for $10,000 will require the issuer to pay $600 in interest. 2.b) Interest expense is considered an operating expense on the income statement. 3.c) Payment of interest is considered an operating activity on the statement of cash flows. 4.d) Payment of interest on a one-year note due on March 1 will include a reduction in liabilities. 5.e) The adjustment to recognize interest expense is an asset use transaction.

34) Fisher Company has been named as the defendant in a class action lawsuit. In addition, the company is located in a region that normally has an active hurricane season. Indicate whether each of the following statements is true or false. 1.a) If the likelihood of a future obligation is probable and can be reasonably estimated, a liability should be recognized on the balance sheet. 2.b) If the outcome is probable, but cannot be reasonably estimated, the contingency should be disclosed in the notes to the financial statements. 3.c) If the outcome is reasonably possible but not likely, the contingency should be disclosed in the notes to the financial statements. 4.d) Every lawsuit, regardless how frivolous, should be disclosed in the notes to the financial statements. 5.e) Since it is located in a region for which an active hurricane season has been predicted, the company must disclose the contingent liability, which is the potential for catastrophic loss, in the notes to their financial statements.

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35) Clarion Company provides a one-year warranty on all merchandise it sells. In Year 1, the company recorded sales of $500,000. It estimated that the warranty costs on these sales would amount to $2,000. In July of Year 2, Clarion paid $250 to satisfy a warranty claim. Indicate whether each of the following statements is true or false. 1.a) Clarion's adjustment to record the warranty at the end of Year 1 decreased total assets and total stockholders' equity. 2.b) Clarion's adjustment to record the warranties at the end of Year 1 increased Clarion's total liabilities. 3.c) The transaction, dated in July of Year 2, decreased total assets and net income for Year 2. 4.d) The $250 payment to satisfy a warranty claim in July of Year 2, decreased Clarion's total liabilities. 5.e) The adjustment to record the warranty at the end of Year 1 did not affect Clarion's revenue for the year.

36)

Indicate whether each of the following statements is true or false.

1.a) The extension of a warranty on goods sold normally represents a legal obligation to the seller of the goods. 2.b) Recognizing the warranty obligation increases the Warranties Payable account and decreases a revenue account. 3.c) Recording the payment of cash to settle a warranty claim increases expenses (Warranties Expense) and decreases liabilities (Warranties Payable). 4.d) Net income is not affected by the payment of cash to settle a warranty claim. 5.e) Total assets are not affected by the adjustment to record the warranty obligation.

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37)

Indicate whether each of the following statements is true or false.

1.a) The amount of warranty expense is an estimate that is based on the amount of merchandise sold. 2.b) A warranty obligation only occurs if a buyer purchases an extended warranty. 3.c) When a warranty claim is settled, the seller's equity decreases. 4.d) When a warranty claim is settled, the seller's liabilities increase. 5.e) Product warranties usually represent legal liabilities that must be reported in the financial statements.

38)

Indicate whether each of the following statements is true or false.

1.a) The amount of federal tax withheld from an employee's salary depends on the employee's gross pay and the number of withholding allowances the employee claims. 2.b) Withheld taxes are recorded in the payroll tax expense account. 3.c) An employer will submit $8,250 in FICA taxes for an employee who earns $55,000 annually. (Assume a Social Security rate of 6 percent on the first $110,000 of income and a Medicare rate of 1.5 percent on all earnings.) 4.d) A voluntary deduction, such as a charitable contribution, creates a liability when it is withheld from employee pay. 5.e) If an employer records gross pay of $2,400 and withholds $700 of that amount, then the employer will recognize $1,700 in salary expense.

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39)

Indicate whether each of the following statements is true or false.

1.a) Operating cycles for most businesses are less than one year. 2.b) If a business does not plan to use any of its current assets to repay a debt, then that debt is listed as long term even if it is due within a year. 3.c) The current ratio is computed by dividing current assets by net income. 4.d) The current ratio is a useful measure of a company's liquidity. 5.e) Liquidity is the ability of a business to repay liabilities in the long run.

40) Zinke Company borrowed $100,000 from Plains Bank on July 31, Year 1. The note carried a 6% interest rate with a one-year term to maturity. Required: 1.1) Show the effects of borrowing the money and then the adjustment required at the end of Year 1 on the accounting equation. 2.2) What is the amount of interest expense for Year 1? 3.3) How does this transaction affect the statement of cash flows for the Zinke Company for Year 1?

41) Moreno Company began Year 1 with a balance of $300 in Sales Tax payable. During the year, the company recorded taxable sales of $92,500. The ending balance in Sales Tax payable was $445. Moreno's sales tax rate is 4%. Required: 1.a) How much sales tax did Moreno collect during Year 1? 2.b) How much sales tax did Moreno remit (pay to taxing authority) during Year 1?

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42) Broward Company estimated its warranty obligations to customers at $6,250 for the current year. During the year, Broward paid $3,920 to settle warranty claims made by customers. Required: 1.a) What is the amount of warranty expense for the current year? 2.b) If this is the first year of operations, what is the amount of warranty liability that will be shown on the balance sheet at the end of the year?

43) At the beginning of Year 2, McKee, Incorporated had a balance in the Warranties Payable account of $15,600. During the year McKee sold for $650,000 several products that carried a two-year warranty. McKee estimated that warranty expense would be 3% of sales for the year. Required: a) If McKee's incurred actual warranty cost is $12,500 during Year 1, what is the balance in the Warranties Payable account after the adjustment for warranty expense?

44) The following is a list of balance sheet accounts (in random order) and balances for Premium Office Supply Company. They have been updated as of December 31, Year 1. Builiding Land

$ 240,000 80,000

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Retained earnings Notes payable (due in 10years) Inventory Equipment Accounts payable Common stock Accumulated Depreciation - Builiding Accumulated Depreciation - Equipment Cash Unearned revenue Accounts receivable

320,000 136,000 480,000 96,000 112,000 480,000 80,000 32,000 80,000 16,000 200,000

Required: Prepare a classified balance sheet for Premium Office Supply Company at December 31, Year 1.

45)

Chester Company has the following post-closing balances on December 31, Year 1:

Cash Marketable securities Accounts receivable Inventory Equipment Accumulated depreciation Land Accounts payable Unearned revenue Notes payable - due in 6 months Bonds payable - due in 20 years Common stock Retained earnings Totals

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$ 20,000 32,000 48,000 80,000 140,000 88,000 200,000 72,000 8,000 40,000 80,000 100,000 132,000 $ 520,000

Required: 1.1) Use the balances of Chester Company to prepare the current assets and current liabilities sections of Chester's balance sheet at December 31, Year 1. 2.2) Calculate the current ratio at December 31, Year 1. Show all calculations and round the ratio to two decimal places.

46) On October 1, Kramer Company issued a $100,000 face value discount note. The note had a 6% discount rate and a one-year term to maturity. Kramer received cash in the amount of $94,000. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

47) On December 31, Colfax Company recognized accrued interest expense in the amount of $1,500. The interest expense was related to a discount note that Colfax had issued earlier in the year. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

48) On December 31, Year 2, Bates Company paid $60,000 to Municipal Bank to pay off the face value of a discount note that Bates had issued one year earlier. Show the effects of the payment and recognition of Year 2 interest on the note. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

49)

Statement of Cash Flows

How is the carrying value of a discount note payable computed?

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Answer Key Test name: Chap 09_2e_Problem Materials 1) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

The year-end adjustment to accrue interest expense increases liabilities (Interest Payable) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. It does not affect the statement of cash flows. 2) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D D NA I D

Statement of Cash Flows D

Because the note's issuance and repayment both occurred within the same year, interest had not been previously accrued. Therefore, the repayment decreases assets (cash) by $20,800, decreases liabilities (notes payable) by $20,000, and decreases stockholders' equity (retained earnings) by $800. It increases expenses (interest expense) by $800, which decreases net income. The repayment of principal is reported as a cash outflow from financing activities and the payment of interest is reported as a cash outflow from operating activities. 3) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

Issuing a note payable increases assets (Cash) and increases liabilities (Notes Payable). It is reported as a cash inflow from financing activities. 4) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D D NA I D

Statement of Cash Flows D

Repaying the note and interest decreases assets (Cash), decreases liabilities (Notes Payable and Interest Payable), and decreases stockholders' equity (Retained Earnings). It increases expenses (for the Year 2 interest expense), which decreases net income. The principal is reported as a cash outflow from financing activities and the interest is reported as a cash outflow from operating activities. 5) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows D

The purchase increases assets (Machine) and decreases assets (Cash), for a net increase in assets. It also increases liabilities (Notes Payable). The cash outflow is reported as an investing activity on the statement of cash flows. 6) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I I I NA I

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Statement of Cash Flows I

The sale increases assets (Cash), increases liabilities (Sales Tax Payable) and increases stockholders' equity (Retained Earnings). It increases revenue (sales), which increases net income. It is reported as a cash inflow from operating activities. 7) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

Statement of Cash Flows D

Paying sales tax decreases assets (Cash) and decreases liabilities (Sales Tax Payable). It is reported as a cash outflow from operating activities on the statement of cash flows. 8) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA NA NA NA NA NA

Statement of Cash Flows NA

Contingent liabilities that are considered reasonably possible, but not probable, are not reported on the financial statements. They are disclosed in the footnotes to the financial statements. 9) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

If a future obligation is probable and reasonably estimable, accruing that liability increases liabilities (Contingent Liabilities) and decreases stockholders' equity (Retained Earnings). It increases expenses, which decreases net income. It does not affect the statement of cash flows. 10) Version 1

Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

The adjustment made at the end of Year 1 to estimate future warranty costs related to Year 1 sales increases liabilities (Warranties Payable) and decreases stockholders' equity (Retained Earnings). It increases expenses (warranty expense), which decreases net income. It does not affect the statement of cash flows. 11) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

Statement of Cash Flows D

The payments to satisfy warranty claims decrease assets (Cash) and decrease liabilities (Warranties Payable). They do not affect the income statement. The payments are reported as cash outflows from operating activities. 12) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D I D NA I D

Statement of Cash Flows D

Paying the salaries decreases assets (Cash), increases liabilities (Employee Income Tax Payable), and decreases stockholders' equity (Retained Earnings). It increases expenses (salary expense), which decreases net income. The payment is reported as a cash outflow from operating activities on the statement of cash flows. 13) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net

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Statement of Cash

Equity D

Income D

Flows D

Independent contractors are not subject to payroll taxes. The payment to the independent contractor decreases assets (Cash) and decreases stockholders' equity (Retained Earnings). It increases expenses (external labor expense), which decreases net income. It is reported as a cash outflow from operating activities on the statement of cash flows. 14) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

Statement of Cash Flows D

Paying withheld employment taxes decreases assets (Cash) and decreases liabilities (Employee Income Tax Payable). It does not affect the income statement. It is reported as a cash outflow from operating activities on the statement of cash flows. 15) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

Recognizing the employer portion of employment taxes increases liabilities (FICA Tax Payable and Unemployment Tax Payable) and decreases stockholders' equity (Retained Earnings). It increases expense (payroll tax expense), which decreases net income. It does not affect the statement of cash flows until the taxes are paid. 16) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

Recording accrued vacation pay increases liabilities (Vacation Pay Payable) and decreases stockholders' equity (Retained Earnings). It increases expenses (vacation pay expense), which decreases net income. It does not affect the statement of cash flows. 17) $1,760 and $3,520 Year 1 (September thru December): $66,000 × 8% × (4 ÷ 12) = $1,760 Year 2 (January thru August): $66,000 × 8% × (8 ÷ 12) = $3,520 18) The proceeds from issuing a note payable are reported as a cash inflow from financing activities. The accrual of interest expense does not affect cash flows. The repayment of principal is reported as a cash outflow from financing activities. The payment of interest is reported as a cash outflow from operating activities. 19) Accrual accounting Accrual accounting requires that companies recognize expenses in the period in which they are incurred regardless of when cash is paid 20) A liability increases because the company is collecting sales tax from the customer and owes that tax to the state taxing authority. It is recorded in an account called sales tax payable. 21) A pending lawsuit should be recognized in a company's financial statements if the outcome is deemed to be probable, and if its amount can be reasonably estimated. The lawsuit should be disclosed in the notes to the financial statements if the outcome is reasonably possible, or, if probable but the amount cannot be reasonably estimated.

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22) Assets (Cash) are decreased and liabilities (Warranties Payable) are decreased. The cash payment for the repair is not an expense. Warranty expense was recognized in the period in which the sale was made (when the Warranties Payable account was increased). The payment decreases assets (Cash) and liabilities (Warranties Payable). 23) Warranty expense is recognized when goods are sold that are subject to warranty. 24) The recognition of warranty expense does not affect the statement of cash flows. A cash outflow from operating activities will be recorded on the statement of cash flows when cash is paid to settle a warranty claim. 25) Businesses must distinguish between independent contractors and employees because payroll taxes apply only to employees. When a business supervises, directs, and controls an individual's work, the individual is an employee of the business. When a business pays an individual for specific services, but the individual supervises and controls the work, then that individual is an independent contractor. Max Manufacturing is required to withhold payroll taxes for employees, such as Ian Brown, and is responsible for remitting those employee taxes, as well as paying the employer portion of FICA and unemployment taxes, to the federal government. Max Manufacturing is not required to withhold taxes for independent contractors, such as Gayle Hubbard, and is not obligated to pay the employer portion of FICA and unemployment taxes for work performed by independent contractors.

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26) Several deductions are made from an employee's monthly salary to arrive at net pay. These include withheld federal, state, and possibly local income taxes, as well as employee portion of FICA (6% for Social Security and 1.5% for Medicare). In addition, he may have other deductions for medical insurance premiums, pension contributions, and charitable contributions. 27) Because meeting obligations on time is critical to business survival, financial analysts and creditors are interested in whether companies will have enough money available to pay bills when they are due. Most businesses provide information about their bill-paying ability by classifying their assets and liabilities according to liquidity. Balance sheets that distinguish between current and noncurrent items are called classified balance sheets. To enhance the usefulness of accounting information, most real-world balance sheets are classified. 28) Liquidity describes the ability to generate sufficient short-term cash flows to pay obligations as they come due. The primary ratio used to evaluate liquidity is the current ratio. The current ratio is calculated by dividing current assets by current liabilities. 29) The current ratio is calculated by dividing current assets by current liabilities. The current ratio is among the most widely used ratios in analyzing financial statements. 30) a) Event 1 2 3 4 5

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Cash flow 40,000 FA NA 30,000 FA (32,000) IA (22,000) OA

b) Trasaction type Asset Source Asset Source Asset Source Asset Exchange Asset Use

6 7 8

28,000 OA NA (4,000) FA

Asset Exchange Claims Exchange Asset Use

31) 1.a) $900 2.b) $3,600 Cash paid at maturity = Principal of $45,000 + Interest of $3,600 = $48,600 3.c) 4. Notes payable Interest payable Total liabilities

$ 45,000 900 $ 45,900

1.b) Interest expense = Face amount of $45,000 × 8% × (3 ÷ 12) = $900 2.c) Interest due on note = $45,000 × 8% × (12 ÷ 12) = $3,600 Cash paid at maturity = Principal of $45,000 + Interest of $3,600 = $48,600 32) a) F b) T c) F d) T e) F 1.a) This is false. Adjustments for accruals never involve cash. 2.b) This is true. The adjustment increases interest expense. 3.c) This is false. Recognition of interest expense decreases net income in Year 1. 4.d) This is true. The adjustment increases interest payable, a liability. 5.e) This is false. The company recognizes an expense, but payment of interest on the loan occurs when the loan is due in the following year.

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33) a) F b) F c) T d) T e) F 1.a) This is false. Interest on this note (which has a term of 8 months) = $10,000 × 6% × (8 ÷ 12) months = $400. 2.b) This is false. Interest expense is reported below operating income on the income statement. 3.c) This is true. Payment of interest, like payment of all expenses, is reported as an operating activity on the statement of cash flows. 4.d) This is true. Because interest on the note had been accrued at the end of the previous year, payment of interest involves a reduction of interest payable. 5.e) This is false. The adjustment is a claims exchange transaction that increases liabilities (Interest Payable) and decreases stockholders’ equity (Retained Earnings).

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34) a) T b) T c) T d) F e) F 1.a) This is true. If the likelihood of a future obligation arising is probable (likely) and its amount can be reasonably estimated, a liability is recognized in the financial statements. 2.b) This is true. If the likelihood of a future obligation is probable but cannot be reasonably estimated, no liability is reported on the balance sheet. The potential liability is, however, disclosed in the notes to the financial statements. 3.c) This is true. If the likelihood of a future obligation arising is reasonably possible but not likely, no liability is reported on the balance sheet. The potential liability is, however, disclosed in the notes to the financial statements. 4.d) This is false. If the likelihood of a future obligation arising is remote, which might be the case with a frivolous lawsuit, no liability need be recognized in the financial statements or disclosed in the notes to the statements. 5.e) This is false. All businesses face uncertainties such as competition and damage from floods or storms. Such uncertainties are not contingent liabilities, however, because they do not arise from past events.

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35) a) F b) T c) F d) T e) T 1.a) This is false. The adjustment would increase liabilities (warranties payable) and decrease stockholders' equity (retained earnings). It increases expenses (warranty expense), which decreases net income. 2.b) This is true. The adjustment would increase liabilities (warranties payable). 3.c) This is false. The payment of $250 to satisfy the warranty claim decreased assets (cash) and decreased liabilities (warranties payable). 4.d) This is true. The $250 payment decreases warranties payable, a liability. 5.e) This is true. The adjustment would increase liabilities (warranties payable) and decrease stockholders' equity (retained earnings). It increases expenses (warranty expense), which decreases net income. It does not affect revenue.

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36) a) T b) F c) F d) T e) T 1.a) This is true. Offering a warranty creates a legal obligation on the part of the seller. 2.b) This is false. Recognizing the warranty obligation increases liabilities (warranties payable) and expenses (warranty expense). It does not decrease revenue. 3.c) This is false. Recording the payment of cash to settle a warranty claim decreases assets (cash) and decreases liabilities (warranties payable). 4.d) This is true. Recording warranty payments does not affect revenues or expenses; thus, it does not affect net income. 5.e) This is true. The adjustment is a claims exchange transaction that increases liabilities (warranties payable) and decreases stockholders' equity (retained earnings). It increases expenses (warranty expense), which decreases net income. 37) a) T b) F c) F d) F e) T 1.a) This is true. Warranty expense is generally estimated as a percentage of sales. 2.b) This is false. A warranty obligation occurs whenever a warranty is offered, whether the customer pays extra or not. 3.c) This is false. When a warranty claim is settled, it decreases assets (cash) and liabilities (warranties payable). It does not affect expenses, net income, or stockholders' equity. 4.d) This is false. Settling a warranty claim decreases assets (cash) and liabilities (warranties payable). 5.e) This is true. Although the amount and timing of warranty obligations are uncertain, warranties usually represent liabilities that must be reported in the financial statements.

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38) a) T b) F c) T d) T e) F 1.a) This is true. Gross pay increases federal tax withheld and allowances decrease federal tax withheld. 2.b) This is false. Withheld taxes are recorded in the employment taxes payable account, but are not included in payroll tax expense. 3.c) This is true. The employer will submit $4,125 of employer FICA taxes and $4,125 of employee FICA taxes, for a total of $8,250. 4.d) This is true. When a voluntary deduction is made, the employer has an obligation to pay that amount to the intended party, which creates a liability. 5.e) This is false. Salary expense will be recorded for the full amount of gross pay. 39) a) T b) T c) F d) T e) F 1.a) This is true. An operating cycle is defined as the average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash. For most businesses, the operating cycle is less than one year. 2.b) This is true. In general, if a business does not plan to use any of its current assets to repay a debt, that debt is listed as long term even if it is due within one year. 3.c) This is false. Current ratio is equal to current assets divided by current liabilities. 4.d) This is true. The current ratio is a measure of liquidity. 5.e) This is false. Liquidity describes the ability to generate sufficient short-term cash flows to pay obligations as they come due. 40) 1) Assets

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Liabilities

Equity

July 31 December 31

100,000

2,500

(2,500)

2) $2,500 3) The proceeds of $100,000 are reported as a cash inflow from financing activities. 41) 1.a) $3,700 2.b) $3,555 1.a) Sales tax collected = Sales of $92,500 Tax rate of 4% = $3,700 2.b) Ending balance of sales tax payable = Beginning balance of sales tax payable + Sales tax collected − Sales tax remitted $445 = $300 + $3,700 − Sales tax remitted Sales tax remitted = $3,700 + $300 − $445 = $3,555 42) 1.a) $6,250 2.b) $2,330 1.a) The recognition of warranty obligations to customers who purchased the merchandise during the year increases warranty expense (with an increase to warranties payable) for $6,250, which is the amount of the estimate of the warranty obligation. 2.b) Ending balance of warranties payable = Beginning balance of warranties payable + Warranty expense − Warranty claims paid Ending balance of warranties payable = $0 (since this is the first year of operations) + $6,250 − $3,920 = $2,330 43) a) Beginning balance in warranties payable Less: Warranty claims

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$ 15,600 (12,500)

Add: Warranty expense Ending balance in warranties payable

19,500 $ 22,600

a) Warranty expense = Sales of $650,000 × 3% = $19,500 44) Premium Office Supply Company Classified Balance Sheet As of December 31, Year 2 Assets Current Assets Cash

$ 80,000

Accounts receivable

200,000

Inventory

480,000

Total Current Assets

760,000

Property, Plant and Equipment Equipment Less: Accumulated depreciation Building Less: Accumulated depreciation Land

96,000 (32,000) 240,000 (80,000) 80,000

Total Property, Plant, and Equipment

304,000

Total Assets

$ 1,064,000

Liabilities and Stockholders' Equity Current Liabilities Accounts payable

$ 112,000

Unearned revenue

16,000

Total Current Liabilities

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$ 128,000

Long-Term Liabilities Notes payable

136,000

Total Liabilities

264,000

Stockholders' Equity Common stock

480,000

Retained earnings

320,000

Total Equity Total Liabilities and Stockholders' Equity

800,000 $ 1,064,000

45) 1) Current Assets: Cash Marketable securities Accounts receivable Inventory Total

$ 20,000 32,000 48,000 80,000 $ 180,000

Current Liabilities: Accounts payable Unearned revenue Notes payable - due in 6 months Total

72,000 8,000 40,000 $ 120,000

2) Current ratio = Current assets of $180,000 ÷ Current liabilities of $120,000 = 1.5 to 1 Indicate how the events affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I = D Not Affected = NA 46) Version 1

Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows I

Issuing the note increases assets (Cash) by $94,000, decreases liabilities (Discount on Notes Payable) by $6,000, and increases liabilities (Notes Payable) by $100,000. Total liabilities increase by $94,000. It does not affect the income statement. The cash proceeds are reported as a cash inflow from financing activities on the statement of cash flows. 47) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

Accruing interest expense on a discount note increases liabilities (by decreasing the Discount on Notes Payable, a contra liability account) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. It does not affect the statement of cash flows. 48) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D D NA I D

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Statement of Cash Flows D

When the note is repaid, Bates must first recognize interest expense for Year 2 by amortizing the remaining balance in the discount on notes payable account. This portion of the transaction increases liabilities (by decreasing Discount on Notes Payable, a contra liability account) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The payment of the note's face value decreases assets (Cash) and decreases liabilities (Notes Payable). The net effect on liabilities is a decrease. The payment is reported as a cash outflow from financing activities for the principal and as a cash outflow from operating activities for the interest. 49) The carrying value of the liability is the difference between the Notes Payable and the Discount on Notes Payable account balances.

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CHAPTER 9 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The borrower is sometimes called the issuer of a note payable. ⊚ true ⊚ false

2) In September of Year 1, Hansen Company issued a note payable to borrow money from its bank. Principal and interest on the note would come due in June Year 2. Interest expense on this note must be accrued at the end of Year 1 for the period from issuance of the note to the last day of the accounting period. ⊚ true ⊚ false

3) Payment of interest on a note payable is considered a financing activity on the statement of cash flows. ⊚ true ⊚ false

4) When calculating interest expense on a 6-month note, multiply the principal by the interest rate, and then multiply by (6 ÷ 12). ⊚ true ⊚ false

5) Joseph Company is preparing to repay a one-year note on May 1, Year 2. The first step in this process is to accrue eight months of interest expense. ⊚ true ⊚ false

6) Vogel Company purchased $8,000 of equipment by making a $500 down payment and issuing a note for the remainder. As a result of this event, assets increased by $8,000. ⊚ true ⊚ false

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7) paid.

Sales tax is reported as revenue when it is collected, and reported as an expense when it is ⊚ ⊚

true false

8) Monthly remittance of sales tax due has no effect on the income statement, but reduces cash flow from operating activities. ⊚ true ⊚ false

9) Flora's Flower Market sells eight potted petunias to a customer for $50.00, plus 5% sales tax. Flora's will recognize $52.50 in sales revenue. ⊚ true ⊚ false

10) All lawsuits in which a company has been named a defendant should be either disclosed in the company's notes to the financial statements, or recognized as a liability on its balance sheet. ⊚ true ⊚ false

11)

Vacation pay is considered a contingent liability. ⊚ true ⊚ false

12)

Contingent liabilities are only recognized if they arise from past events. ⊚ true ⊚ false

13) If a company is in a region in which floods or earthquakes are deemed to be possible, the company should record a contingent liability. ⊚ true ⊚ false

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14) If a company offers a warranty on the products it sells, the company records the warranty expense at the time that service is provided to customers under the terms of the warranty. ⊚ true ⊚ false

15)

Recording an adjustment for product warranties is a claims exchange transaction. ⊚ true ⊚ false

16) At the end of Year 1, Durango Company recorded an adjustment for its obligation under product warranties. During Year 2, it paid cash to settle warranty claims from its customers. The Year 2 warranty settlements are asset use transactions. ⊚ true ⊚ false

17) Federal Insurance Contributions Act (FICA) taxes are recorded both as salary expense and as payroll tax expense. ⊚ true ⊚ false

18)

Employers must withhold unemployment taxes from employee salaries. ⊚ true ⊚ false

19) The Wage and Tax Statement, Form W-2, is sent to the employee annually to report earnings and withheld taxes. ⊚ true ⊚ false

20)

Independent contractors must be individuals who are employed by another company. ⊚ true ⊚ false

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21) A classified balance sheet is one that distinguishes between operating and non-operating assets. ⊚ true ⊚ false

22)

A classified balance sheet is necessary for calculating a company's current ratio. ⊚ true ⊚ false

23)

The current ratio is a measure of a company's liquidity. ⊚ true ⊚ false

24) A company with a high current ratio should be concerned that it is not maximizing its earnings potential. ⊚ true ⊚ false

25)

The current ratio is calculated as total current assets divided by total assets. ⊚ true ⊚ false

26) On October 1, Year 1, Harrison Company borrowed money by issuing a $24,000 face value discount note to its bank. The note had an 8% discount rate and had a one-year term to maturity. The amount of cash that Harrison received on that date was $22,080. ⊚ true ⊚ false

27) On October 1, Year 1, Harrison Company borrowed money by issuing a $24,000 face value discount note to its bank. The note had an 8% discount rate and had a one-year term to maturity. On December 31, Year 1, Harrison should accrue interest expense in the amount of $1,920.

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⊚ ⊚

true false

28) On October 1, Year 1, Harrison Company borrowed money by issuing a $24,000 face value discount note to its bank. The note had an 8% discount rate and had a one-year term to maturity. On that date, Harrison recorded a Discount on Notes Payable in the amount of $1,920. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 29) How does the going concern assumption affect accounting for notes payable? A) It dictates that notes payable be reported at their face value. B) It dictates that interest expense be accrued at the end of the accounting period. C) It dictates that notes payable be reported at their net realizable value. D) It dictates that interest expense be paid when the note matures.

30) Receivables are normally reported on the balance sheet at net realizable value. In contrast, payables are carried at face value. Which accounting principle requires this treatment of payables? A) Materiality concept B) Monetary unit assumption C) Going concern assumption D) Realizability concept

31) What is (are) the term(s) used to describe the party who borrows money as evidenced by a note payable? A) Lender B) Payee C) Issuer D) Issuer and lender

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32) Houston Company borrowed $20,000 from Dallas Company on March 1, Year 1. Houston issued a note payable that had a one-year term and the annual interest rate is 8%. How will the necessary adjustment, dated December 31, Year 1, affect the Year 1 financial statements? A) Increase liabilities and increase expenses B) Increase assets and increase revenues C) Increase assets and increase liabilities D) No effect

33) Franklin Company issued a $40,000 note to the Mercantile Bank on August 1, Year 1. The note carried a one-year term and a 12% rate of interest. How will the adjustment, dated December 31, Year 1, to record accrued interest expense impact the financial statements? A) Decrease assets and decrease retained earnings by $2,000 B) Increase liabilities and decrease stockholders’ equity by $2,000 C) Increase liabilities and decrease stockholders’ equity by $1,600 D) Decrease stockholders’ equity and increase liabilities by $4,800

34) On September 1, Year 1, West Company borrowed $34,000 from Valley Bank. West agreed to pay interest annually at the rate of 9% per year. The note issued by West carried an 18month term. West Company has a calendar year-end. What is the amount of interest expense that will be reported on West's income statement for Year 1? A) $-0B) $1,020 C) $306 D) $765

35) On September 1, Year 1, West Company borrowed $10,000 from Valley Bank. West agreed to pay interest annually at the rate of 6% per year. The note issued by West carried an 18month term. West Company has a calendar year-end. What is the amount of interest expense that will be reported on West's income statement for Year 1?

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A) $-0B) $150 C) $60 D) $200

36) Madison Company issued an interest-bearing note payable with a face value of $12,000 and a stated interest rate of 8% to Metropolitan Bank on August 1, Year 1. The note carried a one-year term. Based on this information alone, what is the amount of cash flow from operating activities reported on Madison’s Year 1 statement of cash flows? A) $960 B) $400 C) $12,000 D) $-0-

37) Madison Company issued an interest-bearing note payable with a face value of $24,000 and a stated interest rate of 8% to Metropolitan Bank on August 1, Year 1. The note carried a one-year term. Based on this information alone, what is the amount of cash flow from operating activities reported on Madison’s Year 1 statement of cash flows? A) $1,920 B) $800 C) $24,000 D) $-0-

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38) Madison Company issued an interest-bearing note payable with a face value of $24,000 and a stated interest rate of 8% to Metropolitan Bank on August 1, Year 1. The note carried a one-year term. Based on this information alone, what is the amount of total liabilities appearing on Madison's balance sheet as of December 31, Year 1? A) $25,120 B) $24,800 C) $25,920 D) $24,000

39) Madison Company issued an interest-bearing note payable with a face value of $24,000 and a stated interest rate of 8% to Metropolitan Bank on August 1, Year 1. The note carried a one-year term. Based on this information alone, what is the amount of total liabilities appearing on Madison's balance sheet as of December 31, Year 1? A) $24,720 B) $24,800 C) $25,920 D) $24,000

40) Riley Company borrowed $42,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 8% annual interest rate. Riley earned cash revenues of $1,080 during Year 1 and $1,700 during Year 2. Assume no other transactions. Based on this information alone, what is the amount of net income (loss) that will be reported on the Year 2 income statement? A) $840 B) $860 C) $(20) D) $2,540

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41) Riley Company borrowed $36,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 7% annual interest rate. Riley earned cash revenues of $1,700 during Year 1 and $1,400 during Year 2. Assume no other transactions. Based on this information alone, what is the amount of net income (loss) that will be reported on the Year 2 income statement? A) $770 B) $630 C) $(190) D) $1,890

42) Riley Company borrowed $48,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 6% annual interest rate. Riley earned cash revenues of $1,140 during Year 1 and $1,500 during Year 2. Assume no other transactions. Based on this information alone, what amount of cash flow from operating activities would appear on the Year 2 statement of cash flows? A) $1,500 inflow. B) $1,380 outflow. C) $780 inflow. D) $48,780 outflow.

43) Riley Company borrowed $36,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 7% annual interest rate. Riley earned cash revenues of $1,700 during Year 1 and $1,400 during Year 2. Assume no other transactions.

Based on this information alone, what amount of cash flow from operating activities would appear on the Year 2 statement of cash flows? A) $770 inflow B) $1,400 inflow C) $38,520 outflow D) $1,120 outflow

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44) Riley Company borrowed $34,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 4% annual interest rate. Riley earned cash revenues of $1,000 during Year 1 and $800 during Year 2. Assume no other transactions.

Based on this information alone, what are the amounts of total liabilities that would appear on Riley's December 31 balance sheets for Year 1 and Year 2, respectively? A) $34,000 and $0 B) $35,020 and $0 C) $35,020 and $35,480 D) $1,020 and $460

45) Riley Company borrowed $36,000 on April 1, Year 1 from Titan Bank. The note issued by Riley carried a one-year term and a 7% annual interest rate. Riley earned cash revenues of $1,700 during Year 1 and $1,400 during Year 2. Assume no other transactions.

Based on this information alone, what are the amounts of total liabilities that would appear on Riley's December 31 balance sheets for Year 1 and Year 2, respectively? A) $36,000 and $0 B) $37,890 and $0 C) $37,890 and $38,520 D) $1,890 and $630

46)

Issuing a note payable is a(n): A) Claims exchange transaction B) Asset source transaction C) Asset use transaction D) Asset exchange transaction

47)

Which of the following is a claims exchange transaction?

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A) Accrual of interest on a note payable B) Issued a note to purchase equipment C) Repaid principal on a note payable D) Paid interest on a note payable

48) Which of the following happens as a result of selling $130 of merchandise to a customer for $200 cash in a state where the sales tax rate is 4%? A) The cash flow from operating activities increases by $208. B) Total assets increase by $78. C) Stockholders' equity increases by $70. D) All of these answer choices are correct.

49) Yang Company sold merchandise for $4,000. The event is subject to a state sales tax of 9%. Based on this information, Yang would be required to A) Recognize sales revenue on $4,360. B) Recognize sales tax liability of $360. C) Recognize sales tax expense of $360. D) Recognize sales revenue of $3,640.

50) Yang Company sold merchandise for $10,000 cash. The event is subject to a state sales tax of 9%. Recognizing the sale will require Yang to A) increase revenue. B) increase assets. C) increase liabilities. D) All of the answers are correct.

51)

Yang Company paid $360 cash to settle its sales tax liability. This event will

Version 1

A) Decrease assets and increase liabilities B) Increase assets and decrease liabilities C) Decrease assets and liabilities D) Increase assets and liabilities

52) Wilson Company earned $4,000 of cash sales. Sales tax is 6%. Which of the following shows how this event would affect the company’s financial statements (ignore the effects of cost of goods sold)? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. 4,000 240 3,760 3,760 n/a 3,760 3,760 OA b. 4,240

240

4,000

n/a

4,000

4,240OA

c. 4,240

240

4,000

n/a

4,000

n/a

d. 4,240

240

4,000

4,240

n/a

4,240

4,240OA

A) Option A B) Option B C) Option C D) Option D

53) Which of the following shows how remitting (paying) sales tax will affect the financial statements of the company making the payment? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. − − n/a n/a + − −OA b.

−

n/a

−

n/a

−OA

−

n/a

−OA

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A) Option A B) Option B C) Option C D) Option D

54)

Which of the following describes the effect of remitting the sales tax to the tax authority? A) Decreases liabilities. B) A claims exchange transaction. C) Decreases stockholders' equity. D) All of these answer choices are correct.

55) Under what condition should a pending lawsuit be recognized as a liability on a company's balance sheet? A) The amount can be reasonably estimated. B) The outcome is probable. C) The outcome is reasonably possible. D) The outcome is probable and can be reasonably estimated.

56) Burger Barn has been named as a plaintiff in a $5 million lawsuit filed by a customer over the addictive nature of the company's burgers. Burger Barn's attorneys have advised them that the likelihood of a future obligation from the suit is remote. What should Burger Barn do as a result of the information that is available? A) Disclose the lawsuit in the notes to the financial statements B) Recognize a $5 million liability on its balance sheet for the contingency C) Ignore the lawsuit in its financial statements D) Settle with the customer immediately for $5 million to avoid harmful publicity

57) Star Company has a contingent liability that has a likelihood of actual occurrence that is classified as probable. Also, the amount of the liability can be reasonably estimated. Under these circumstances, Star is required to Version 1

A) recognize a liability only. B) recognize an expense only. C) recognize a liability and an expense in its financial statements. D) disclose but not recognize the liability or the expense.

58)

According to GAAP a contingent liability can be classified as A) probable and estimable. B) reasonably possible, or probable but not estimable. C) remote. D) All of the answers describe classifications of contingent liabilities.

59) Homer Security Systems experienced an event that had the following effects on its financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income n/a + − n/a + − n/a

Which of the following events would have caused these effects? A) Recognizing a contingent liability that has a remote chance of occurring B) Recognizing a contingent liability that has a reasonably possible chance of occurring but is not estimable C) Recognizing a contingent liability that has a probable chance of occurring and is estimable D) All of the answers describe events that could have caused the effects shown in the financial statements model.

60) GrayCo has initiated a lawsuit against FinCo for a copyright violation. Negotiations between the lawyers representing the two companies suggest that it is probable that GrayCo will win the case and will collect a $2,000,000 settlement fee. Generally Accepted Accounting Principles

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A) require FinCo to recognize a $2,000,000 contingent liability but does not permit GrayCo to recognize a $2,000,000 contingent asset. B) require FinCo to recognize a $2,000,000 contingent liability and GrayCo to recognize a $2,000,000 contingent asset. C) require only FinCo to disclose the suit but does not require the company to show the amount of the settlement as a liability. D) require neither FinCo nor GrayCo to disclose this information in their financial statements.

61) In December Year 1, Lucas Corporation sold merchandise for $10,000 cash. Lucas estimated that the warranty obligation relating to this sale is $700. On February 12, Year 2, Lucas paid cash of $550 to settle a related warranty claim by this customer. Which of the following summarizes the effect of the recognition of the warranty obligation to the customer who purchased this merchandise on the Year 1 financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. n/a (700) 700 700 n/a 700 n/a b. (700)

n/a

(700)

n/a

700

(700)

(700)OA

c. (700)

(700)

n/a

(700) OA

700

(700)

n/a

700

(700)

n/a

A) Option A B) Option B C) Option C D) Option D

62) In December Year 1, Lucas Corporation sold merchandise for $10,000 cash. Lucas estimated that the warranty obligation relating to this sale is $700. On February 12, Year 2, Lucas paid cash of $550 to settle a related warranty claim by this customer. Which of the following summarizes the effect of the payment of cash to settle the warranty claim in Year 2 on the financial statements?

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Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. (430) (550) (120) n/a 120 (120) (430) OA b. (550)

(550)

n/a

(550)OA

c. (550)

(550)

n/a

550

(550)

(550) FA

d. (550)

n/a

(550)

n/a

550

(550

(550)OA

A) Option A B) Option B C) Option C D) Option D

63) In December Year 1, Lucas Corporation sold merchandise for $10,000 cash. Lucas estimated that the warranty obligation relating to this sale is $700. On February 12, Year 2, Lucas paid cash of $550 to settle a related warranty claim by this customer. Which of the following reflects the effect of the year-end adjustment to record estimated warranty expense? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. n/a + − n/a + − n/a b.

n/a

−

n/a

−

n/a

−

n/a

−

−OA

−

n/a

−

n/a

−

n/a

A) Option A B) Option B C) Option C D) Option D

64)

When do the effects of warranty obligations affect the statement of cash flows?

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A) When the sale of merchandise is made. B) When the warranty obligation is recognized. C) When there is a settlement of a warranty claim made by a customer. D) None of these answer choices are correct.

65) During Year 1, its first year of operations, Benitez Company reported sales of $360,000. At the end of Year 1, the company estimated its warranty obligation at 2% of sales. During Year 1, the company paid $4,800 cash to settle warranty claims. Which of the following statements is true? A) Warranty expenses would decrease net earnings by $7,200 in Year 1. B) Cash decreased by $4,800 as a result of the accounting events associated with warranties in Year 1. C) The warranties payable account has a balance of $2,400 at the end of Year 1. D) All of these answer choices are correct.

66) During Year 1, its first year of operations, Benitez Company reported sales of $800,000. At the end of Year 1, the company estimated its warranty obligation at 3% of sales. During Year 1, the company paid $13,000 cash to settle warranty claims. Which of the following statements is true? A) Warranty expenses would decrease net earnings by $24,000 in Year 1. B) Cash decreased by $13,000 as a result of the accounting events associated with warranties in Year 1. C) The warranties payable account has a balance of $11,000 at the end of Year 1. D) All of these answer choices are correct.

67)

The adjusting entry required to recognize warranty expense will cause A) assets and stockholders’ equity to increase. B) liabilities to decrease and stockholders’ equity to increase. C) assets and liabilities to decrease. D) liabilities to increase and stockholders’ equity to decrease.

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68) Extra Supplies had sales of $240,000 in Year 1. Extra warrants its products and estimates warranty expense to be 3% of sales. Which of the following shows how the year-end adjusting entry would affect the company’s assets, liabilities, and stockholders’ equity? Total Assets

Liabilities

Stockholders' Equity

$ 240,000 NA $ 240,000 NA

$ 7,200 $ 7,200 NA (7,200)

$ 232,800 $ (7,200) $ 240,000 $ 7,200

A. B. C. D.

A) Option A B) Option B C) Option C D) Option D

69) Taylor Tools has sales of $400,000 in Year 1. Taylor warrants its products and estimates warranty expense to be 4% of sales. Which of the following shows how the year-end adjusting entry would affect the company’s assets, liabilities, and cash flow from operating activities?

A. B. C. D.

Total Assets

Liabilities

NA NA $ (16,000) $ 16,000

$ 16,000 $ 16,000 $ 16,000 $ (16,000)

Cash Flow from Operating Activities $ (16,000) NA NA NA

A) Option A B) Option B C) Option C D) Option D

70) Which of the following shows how paying off a warranty obligation will affect a company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

Version 1

−

n/a

−

n/a

−

n/a

−

n/a

−

n/a

−OA

n/a

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

71) Tom Toys has sales of $250,000 in Year 1. Tom warrants its products and estimates warranty expense to be 2% of sales. Which of the following shows how the year end adjusting entry for warranty expense would affect the company’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. n/a (5,000) (5,000) n/a 5,000 (5,000) n/a B.

n/a

5,000

(5,000)

n/a

5,000

C. (5,000)

n/a

(5,000)

n/a

5,000

(5,000) (5,000) OA (5,000) n/a

5,000

(5,000)

n/a

5,000

(5,000)

n/a

A) Option A B) Option B C) Option C D) Option D

72) Greer Company pays Jamal Perry a salary of $5,600 per week. How much FICA tax must Greer pay with regards to this employee (including both the employee and employer portions)?(Assume a Social Security rate of 6 percent on the first $110,000 of income and a Medicare rate of 1.5 percent on all earnings.)

Version 1

A) $420 B) $840 C) $-0D) $672

73) Greer Company pays Jamal Perry a salary of $3,000 per week. How much FICA tax must Greer pay with regards to this employee (including both the employee and employer portions)? (Assume a Social Security rate of 6 percent on the first $110,000 of income and a Medicare rate of 1.5 percent on all earnings.) A) $225 B) $360 C) $-0D) $450

74)

What factor distinguishes an employee from an independent contractor? A) The amount of the pay B) Whether or not the company supervises and controls the work C) Whether or not the work is performed on company property D) Whether the individual chooses to be treated as an independent contractor

75)

Which of the following is not an item deducted from salary expense to arrive at net pay? A) FICA tax for Social Security B) FICA tax for Medicare C) Federal unemployment tax D) These answer choices are all deducted from salary expense to arrive at net pay

76)

What is the purpose of the Federal W-4 form?

Version 1

A) To notify the federal government when a new employee is hired B) To allow an employee to choose the number of withholding allowances for calculating federal withholding tax C) To remit monthly payments for FICA to the federal government D) To notify the employee at year-end of the amount of federal tax withheld

77)

Which of the following is responsible for paying social security (FICA) tax? A) Employee only B) Employer only C) Federal government D) Both employee and employer

78)

Which of the following is responsible for paying unemployment tax? A) Employee only B) Employer only C) Federal government D) Both employee and employer

79) Mr. Ortega earns a monthly salary of $4,000. Based on Mr. Ortega’s Form W-4, the tax tables require withholding $450 per month for income taxes. Mr. Ortega has authorized his employer to deduct $190 per month for medical insurance and $15 per month for a charitable contribution to the Humane Society. Assume a FICA tax rate of 6%, a Medicare tax rate of 1.5%, and an Unemployment tax rate of 6% on the first $7,000 of income. Based on this information, Mr. Ortega’s net pay for January 31, Year 1 is A) $3,000. B) $2,805. C) $4,000. D) $3,045.

Version 1

80) Mr. Ortega earns a monthly salary of $4,000. Based on Mr. Ortega’s Form W-4, the tax tables require withholding $450 per month for income taxes. Mr. Ortega has authorized his employer to deduct $190 per month for medical insurance and $15 per month for a charitable contribution to the Humane Society. Assume a FICA tax rate of 6%, a Medicare tax rate of 1.5%, and an Unemployment tax rate of 6% on the first $7,000 of income. Based on this information, the total amount of accrued payroll tax expense incurred by Mr. Ortega’s employer for January is A) $610. B) $300. C) $540. D) $810.

81) Mr. Ortega earns a monthly salary of $4,000. Based on Mr. Ortega’s Form W-4, the tax tables require withholding $450 per month for income taxes. Mr. Ortega has authorized his employer to deduct $190 per month for medical insurance and $15 per month for a charitable contribution to the Humane Society. Assume a FICA tax rate of 6%, a Medicare tax rate of 1.5%, and an Unemployment tax rate of 6% on the first $7,000 of income. Which of the following shows how recognizing the accrued payroll tax expense would affect the employer’s financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. n/a + − n/a + − n/a B.

−

n/a

−

n/a

−

n/a

−

n/a

−

−FA

−

n/a

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

82)

Which of the following items would most likely not be classified as a current asset?

Version 1

A) Office equipment B) Merchandise inventory C) Office supplies D) Prepaid rent

83) On a classified balance sheet, the financial statement user will be able to distinguish between: A) cash flow from operations and cash flow from investing activities. B) current and noncurrent assets. C) product and period costs. D) none of these answer choices are correct.

84) Which of the following items would typically appear in the current liabilities section of a classified balance sheet?

A) Interest payable B) Salaries payable C) Accounts payable D) All of these answer choices are correct.

85)

Which of the following would not likely appear on a classified balance sheet? A) Current assets B) Current retained earnings C) Long-term liabilities D) Long-term assets

86) Which of the following would not likely appear in the current liabilities section of a classified balance sheet?

Version 1

A) Accounts payable B) Salaries payable C) Bonds payable D) Taxes payable

87) A company's classified balance sheet shows current assets of $8,650 and current liabilities of $6,000. What is the company's current ratio? A) 0.69 to 1 B) 1.44 to 1 C) 1.16 to 1 D) 3.26 to 1

88) The following information is taken from the balance sheet of Menendez Company on January 1, Year 1: Current Assets Equipment Land

$ 11,000 31,000 23,000

Current Liabilities Long-term Liabilities Common Stock

$ 4,500 21,000 39,500

Total Assets

$ 65,000

Total Liabilities & Equity

$ 65,000

On January 2, Year 1, the company earned revenue on account of $9,250. How will this transaction affect the current ratio? A) It will decrease the current ratio to 1:1. B) It will increase the current ratio to 4.5:1. C) It will increase the current ratio to 2.4:1. D) It will have no effect on the current ratio.

89) The following information is taken from the balance sheet of Menendez Company on January 1, Year 1: Current Assets Equipment Land

Version 1

$ 12,000 52,000 36,000

Current Liabilities Long-term Liabilities Common Stock

$ 4,000 32,000 64,000

Total Assets

$ 100,000

Total Liabilities & Equity

$ 100,000

On January 2, Year 1, the company earned revenue on account of $8,000. How will this transaction affect the current ratio? A) It will decrease the current ratio to 1:1. B) It will increase the current ratio to 3:1. C) It will increase the current ratio to 5:1. D) It will have no effect on the current ratio.

90) The following information is taken from the balance sheet of Menendez Company on January 1, Year 1: Current Assets Equipment Land

$ 12,000 52,000 36,000

Current Liabilities Long-term Liabilities Common Stock

Total Assets

$ 100,000

Total Liabilities & Equity

$ 4,000 32,000 64,000 $ 100,000

On January 1, Year 1 Menendez Company paid $2,000 cash to reduce its accounts payable.

How will this transaction affect the current ratio? A) It will have no effect on the current ratio. B) It will cause the current ratio to increase. C) It will cause the current ratio to decrease. D) It will potentially affect the current ratio, but the direction of the change cannot be determined without more information.

91)

The following information is taken from the balance sheet of Atlanta Company:

Current assets Property, Plant & Equipment Total assets

$ 720 1,200 $ 1,920

Current liabilities Noncurrent liabilities Total liabilities

$ 600 760 $ 1,360

What is Atlanta Company's current ratio?

Version 1

A) 2.27 to 1 B) 1.2 to 1 C) 1.41 to 1 D) 0.8 to 1

92)

The following information is taken from the balance sheet of Atlanta Company:

Current assets Property, Plant & Equipment Total assets

$ 960 1,450 $ 2,410

Current liabilities Noncurrent liabilities Total liabilities

$ 600 770 $ 1,370

What is Atlanta Company's current ratio? A) 2.5 to 1 B) 1.6 to 1 C) 1.76 to 1 D) 0.66 to 1

93) The December 31, Year 1, balance sheet of Rowan Company shows current assets of $32,000 and current liabilities of $18,000. On January 1, Year 2, the company had the following two transactions: 1) Issued common stock for $14,800 cash 2) Received a $4,000 cash payment for its accounts receivable After the two transactionsare recorded, what is the company’s current ratio? A) 2 to 1 B) 1.8 to 1 C) 2.8 to 1 D) 2.6 to 1

Version 1

94) The December 31, Year 1, balance sheet of Rowan Company shows current assets of $32,000 and current liabilities of $20,000. On January 1, Year 2, the company had the following two transactions: 1) Issued common stock for $10,000 cash 2) Received a $6,000 cash payment for its accounts receivable After the two transactions are recorded, what is the company’s current ratio? A) 2 to 1 B) 1.6 to 1 C) 2.4 to 1 D) 2.1 to 1

95)

What is the current ratio used to evaluate? A) Solvency B) Liquidity C) Equity D) Profitability

96)

How is the current ratio calculated? A) Current assets divided by total assets B) Current assets minus current liabilities C) Current assets divided by current liabilities D) Retained earnings divided by current liabilities

97)

Which of the following terms describes the ability to generate short-term cash flows? A) Profitability B) Solvency C) Stockholder's Equity D) Liquidity

Version 1

98) When a company borrows money by issuing a discount note, the company will receive an amount of cash that is A) less than the face value of the note. B) greater than the face value of the note. C) equal to the face value of the note. D) greater than the liquidation value of the note.

99) On October 1, Year 1 Coker Company issued a $2,000 face value discount note that carried a 6% annual interest rate and a one year term to maturity. On the date of issue A) the amount of total assets would increase by $2,000. B) the amount of total liabilities would increase by $1,880. C) the amount of total assets would increase by $2,120. D) the amount of total liabilities would increase by $2,120.

100) On October 1, Year 1, Hartford Company issued a $20,000 face value discount note. The note had a 6% discount rate and a one-year term to maturity. Which of the following would be included in the adjustment, dated December 31, Year 1, to recognize interest accrued since the issuance date? A) An increase to Discount on Notes Payable of $300 B) An increase to Interest Expense for $300 C) An increase to Interest Payable for $300 D) None of these answer choices are correct.

101) Seattle Company issued a $90,000 face value discount note payable to First Federal Bank on September 1, Year 1. The note had a 4% discount rate and a one-year term. What is the amount of interest expense appearing on the Year 1 income statement?

Version 1

A) $1,200 B) $3,600 C) $2,400 D) $7,200

102) Seattle Company issued a $90,000 face value discount note payable to First Federal Bank on September 1, Year 1. The note had a 4% discount rate and a one-year term. What is the effect of the accrual of interest expense on the financial statements? A) Liabilities will increase and retained earnings will decrease. B) Assets and liabilities will decrease. C) Assets will increase and retained earnings will increase. D) Liabilities will increase and assets will decrease.

103) Seattle Company issued a $90,000 face value discount note payable to First Federal Bank on September 1, Year 1. The note had a 4% discount rate and a one-year term. What is the carrying value of the liability appearing on the December 31, Year 1 balance sheet? A) $80,400 B) $87,600 C) $90,000 D) $88,800

104) Baltimore Company issued a $9,000 face value discount note to Bank of the Chesapeake on March 1, Year 1. The note had a 5% discount rate and a one-year term to maturity. How would the adjustment to record interest expense on December 31, Year 1 affect the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. n/a 375 (375) n/a 375 (375) n/a

Version 1

n/a

450

(450)

n/a

450

(450)

n/a

c. (375)

n/a

(375)

n/a

375

(375)

(375) OA

d. (450)

(450)

n/a

(450)OA

A) Option A B) Option B C) Option C D) Option D

105) Baltimore Company issued a $9,000 face value discount note to Bank of the Chesapeake on March 1, Year 1. The note had a 5% discount rate and a one-year term to maturity. After accruing all interest expense due as of April 1, Year 2, Baltimore Company made the cash payment for the full amount due (i.e., principal and interest) to Bank of the Chesapeake. How does the cash payment affect Baltimore's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. (9,450) (9,450) n/a n/a n/a n/a (9,000) FA/(450) FA b. (8,550) (8,550) n/a n/a n/a n/a (8,550) FA c. (9,000) (9,000) n/a n/a n/a n/a (9,000) FA d. (9,000) (9,000) n/a n/a n/a n/a (8,550) FA/(450) OA

A) Option A B) Option B C) Option C D) Option D

106) How does the amortization of the discount on a note payable affect a company's financial statements? Version 1

A) Decreases interest expense and decreases liabilities B) Decreases interest expense and increases liabilities C) Increases interest expense and decreases liabilities D) Increases interest expense and increases liabilities

107)

Which of the following statements is true regarding discount notes?

A) They are recorded in the account "notes payable" at more than face value on the day of issue. B) They are recorded in the account "notes payable" at face value on the day of issue. C) They are recorded in the account "notes payable" at less than face value on the day of issue. D) They are not recorded until the maturity date.

108) Craig Company issued a discount note for cash. How does this event affect Craig's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income a. + n/a + + n/a + +OA b.

n/a

+FA

n/a

+FA

n/a

+OA

A) Option A B) Option B C) Option C D) Option D

109)

Which of the following accounts appear in the liabilities section of the balance sheet?

Version 1

A) Accounts payable, notes payable, allowance for doubtful accounts B) Warranties payable, discount on notes payable, accounts payable C) Notes payable, discount on notes payable, credit card receivables D) Accounts payable, allowance for doubtful accounts, warranties payable

110) During Year 1, Bradley Corporation issued a $20,000 face value discount note to Fidelity Bank. The note had a 6% discount rate and a one-year term to maturity. On December 31, Year 1, Bradley failed to make the year-end adjustment to accrue the related interest. Which of the following summarizes the effect of this error? A) Net income for Year 1 is overstated and liabilities for Year 1 are overstated B) Net income for Year 1 is understated and net income for Year 2 is overstated C) Net income for Year 1 is understated and liabilities for Year 1 are overstated D) Net income for Year 2 is understated and liabilities for Year 1 are understated

111)

What type of account is Discount on Notes Payable? A) Contra liability B) Liability C) Contra asset D) Expense

Version 1

Answer Key Test name: Chap 09_2e_Test Bank_MCQs_TF 1) TRUE Since the borrower issues the note, the borrower is sometimes called the issuer. 2) TRUE Because the money borrowed helps Hansen to generate revenue in Year 1, it is necessary for Hansen to recognize the expense (interest) related to that borrowed money in Year 1. 3) FALSE Payment of interest is an operating activity. 4) TRUE Interest rates are always expressed as annual rates, so it is necessary to multiply by 6 out of 12 months for a 6-month note. 5) FALSE At the time of repayment, Jackson should accrue 4 months of interest expense (January 1—May 1, Year 2). 6) FALSE Assets (equipment) increase by $8,000 and assets (cash) decreases by $500, for a net increase of $7,500. Liabilities (notes payable) increase by $7,500. 7) FALSE When sales tax is collected, it is reported as a liability, which is decreased when the tax is paid. It has no effect on the income statement. 8) TRUE

Version 1

Remittance of sales tax decreases assets (cash) and liabilities (sales tax payable). It does not affect the income statement. It is reported as a cash outflow from operating activities. (Recall that the collection of sales tax is reported as a cash inflow from operating activities). 9) FALSE Only the $50 selling price is considered revenue. The $2.50 of sales tax collected is recorded as a liability (sales tax payable). 10) FALSE If the likelihood of a future obligation arising is remote, which might be the case with a frivolous lawsuit, no liability need be recognized in the financial statements or disclosed in the notes to the statements. 11) TRUE If the likelihood of a future obligation arising is probable (likely) and its amount can be reasonably estimated, a liability is recognized in the financial statements. Contingent liabilities in this category include warranties, vacation pay, and sick leave. 12) TRUE Contingent liabilities cannot be reported for events that have not yet occurred, such as hurricanes or other natural disasters. 13) FALSE All businesses face uncertainties such as competition and damage from floods or storms. Such uncertainties are not contingent liabilities, however, because they do not arise from past events. 14) FALSE Although the exact amount of future warranty claims is unknown at the time of the sale, the company must estimate the amount of the warranty liability and report the estimate in the financial statements that include the related sales. Recognizing this obligation increases liabilities (warranties payable) and reduces stockholders’ equity (retained earnings). Recognizing the warranty expense reduces net income. Version 1

15) TRUE Liabilities (warranties payable) increase and stockholders’ equity (retained earnings) decreases as the result of warranties expense. 16) TRUE Assets (cash) decrease and liabilities (warranties payable) decrease when the company pays cash to settle warranty claims. 17) TRUE The employee portion of FICA is withheld from employees' gross pay, and is, in effect, included in salary expense. The employer portion of FICA is considered payroll tax expense. 18) FALSE Unemployment tax is paid by the employer and is not withheld from employee salaries. 19) TRUE The employee then sends a copy of the W-2 to the IRS as evidence of earnings and taxes paid. 20) FALSE When a business pays an individual for specific services, but the individual supervises and controls the work, then that individual is an independent contractor. Independent contractors can be self-employed. 21) FALSE A classified balance sheet distinguishes between current and non-current assets and liabilities. 22) TRUE The current ratio is the ratio of current assets to current liabilities, so it is necessary to distinguish between current and noncurrent assets and liabilities. A classified balance sheet makes these distinctions. 23) TRUE The primary ratio used to evaluate liquidity is the current ratio. 24) TRUE Version 1

A high current ratio may indicate that the company has an excess of cash, which could be put to better use, or an excess of receivables or inventory. Any of these may prevent a company from maximizing its earnings potential. 25) FALSE The current ratio equals current assets divided by current liabilities. 26) TRUE When a discount note is issued, the amount of the discount is deducted from the face value of the note to determine the amount of cash received. Proceeds from discounted note = Face value of $24,000 − Discount of ($24,000 × 8%) = $22,080 27) FALSE Discount = $24,000 × 8% = $1,920 Interest expense = $1,920 ÷ 12 months × 3 months (October 1— December 31) = $480 28) TRUE $24,000 × 8% = $1,920 Discount on Notes Payable 29) A Unless there is evidence to the contrary, companies are assumed to be going concerns that will continue to operate. Under this going concern assumption, companies expect to pay their obligations in full. Notes payable are therefore reported at face value. 30) C Unless there is evidence to the contrary, companies are assumed to be going concerns that will continue to operate. Under this going concern assumption, companies expect to pay their obligations in full. Notes payable are therefore reported at face value. In contrast, companies need to estimate the net realizable value of receivables, which is the amount of receivables a company expects to actually collect. Version 1

31) C Since the borrower issues the note, the borrower is sometimes called the issuer. 32) A At the end of the year, the company would make an adjustment to recognize ten months (March 1 through December 31) of accrued interest expense. Accruing interest expense increases liabilities (Interest Payable) and decreases stockholders’ equity (Retained Earnings). It increases interest expense, which decreases net income. The cash flow statement is not affected. 33) B Accrued interest expense = $40,000 × 12% × (5 ÷ 12) = $2,000 The adjustment to accrue interest expense will increase liabilities (Interest Payable) and decrease stockholders’ equity (Retained Earnings). It increases expenses, which will decrease net income. It does not affect the statement of cash flows. 34) B Interest expense (September 1 through December 31) = $34,000 × 9% × (4 ÷ 12) = $1,020 The fact that it was an 18-month note does not affect the Year 1 interest expense. 35) D Interest expense (September 1 through December 31) = $10,000 × 6% × (4 ÷ 12) = $200 The fact that it was an 18-month note does not affect the Year 1 interest expense. 36) D

Version 1

The $12,000 borrowed is classified as a financing activity, not an operating activity. No interest was paid in Year 1, so there is no cash flow related to the interest. 37) D The $24,000 borrowed is classified as a financing activity, not an operating activity. No interest was paid in Year 1, so there is no cash flow related to the interest. 38) B Interest payable = $24,000 × 8% × (5 ÷ 12) = $800 Total liabilities = Note payable of $24,000 + Interest payable of $800 = $24,800 39) B Interest payable = $24,000 × 8% × (5 ÷ 12) = $800 Total liabilities = Note payable of $24,000 + Interest payable of $800 = $24,800 40) B Interest expense = $42,000 × 8% × (3 ÷ 12) = $840 Net income = Revenue of $1,700 − Interest expense of $840 = $860 41) A Interest expense = $36,000 × 7% × (3 ÷ 12) = $630 Net income = Revenue of $1,400 − Interest expense of $630 = $770 42) B Cash paid for interest during Year 2 = $48,000 × 6% = $2,880 Net cash flow from operating activities for year 2 = Inflow from revenue of $1,500 − Outflow for interest of $2,880 = $1,380 The repayment of principal in the amount of $48,000 is a cash outflow from financing activities. 43) D

Version 1

Cash paid for interest during Year 2 = $36,000 × 7% = $2,520 Net cash flow from operating activities for year 2 = Inflow from revenue of $1,400 − Outflow for interest of $2,520 = $1,120 The repayment of principal in the amount of $36,000 is a cash outflow from financing activities. 44) B End of Year 1: Interest payable = $34,000 × 4% × (9 ÷ 12) = $1,020 Total liabilities = Note payable of $34,000 + Interest payable of $1,020 = $35,020 End of Year 2: The note is repaid and the full amount of interest on the note was paid before the end of Year 2, so there are no remaining liabilities at that date. 45) B End of Year 1: Interest payable = $36,000 × 7% × (9 ÷ 12) = $1,890 Total liabilities = Note payable of $36,000 + Interest payable of $1,890 = $37,890 End of Year 2: The note is repaid and the full amount of interest on the note was paid before the end of Year 2, so there are no remaining liabilities at that date. 46) B Issuing the note is an asset source transaction. The asset account Cash increases and the liability account Notes Payable increases. 47) A

Version 1

The accrual of interest on a note payable is a claims exchange transaction because the stockholders’ equity account Retained Earnings decreases (because Interest Expense increases) and the liability account Interest Payable increases. Issuing the note is an asset source transaction because the asset account Cash increases and the liability account Notes Payable increases. Repaying the principal (or interest) on a note payable is an asset use transaction since the asset account Cash decreases and the liability account Notes Payable (or Interest Payable) decreases. 48) D Sales tax collected = $200 × 4% = $8 Cash collected = Sale of $200 + Sales tax of $8 = $208 The transaction increases cash flow from operating activities by $208. The transaction increases assets (cash) by $208 and decreases assets (inventory) by its cost of $130, resulting in a net increase in assets of $78 (or $208 − $130). It also increases liabilities by the sales tax collected of $8 and increases stockholders’ equity (retained earnings) by $70. Thus: Increase in assets of $78 = Increase in Liabilities of $8 + Increase in Stockholders’ equity of $70. The increase in stockholders’ equity is also explained as follows. Revenues (sales) increase by $200 and expenses (cost of goods sold) increase by $130, which results in an increase in net income of $70 (which increases retained earnings). 49) B Yang is required by the government to collect the tax from the customer.Yang is then obligated to pay the tax to the government.As a result, Yang incurs a $360 liability ($4,000 × 0.09) when the sales event occurs. 50) D

Version 1

All of the answers describe effects that would result from recognizing the sales event. Yang would receive $10,900 [$10,000 + ($10,000 × 0.09)] cash.This would cause assets (Cash) to increase.Yang would recognize a $900 obligation ($10,000 × 0.09) for the cash that was collected for the taxing authority. This increases liabilities (Sales Tax Payable).Finally,Yang would recognize $10,000 of sales revenue. 51) C Paying off a sales tax liability is no different than paying off any other liability.It is an asset use transaction.Assets (Cash) decrease and liabilities (Sales Tax Payable) decrease. 52) B Wilson would receive $4,240 [$4,000 + ($4,000 × 0.06)] cash.This cash inflow would cause assets (Cash) to increase.Wilson would recognize a $240 obligation ($4,000 × 0.06) for the cash that was collected for the taxing authority. This increases liabilities (sales tax payable).Finally, Wilson would recognize $4,000 of sales revenue which would cause net income and ultimately stockholders’ equity (Retained Earnings) to increase.Since the $4,240 cash inflow is related to operating the business, it would be classified as an operating activity on the statement of cash flows. 53) D Paying off a sales tax liability is an asset use transaction.Assets (Cash) decrease and liabilities (Sales Tax Payable) decrease.There is no impact on the income statement because the revenue was recorded previously at the time the sales event occurred.Since the cash outflow is related to operating the business, it would be classified as an operating activity on the statement of cash flows. 54) A Remittance of sales tax decreases assets (cash) and decreases liabilities (sales tax payable). Version 1

55) D A contingent liability should be recorded in the financial statements as a liability if the outcome is considered probable and the amount owed can be reasonably estimated. If it is considered only reasonably possible, it is only disclosed in the notes to the financial statements. 56) C Because the obligation is considered remote, it is neither recognized nor disclosed in Burger Barn's financial statements. 57) C If a contingent liability is classified as probable and estimable, GAAP requires that the liability and related expense be shown in the financial statements. 58) D Contingent liabilities can be classified as any of the categories listed above. 59) C Contingent liabilities that are remote do not have to be recognized or disclosed.Contingent liabilities that have a reasonably possible chance of occurring but are not estimable must be disclosed in the footnotes to financial statements but are not recognized in the financial statements.Only contingent liabilities that have a probable chance of occurring and that are estimable require disclosure in the financial statements. 60) A Due to the conservatism principle GAAP frequently requires potential expenses and liabilities to be reported while it prohibits reporting potential gains and assets. 61) D

Version 1

Estimating future warranty costs related to Year 1 sales increases liabilities (Warranties Payable) and decreases stockholders’ equity (Retained Earnings). It increases expenses (Warranty Expense), which decreases net income. It does not affect the statement of cash flows. 62) B Paying $550 to satisfy a warranty claim decreases assets (Cash) by $550 and decreases liabilities (Warranties Payable) by $550. The $550 outflow is reported as an operating activity on the statement of cash flows. 63) A The adjustment increases liabilities (Warranties Payable) and decreases stockholders’ equity (Retained Earnings). It increases expenses (Warranty Expense), which decreases net income. It does not affect the statement of cash flows. 64) C Cash is usually used to settle a warranty claim made by a customer and affects the statement of cash flows at that time. Although cash may be collected when the sale is made, that cash is not related to the warranty obligation. The accrual of the warranty obligation increases the liability Warranties Payable and increases Warranty Expense; as such, that transaction does not affect the statement of cash flows. 65) D Year 1 Warranty expense = $360,000 × 2% = $7,200 Accruing the warranty obligation increases liabilities (warranties payable) and increases expenses (warranty expense) by $7,200. Settlement of the warranty claims decreases assets (cash) and decreases liabilities (warranties payable) by $4,800. Thus, at the end of Year 1, the warranties payable account has a balance of $2,400 ($7,200 − $4,800). Cash decreases by $4,800 when the warranty obligations are settled. 66) D Version 1

Year 1 Warranty expense = $800,000 × 3% = $24,000 Accruing the warranty obligation increases liabilities (warranties payable) and increases expenses (warranty expense) by $24,000. Settlement of the warranty claims decreases assets (cash) and decreases liabilities (warranties payable) by $13,000. Thus, at the end of Year 1, the warranties payable account has a balance of $11,000 ($24,000 − $13,000). Cash decreases by $13,000 when the warranty obligations are settled. 67) D When a company recognizes warranty expense, it acknowledges its obligation to repair or replace defective products that were sold to customers. As a result, liabilities (Warranties Payable) increase. The recognition of the warranty expense decreases net income and ultimately stockholders’ equity (Retained Earnings). 68) B The amount of warranty expense to recognize is $7,200 ($240,000 × 0.03). When a company recognizes warranty expense, it acknowledges its obligation to repair or replace defective products that were sold to customers. As a result, liabilities (Warranties Payable) increase. The recognition of the expense decreases net income and ultimately stockholders’ equity (retained earnings). Assets will not be affected until later when the company has to pay cash to repair or replace a defective product. 69) B

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The amount of warranty expense and related liability required to recognize is $16,000 ($400,000 × 0.04). When a company recognizes warranty expense, it acknowledges its obligation to repair or replace defective products that were sold to customers. As a result, liabilities (warranties payable) increase. The recognition of the expense decreases net income and ultimately stockholders’ equity (retained earnings). Cash flow is not affected when the expense is recognized. A cash flow will occur later when the company has to pay cash to repair or replace a defective product. Assets will not be affected until later when the company has to pay cash to repair or replace a defective product. 70) C Paying off a warranty liability is no different than paying off any other liability. It is an asset use transaction. Assets (Cash) decrease and liabilities (Warranties Payable) decrease. There is no impact on the income statement. Since the cash payment is associated with the company’s operations, it is classified as an operating activity. 71) D The amount of warranty expense and related liability required to recognize is $5,000 ($250,000 × 0.02). When a company recognizes warranty expense, it acknowledges its obligation to repair or replace defective products that were sold to customers. As a result, liabilities (Warranties Payable) increase. The recognition of the warranty expense decreases net income and ultimately stockholders’ equity (Retained Earnings). Cash flow is not affected when the expense is recognized. A cash flow will occur later when the company has to pay cash to repair or replace a defective product. 72) B Employee’s portion of FICA = $5,600 × 7.5% = $420, which is withheld from Jamal’s gross pay. The company matches that amount and, as such, is responsible for a total of $840 (or $420 + $420). Version 1

73) D Employee’s portion of FICA = $3,000 × 7.5% = $225, which is withheld from Jamal’s gross pay. The company matches that amount and, as such, is responsible for a total of $450 (or $225 + $225). 74) B When a business supervises, directs, and controls an individual’s work, the individual is an employee of the business. When a business pays an individual for specific services, but the individual supervises and controls the work, then that individual is an independent contractor. 75) C Federal unemployment tax is paid entirely by the employer; as such, it is not withheld from an employee's pay. 76) B Employee’s Withholding Allowance Certificate, Form W-4, is the form used to document the number of allowances claimed by an employee. Employees are generally allowed to claim one allowance for themselves and one for each legal dependent. 77) D The federal government collects the tax. The employer and employee pay the tax to the government. 78) B Only the employer is responsible for paying unemployment tax. 79) D $4,000 Gross Pay − $450 Income Tax − $240 FICA Tax − $60 Medicare Tax − $190 Medical Insurance − $15 Humane Society = $3,045 Net Pay. Note: only the employer pays unemployment tax. 80) C FICA tax expense − Social Security (4,000 × 6%) FICA tax expense − Medicare (4,000 × 1.5%) Federal unemployment tax expense ($4,000 × .006)

$ 240 60 24

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State unemployment tax expense ($4,000 × .054) Total Payroll Tax

216 $ 540

Note: The employer matches the employee’s FICA taxes as well as paying unemployment taxes. 81) A Recognizing accrued payroll tax expense is an equity exchange transaction. Payroll tax expense increases which causes net income and ultimately stockholders’ equity to decrease. Various tax liability accounts increase. Cash flow is not affected. 82) A A current (short-term) asset is expected to be converted to cash or consumed within one year or an operating cycle, whichever is longer. An operating cycle is defined as the average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash. Merchandise inventory, office supplies, and prepaid rent would be classified as current assets. Office equipment is not a current asset because it would be used for more than one year or one operating cycle. 83) B Classified balance sheets distinguish between current and noncurrent items with regards to both assets and liabilities. 84) D Current (short-term) liabilities would be those due within one year or an operating cycle, whichever is longer. An operating cycle is defined as the average time it takes a business to convert cash to inventory, inventory to accounts receivable, and accounts receivable back to cash. Accounts payable, interest payable, and salaries payable are typically current liabilities. 85) B

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Retained earnings are not separated into current versus long-term categories. The primary purpose of identifying current assets and liabilities is to easily assess a company’s ability to use its current assets to satisfy its current obligations. Classifying retained earnings into current versus noncurrent components would not provide insight into a company’s ability to meet its current obligations. 86) C Bond liabilities are obligations that normally extend for many years. Indeed, most bond obligations have terms of 20 or more years. 87) B Current ratio = Current assets ÷ Current liabilities Current ratio = $8,650 ÷ $6,000 = 1.44 to 1 88) B Current ratio = Current assets ÷ Current liabilities Current ratio = ($11,000 + $9,250) ÷ $4,500 = 4.5 to 1 89) C Current ratio = Current assets ÷ Current liabilities Current ratio = ($12,000 + $8,000) ÷ $4,000 = 5 to 1 90) B Current ratio = Current assets ÷ Current liabilities Before transaction: Current ratio = $12,000 ÷ $4,000 = 3 to 1 After transaction: Current ratio = ($12,000 − $2,000) ÷ ($4,000 − $2,000) = 5 to 1 91) B Current ratio = Current assets ÷ Current liabilities Current ratio = $720 ÷ $600 = 1.2 to 1 92) B Current ratio = Current assets ÷ Current liabilities Current ratio = $960 ÷ $600 = 1.6 to 1 93) D Version 1

Current ratio = Current assets ÷ Current liabilities Current ratio = ($32,000 + $14,800 + $4,000 − $4,000) ÷ $18,000 = 2.6 to 1 94) D Current ratio = Current assets ÷ Current liabilities Current ratio = ($32,000 + $10,000 + $6,000 − $6,000) ÷ $20,000 = 2.1 to 1 95) B The primary ratio used to evaluate liquidity is the current ratio. Liquidity describes the ability to generate sufficient short-term cash flows to pay obligations as they come due. 96) C Current ratio = Current assets ÷ Current liabilities 97) D Liquidity describes the ability to generate sufficient short-term cash flows to pay obligations as they come due. 98) A The borrower (issuer) agrees to repay the face value of a discount note at the maturity date. The borrower agrees to accept an amount of cash that is less than the face value of the note on the day of issue. The difference between the face value and the amount of cash the borrower receives is interest. For example, assume a company receives $900 cash when it issues a $1,000 discount. In other words, the company receives $900 on the day of issue and it has to repay $1,000 on the maturity date. The $100 difference ($1,000 − $900) is the amount of interest expense incurred by the borrower. 99) B

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The borrower (issuer) will receive cash equal to the $2,000 face value less the $120 ($2,000 × 0.06) discount. Specifically, total assets will increase by $1,880 cash ($2,000 face value − $120 discount). Total liabilities would also increase by $1,880. The balance sheet would show a $2,000 Notes Payable account less a $120 Discount on Notes Payable account. Since the Discount on Notes Payable account is a contra liability account the net increase in liabilities is $1,880 ($2,000 face value − $120 discount). 100) B Discount = $20,000 × 0.06 × 1 = $1,200 Three months (October 1—December 31) have passed. Amortization of discount = Discount of $1,200 × (3 ÷ 12) = $300 The adjustment will increase interest expense and decrease discount on notes payable by $300. 101) A Discount = $90,000 × 0.04 × 1 = $3,600 Four months (September 1—December 31) have passed. Year 1 interest expense = Amortization of discount = Discount of $3,600 × (4 ÷ 12) = $1,200 102) A The adjustment to accrue interest expense will increase liabilities (by decreasing Discount on Notes Payable, a contra liability account) and decrease stockholders’ equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. It does not affect the statement of cash flows. 103) B

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Discount = $90,000 × 0.04 × 1 = $3,600 Four months (September 1—December 31) have passed. Amortization of discount = Discount of $3,600 × (4 ÷ 12) = $1,200 Carrying value = Notes payable account balance of $90,000 − Discount on notes payable account balance of ($3,600 − $1,200) = $87,600 104) A Discount = $9,000 × 0.05 × 1 = $450 Ten months (March 1—December 31) have passed. Year 1 interest expense = Amortization of discount = Discount of $450 × (10 ÷ 12) = $375 The year-end adjustment increases liabilities (by decreasing Discount on Notes Payable, a contra liability account) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. 105) D The maturity date of the note is April 1, Year 2. At maturity, since all interest has been accrued through that date, the discount account has been reduced to zero, so the carrying value of the liability is equal to the note’s face value. At maturity, the face value of the note of $9,000 is repaid, which decreases assets (Cash) and liabilities (Notes Payable). However, only the amount initially borrowed of $8,550 is reported as a cash outflow from financing activities; the amount of the discount that is paid of $450 is reported as an operating activity since it represents interest expense. 106) D

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The bookkeeping technique of converting the discount to interest expense over the term of the loan is described as amortizing the discount. Amortizing the discount increases liabilities (by decreasing the Discount on Notes Payable, a contra liability account) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. 107) B When issued, the face value of the discount note is recorded in the notes payable account and the amount of the discount is recorded in the discount on notes payable account. 108) C Issuing a discount note increases assets (Cash) and increases liabilities (Notes Payable, less Discount on Notes Payable). The cash received is reported as a cash inflow from financing activities. 109) B Accounts payable, warranties payable, and discount on notes payable, which is a contra liability account, all appear in the liabilities section of the balance sheet. The allowance for doubtful accounts and credit card receivables appear in the assets section of the balance sheet. 110) D

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The year-end adjustment that should have been made would have increased liabilities (by decreasing discount on notes payable, a contra liability account) and increased expenses (interest expense), which decreases net income in Year 1. Neglecting to make the adjustment would understate liabilities at the end of Year 1 and overstate Year 1 net income. The note matures in Year 2. When the payment of the note and interest is recorded in Year 2, this error also causes the company to recognize all 12 months of interest expense in Year 2, instead of just 9 months, which causes Year 2 net income to be understated. 111) A The Discount on Notes Payable account is a contra liability account. The carrying value of the liability is the difference between the Notes Payable and Discount accounts

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CHAPTER 10: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Kirkland Company issued $200,000 of bonds payable at 101.5. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Kirkland Company paid cash and recognized interest expense on bonds that it had issued at 101.5 on January 1, Year 1. The company uses the straight-line method to amortize bond discounts and premiums. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Briand Company issued $200,000 of bonds payable at 98. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

4) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Briand Company paid cash and recognized interest expense on bonds it had issued at 98 on January 1, Year 1. The company uses the effective interest method to amortize bond discounts and premiums. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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5) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Briand Company paid cash and recognized interest expense on bonds it had issued at face value on January 1, Year 1. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Morris Comapny issued $100,000 of bonds at face value. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Ravenwood Company issued a long-term installment note. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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9) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Ravenwood Company made an annual payment on a long-term installment note payable. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

10) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Flagler Corporation signed a contract with the City Bank for a line of credit that permitted Flagler to borrow up to $50,000. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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11) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On January 1, Year 1, Flagler Corporation borrowed $20,000 on a line-of-credit from City Bank. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

12) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter dollar amounts. Increase = I Decrease = D Not Affected = NA On December 31, Year 1, Flagler Corporation had a balance of $20,000 on a line-of-credit with City Bank. Flagler made a payment of $11,200, which included $10,000 on the principal and $1,200 interest. Show the effects of this transaction on the financial statements. Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

13)

Discuss the tax advantage of long-term debt financing.

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14) Why does interest expense decrease during the life of an installment note payable? How is the amount of interest expense computed?

15)

Describe the advantage of establishing a line of credit.

16)

How are interest rates normally set for lines of credit?

17) Discuss the purpose of restrictive covenants included in loan agreements and provide three examples.

18)

Discuss the purpose of a sinking fund.

19)

Explain the special feature that makes callable bonds attractive to an issuing corporation.

20) Why would some bonds be classified as "secured bonds"? Provide an example of a common type of secured bond.

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21) What is meant by the "spread" with regards to financial leverage? What does the "spread" have to do with the issuance of bonds?

22) What is the market rate of interest? What factors influence the market rate of interest? When the market rate of interest is higher than the stated rate of interest, will the bonds sell at a premium or at a discount?

23)

What is the issue price of $200,000 of bonds that sell at 95.5?

24) Why do some bonds sell at a premium? How does a premium impact the effective interest rate?

25) Describe the effect on the accounting equation of the issuance of bonds at 103.5 that have a face value of $500,000, a stated rate of interest of 8%, and a 10-year term to maturity. Use numerical amounts in your answer.

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26) If $200,000 of 12% bonds are issued at 101.5, what amount of cash will be received by the corporation?

27) Which financial statements are affected by the payment of bond interest and the related amortization of a discount? Describe how each of the four financial statements is affected.

28) Alexander Corporation issued 20-year bonds at a discount in Year 1. Will Alexander's net income for Year 1 be higher, lower, or the same as it would have been had the bonds been issued at face value? Why?

29) Does the amortization of a bond premium increase, decrease, or not affect interest expense for an accounting period? Explain.

30) If a company uses the effective interest method to amortize a bond discount, does the interest expense increase, decrease, or stay the same over time? Explain.

31) Explain the difference between the straight-line method and the effective interest method when amortizing bond discounts and premiums.

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32)

Discuss one advantage of issuing bonds versus borrowing money from a bank.

33) Does United States tax law encourage debt financing or equity financing of a corporation? Why?

34)

Explain the concept of financial leverage.

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 35) On January 1, Year 1, Carlyle Corporation issued a 5-year term note. The note requires an annual cash payment on December 31 of each year. The payment includes a principal repayment and interest. Indicate whether each of the following statements is true or false. 1.a) Issuing the note will increase assets and liabilities. 2.b) The first payment on the note will reduce liabilities and assets but will not affect stockholders’ equity. 3.c) The second payment on the note will include higher interest expense than did the first payment. 4.d) Each payment on the note includes a cash flow from operating activities and a cash flow from financing activities. 5.e) The amount of the principal repayment will increase with each succeeding payment.

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36) Indicate whether each of the following statements is true or false. 1.a) Interest expense on long-term installment notes increases each year. 2.b) Cash for machinery or buildings is often obtained by issuing long-term debt. 3.c) Short-term notes payable normally mature within a year. 4.d) Long-term installment notes are repaid all at once two to five years after the issue date. 5.e) Most long-term loans are obtained from the corporation's stockholders.

37) Indicate whether each of the following statements about lines of credit is true or false. 1.a) Line-of-credit agreements generally involve a fluctuating rate of interest. 2.b) A line-of-credit agreement allows a company to borrow on an as-needed basis. 3.c) Interest rates on line-of-credit agreements are often pegged to the consumer price index. 4.d) The signing of a line-of-credit agreement is an asset source transaction. 5.e) The expense recognition for the payment of monthly interest is an asset exchange transaction.

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38) Indicate whether each of the following statements about bonds is true or false. 1.a) The carrying value of a bond increases over time if the bond was issued at a premium. 2.b) At the end of the term of the bonds, the carrying value of a bond issue is equal to the issue price. 3.c) If bonds are sold below face value, the difference between the issue price and the face value is called the bond discount. 4.d) The payment of interest is an operating activity on the statement of cash flows. 5.e) The issuance of bonds does not appear on the statement of cash flows.

39) Indicate whether each of the following statements about bonds payable is true or false. 1.a) A convertible bond may be converted into stock of the issuing company at the option of the bondholder. 2.b) Businesses typically issue bonds to banks to borrow large amounts of cash. 3.c) A debenture is an unsecured bond. 4.d) Callable bonds may be turned in for early retirement at the option of the bondholder. 5.e) The issuer of a bond receives cash when the bond is issued.

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40) On January 1, Year 1, O’Keefe Company issued bonds with a face value of $400,000 and a stated interest rate of 10%. The bonds have a life of ten years and were sold at 108. O’Keefe uses the straight-line method to amortize bond discounts and premiums. On December 31, Year 4, O’Keefe called the bonds at 106. Indicate whether each of the following statements is true or false. 1.a) The interest expense for Year 1 was $40,000. 2.b) The balance in the bonds payable account was $400,000 on December 31, Year 1. 3.c) The carrying value of bonds payable was $419,200 on December 31, Year 4. 4.d) When O’Keefe repurchased the bonds, total assets decreased by $419,200. 5.e) When O’Keefe repurchased the bonds, it had to recognize a loss in the amount of $4,800.

41) Indicate whether each of the following statements about bonds payable is true or false. 1.a) Premium on Bonds Payable is recorded when bonds are issued at less than their face value. 2.b) Premium on Bonds Payable is a liability account. 3.c) The balance in the Discount on Bonds Payable account increases liabilities. 4.d) Discount on Bonds Payable is an expense account. 5.e) A discount on bonds payable occurs when the stated interest rate on the bonds is less than the market or effective interest.

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42) Indicate whether each of the following statements about bonds payable is true or false. 1.a) At the time of issue, the effective interest rate of a particular bond is equal to the market rate of interest for bonds with a similar level of risk. 2.b) When bonds are sold at 105, the stated interest rate of the bonds is lower than the market rate for investments with a similar level of risk. 3.c) When bonds are sold at 95, the stated interest rate of the bonds is lower than the market rate for investments with a similar level of risk. 4.d) When bonds are sold at 100, the stated interest rate of the bonds is lower than the market rate for investments with a similar level of risk. 5.e) When bonds are sold at 101, the bonds were issued at a premium.

43) Indicate whether each of the following statements regarding the effective interest method is true or false. 1.a) The effective interest method matches interest expense with the change in the carrying value of the bond. 2.b) Interest expense on a bond issued at a discount will be lower in the bond's first year than if the company had used straight-line amortization. 3.c) The carrying value of a bond issued at a premium will decrease by smaller and smaller amounts each year. 4.d) Interest expense is calculated by multiplying the beginning carrying value of the bond by the stated rate of interest. 5.e) Effective interest amortization can only be used on bonds that pay interest annually.

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44) Indicate whether each of the following statements is true or false. 1.a) EBIT stands for earnings before income taxes. 2.b) EBIT can be used in the computation of the return-on-assets ratio. 3.c) A low times-interest-earned ratio is a sign of a high-risk company. 4.d) Dividends are deductible in the determination of taxable income. 5.e) Interest is deducted on the income statement but is ignored on the tax return.

45) On January 1, Year 1, Mayberry Company borrowed cash from Central Bank by issuing a $75,000 face value 3-year installment note payable that carried a 9% interest rate. The note is to be repaid by making annual cash payments of $29,629.11, which includes both principal and interest. The payments are to be made on December 31 of each year. Required: 1.a) Prepare an amortization schedule for the term of the loan, showing the amounts to be paid on principal and interest for Year 1, Year 2, and Year 3 and the loan balance at the end of each year. (Round your answers to two decimal points.) 2.b) What amount of interest expense will be shown on the Year 2 income statement? 3.c) What amount of liability for the note will be shown on the balance sheet as of December 31, Year 2?

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46) On January 1, Year 1, Hawk Company borrowed $100,000 from the Community Bank, issuing a three-year, 8% note payable. Payments of $38,803.35 are to be made each year on December 31. The payment will include both the interest and a portion of the principal. (Round your answers to two decimal points.) Required: Using the table below, prepare an amortization schedule for the note. Date

Beginning Balance

Payment

Interest

Principal

Ending Balance

47) Rodgers Equipment Company sold a ten-year, 6% bond issue at 102.5. Rodgers received proceeds of $256,250 from the sale of these bonds. Required: Determine the face value of these bonds.

48) Marvin Corporation issued $500,000 of 8%, 10-year bonds for 98 on January 1, Year 1. Interest is payable annually on December 31. The company uses the straight-line method to amortize bond discounts and premiums. Required: 1.a) Prepare the liabilities section of the balance sheet at December 31, Year 1. 2.b) Determine the amount of interest expense reported on the Year 1 income statement. 3.c) Prepare the operating activities section of the Year 1 statement of cash flows.

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49) On July 1, Year 1, Morrison Company issued bonds with a face value of $200,000, a stated rate of interest of 8%, and a 10-year term to maturity. The bonds were issued at 92. Interest is payable semiannually on January 1, and July 1. (Hint: There are 20 interest payments.) The company uses straight-line amortization for premiums and discounts on bonds payable. Required: 1. a) Determine the amounts of interest expense that will be shown on the income statements for: 1) Year 1 2) Year 2 b) Determine the amounts of interest payments that will be shown on the statement of cash flows for: 1) Year 1 2. 2) Year 2

50) Compute the amount of cash a company will receive from the following bond issues. Required: 1.a) ________ Issued $200,000 of 5-year, 8% bonds at 98 2.b) ________ Issued $800,000 of 4-year, 9% bonds at 95 3.c) ________ Issued $400,000 of 10-year, 8% bonds at 102.5 4.c) ________ Issued $100,000 of 5-year, 12% bonds at 103

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51) Greenwood Company issued bonds with a face value of $150,000, a stated interest rate of 6% bonds, and a 10-year maturity term. Interest is payable in cash on December 31 of each year. The bonds were sold at 103.5. The company uses the straight-line method to amortize bond discounts and premiums. Required: Calculate the amount of annual interest expense

52) San Jose Company issued ten-year 8% bonds with a face value of $100,000, for $107,023.58 on January 1, Year 1 when the market (effective) rate of interest was 7%. The bonds pay annual interest each December 31. San Jose uses the effective interest method to amortize bond discounts and premiums. (Round all intermediate calculations and final answers to two decimal places.) Required: a) Determine the annual amount of cash that will be paid to bondholders for interest? b) Calculate the amounts of: (1) Interest expense in Year 1 (2) Premium amortization in Year 1 (3) Carrying amount of the liability on December 31, Year 1 c) Calculate the amounts of: (1) Interest expense in Year 2 (2) Premium amortization in Year 2 (3) Carrying amount of the liability at December 31, Year 2? d) Determine the total amount of interest that will be recorded in interest expense over the life of the bond.

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53) Stanton Company issued ten-year 7% bonds with a face value of $100,000, for $96,567.94 on January 1, Year 1, when the market (effective) rate of interest was 7.5%. The bonds pay annual interest each December 31. Stanton uses the effective interest method to amortize bond discounts and premiums. (Round your answers to two decimal places.) Required: a) Determine the annual amount of cash that will be paid to bondholders for interest. b) Calculate the amounts of: (1) Interest expense in Year 1 (2) Discount amortization in Year 1 (3) Carrying amount of the liability on December 31, Year 1 c) Calculate the amounts of: (1) Interest expense in Year 2 (2) Premium amortization in Year 2 (3) Carrying amount of the liability at December 31, Year 2? d) Determine the total amount of interest that will be recorded in interest expense over the life of the bond.

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54) On January 1, Year 1, Hanover Corporation issued bonds with a face value of $300,000 and a 10-year term to maturity. On that date, the market interest rate was 7%. The bonds were issued at 103.5. Interest in the amount of $22,495 is payable in cash on December 31 of each year. Hanover Corporation uses the effective interest method to amortize discounts and premiums on bonds. (Round all intermediate calculations to two decimal places and final answers to whole dollars.) Required: 1.a) Determine the amount of the premium on the bonds when they were issued. 2.b) (1) Determine the amount of interest expense for Year 1. 3.b) (2) Determine the amount of premium amortization for Year 1. 4.c) Determine the carrying value of the bonds on December 31, Year 1. 5.d) Determine the amount of interest expense for Year 2.

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Answer Key Test name: Chap 10_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

Issuing bonds at a premium increases assets (Cash) and increases liabilities (both Bonds Payable and Premium on Bonds Payable). It is reported as a cash inflow from financing activities on the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D D NA I D D

The payment of cash and recognition of interest expense decreases assets (Cash), decreases liabilities (Premium on Bonds Payable), and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The cash payment for interest is reported as a cash outflow from operating activities. 3) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

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Issuing bonds at a discount increases assets (Cash), increases liabilities (Bonds Payable), and decreases liabilities (by increasing the Discount on Bonds Payable, a contra liability account). The net effect on liabilities is an increase (since the face value of the bonds exceeds the discount). The cash received is reported as a cash inflow from financing activities on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D I D NA I D D

The cash payment and recognition of interest expense decreases assets (Cash), increases the carrying value of the bond liability (through a decrease in the bond discount), and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The cash payment for interest is reported as a cash outflow from operating activities on the statement of cash flows. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D NA D NA I D D

The payment of cash and recognition of interest expense decreases assets (Cash) and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The cash payment for interest is reported as a cash outflow from operating activities on the statement of cash flows. 6) Balance Sheet

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Income Statement

Statement 22

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

of Cash Flows D

The repayment of a bond at maturity decreases assets (Cash) and decreases liabilities (Bonds Payable). The repayment of principal is reported as a cash outflow from financing activities on the statement of cash flows. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

Issuing bonds at face value increases assets (Cash) and increases liabilities (Bonds Payable). It is reported as a cash inflow from financing activities on the statement of cash flows. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

Issuing a long-term installment note increases assets (Cash) and increases liabilities (Note Payable). It is reported as a cash inflow from financing activities on the statement of cash flows. 9) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D D NA I D D

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Making a payment on an installment note decreases assets (Cash) by the amount of the payment, decreases liabilities ( Note Payable) by the amount of the principal amortization, and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The amount of the principal amortization is reported as a cash outflow from financing activities, and the amount of interest expense recognized is reported as a cash outflow from operating activities. 10) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income NA NA NA NA NA NA NA

Signing a contract for a line of credit does not affect the financial statements. The financial statements are not affected until the line of credit is used. 11) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I I NA NA NA NA I

Borrowing on a line of credit increases assets (Cash) and increases liabilities (Line of Credit liability). It is reported as a cash inflow from financing activities on the statement of cash flows. 12) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D D NA I D D

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Making a payment on a line of credit decreases assets (Cash) for the amount of the payment, decreases liabilities (Line of Credit liability) for the amount of the principal payment, and decreases stockholders' equity (Retained Earnings). It increases expenses (interest expense) for the amount of the interest payment, which decreases net income. The principal repayment is reported as a cash outflow from financing activities, while the interest payment is reported as a cash outflow from operating activities on the statement of cash flows. 13) If a company finances investment purchases with long-term debt, the company will pay interest. That interest will reduce taxable net income. In contrast, the dividends that a company would pay related to equity financing are not tax deductible. 14) Interest expense on a note payable is based on remaining principal balance. Because each payment includes a principal repayment as well as a payment for interest, the amount of principal would decrease with time. The interest is computed by multiplying the stated rate times the principal balance. 15) A line of credit enables a company to borrow or repay funds as needed. 16) Interest rates are normally variable, depending on some publicly announced rate such as the rate paid on U.S. government treasury bills. 17) Creditors often obtain additional protection by including restrictive covenants in loan agreements. Such covenants may restrict additional borrowing, limit dividend payments, or restrict salary increases. If the loan restrictions are violated, the borrower is in default and the loan balance is due immediately.

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18) To ensure there is enough cash available at maturity to pay off the debt, a bond agreement may require the issuer to make regular payments into a sinking fund. Money deposited in the sinking fund is usually managed by an independent trustee who invests the funds until the bonds mature. At maturity, the funds and the proceeds from the investments are used to repay the bond debt. 19) Callable bonds allow the issuing corporation to redeem (pay off) the bond debt before the maturity date. If interest rates decline, this feature benefits the issuing company because it could borrow additional money at a lower rate and use the proceeds to pay off its higher rate bonds. 20) Some bonds are classified as "secured bonds" because they contain a clause that guarantees that the bondholders will be given certain identifiable assets in case of default. A common type of secured bond is called a mortgage bond. With a mortgage bond, a designated piece of property is conditionally transferred to the bondholder until the bond is paid. 21) As with other forms of credit, bonds may provide companies increased earnings through financial leverage. If a company can borrow money at 7% through a bond issue and invest the proceeds at 12%, the company's earnings benefit from the 5% (12% − 7%) spread. Also, bond interest expense, like other forms of interest expense, is tax deductible, making the effective cost of borrowing less than the interest expense because the interest expense reduces the tax expense. Because dividend payments are not tax deductible, equity financing (e.g., issuing common stock) does not offer this advantage.

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22) When a bond is issued, the effective interest rate is determined by current market conditions. Market conditions are influenced by many factors, such as the state of the economy, government policy, and the law of supply and demand. These conditions are collectively reflected in the market interest rate. The effective rate of interest investors are willing to accept for a particular bond equals the market rate of interest for other investments with similar levels of risk at the time the bond is issued. When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. 23) $191,000 Issue price = Face value of $200,000 × 95.5% = $191,000 24) When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate. When bonds are sold for more than their face value, the difference between the amount received and the face value is called a bond premium. Bond premiums reduce the effective interest rate. 25) Assets (cash) will increase by $517,500, which is the face value of $500,000 times 103.5%. Liabilities will also increase by $517,500, which is the sum of the increase in the bonds payable account of $500,000 and the increase in the premium on bonds payable account of $17,500. 26) $203,000 Proceeds (issuance price) = Face value of $200,000 × 101.5% = $203,000

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27) Expenses (interest expense) increase and net income decreases on the income statement. Assets (Cash) decrease, liabilities (Carrying Value of Bonds) increase, and stockholder's equity (Retained Earnings) decreases on the balance sheet. The statement of cash flows reports the cash paid for interest as a cash outflow from operating activities. 28) Net income would be lower. A discount acts to increase borrowing cost from the stated interest rate to the effective rate, which is higher. Accordingly, a higher interest expense would yield a lower net income. 29) The amortization of a bond premium decreases the amount of interest expense for an accounting period. This decrease is caused by charging part of the interest payment each period to the bond premium as an amount of premium amortization. 30) Amortization of a bond discount using the effective interest method will cause interest expense to increase over time because interest expense is being recognized on a larger and larger amount of principal each year. 31) The straight-line method involves dividing the total premium or discount by the number of interest payment periods. While the amount of amortization is the same each period, the effective interest changes each period because the carrying value of the bond issue changes. The effective interest method, though more complex, applies a constant interest rate to the carrying value. The interest expense is first computed by multiplying the carrying amount of the bond issue by the effective rate of interest. The amount to be amortized is computed by comparing the interest expense to the cash interest. Accordingly, the interest expense and the amount of discount or premium to be amortized change each time.

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32) Bonds usually have longer terms than notes issued to banks. While typical bank loan terms range from 2 to 5 years, bonds normally have 20-year terms to maturity. Longer terms to maturity allow companies to implement long-term strategic plans without having to worry about frequent refinancing arrangements. In addition, bond interest rates may be lower than bank interest rates. By issuing bonds directly to the public, companies can pay lower interest costs. 33) Tax law generally favors debt financing because interest expense is deductible for tax purposes. Dividends paid to shareholders are not deductible for tax purposes. 34) Leverage refers to the concept of increasing earnings through debt financing. If a firm borrows at 6% and earns 10% on assets, the company and its stockholders have benefited from the 4% spread, which is the difference between the two interest rates. 35) a) T b) F c) F d) T e) T 1.a) This is true. Issuing an installment note increases assets (Cash) and liabilities (Notes Payable). 2.b) This is false. Each payment made decreases assets (Cash), liabilities (Notes payable), and stockholders’ equity (Retained Earnings). 3.c) This is false. The second payment on the note will include less interest expense than did the first payment. 4.d) This is true. The portion of a payment that reduces principal is a cash flow from financing activities, and the portion that is interest is a cash flow from operating activities. 5.e) This is true. As interest expense goes down with each payment, the portion that reduces principal on the liability goes up.

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36) a) F b) T c) T d) F e) F 1.a) This is false. Interest on long-term installment notes decreases each year. 2.b) This is true. Machinery and buildings are usually financed by issuing long-term debt because the assets will be used over many accounting periods. 3.c) This is true. This is the definition of a short-term note 4.d) This is false. Long-term installment notes are repaid over a period of many years, not all at once. 5.e) This is false. Most long-term notes are obtained from banks or other lenders. 37) a) T b) T c) F d) F e) F 1.a) This is true. Interest rates fluctuate and are applied independently to each withdrawal from a line of credit. 2.b) This is true. A line of credit is a flexible way for a company to borrow cash as needed. 3.c) This is false. Interest rates are often pegged to the prime rate, not to the consumer price index. 4.d) This is false. The signing of a line-of-credit agreement does not require recording of a transaction. A transaction is only recorded when the line of credit is utilized. 5.e) This is false. Paying interest on a line of credit is an asset use transaction that decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings).

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38) a) F b) F c) T d) T e) F 1.a) This is false. The carrying value of a bond that is issued at a premium decreases over time. 2.b) This is false. The carrying value of a bond is equal to the issue price on the date that the bond is issued. The carrying value of a bond, whether issued at a discount or at a premium, is equal to the face value at the end of the bond’s term. 3.c) This is true. A bond discount is the difference between the bond’s face value and its issue price if the bond is issued below face value. 4.d) This is true. Payment of interest is an operating activity on the statement of cash flows. 5.e) This is false. Issuing bonds is reported as a cash inflow from financing activities on the statement of cash flows. 39) a) T b) F c) T d) F e) T 1.a) This is true. The bondholder, not the issuer, has the option of converting a convertible bond into stock. 2.b) This is false. Businesses typically issue notes to banks to evidence borrowing arrangements. 3.c) This is true. Debenture bonds are unsecured bond issued by large, established companies with excellent credit. 4.d) This is false. The bond issuer, not the bondholder, has the option of calling a callable bond. 5.e) This is true. The issuer of a bond receives cash and the bondholder pays cash when a bond is issued.

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40) a) F b) T c) T d) F e) T 1.a) This is false. Interest payment = $400,000 × $10% = $40,000; Premium = Face value of $400,000 × 8% = $32,000; Amortization of premium = Premium of $32,000 ÷ 10 years = $3,200 per year; Year 1 Interest expense = Cash payment of $40,000 − Premium amortization of $3,200 = $36,800 2.b) This is true. The balance in the bonds payable account is $400,000, the face value of the bonds, the entire time that the bonds are outstanding. Only the premium on bonds payable account changes. 3.c) This is true. Issue price = Face value of $400,000 × 108% = $432,000; Carrying value at December 31, Year 4 = $432,000 − [Amortization of $3,200 per year (computed in part a × 4 years)] = $419,200 4.d) This is false. Total assets decreased by the call price of $424,000 (or Face value of $400,000 × Call price of 106%). 5.e) This is true. Loss on bond redemption = Call price of $424,000 (computed in part d) − Carrying value of $419,200 at December 31, Year 4 (computed in part c) = $4,800

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41) a) F b) T c) F d) F e) T 1.a) This is false. Premium on Bonds Payable is recorded when bonds are issued for more than their face value. 2.b) This is true. Premium on Bonds Payable is a liability account, while Discount on Bonds Payable is a contra-liability account. 3.c) This is false. The balance in Discount on Bonds Payable reduces liabilities. It is a contra-liability. 4.d) This is false. Discount on Bonds Payable is a contra-liability, not an expense account. 5.e) This is true. Issuing bonds with a stated rate lower than the market rate results in a discount. 42) a) T b) F c) T d) F e) T 1.a) This is true. Bonds are compared with others of similar risk when establishing the effective rate. 2.b) This is false. When bonds are sold at 105 (a premium), the stated rate of the bonds is higher than the market rate. 3.c) This is true. When bonds are sold at 95 (a discount), the stated rate of the bonds is lower than the market rate. 4.d) This is false. When bonds are sold at 100 (face value) the stated rate of the bonds is equal to the market rate. 5.e) This is true. Selling bonds at 101 means that the bonds are issued for 101% of their face value, or at a premium.

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43) a) T b) Tc) F d) F e) F 1.a) This is true. The difference between the effective interest method and the straight-line method is that the effective interest method matches interest expense with the carrying value of the bond. 2.b) This is true. Because amortizing a bond issued at a discount using effective interest matches interest expense with the increasing carrying value of the bond, a company will recognize smaller amounts of interest expense in the first years of a bond’s life and higher amounts in the last years. The straight-line method recognizes equal amounts every year. 3.c) This is false. The carrying value of a bond issued at a premium will decrease by larger and larger amounts each year as interest expense with each payment becomes smaller and smaller. 4.d) This is false. Interest expense using the effective interest method is equal to the carrying value at the beginning of the year multiplied by the market rate of interest, not the stated rate. 5.e) This is false. Effective interest amortization can be used whether interest is paid annually or semi-annually. 44) a) F b) T c) T d) F e) F 1.a) This is false. EBIT stands for earnings before interest and taxes. 2.b) This is true. The return-on-assets ratio is commonly computed by dividing EBIT by total assets. 3.c) This is true. A low times-interest-earned ratio indicates that a company may have difficulty making required interest payments. 4.d) This is false. Dividends are not tax deductible. 5.e) This is false. Interest is deducted on both the income statement and the tax return. 45) a) Date

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Beginning

Payment

Interest

Principal

Ending

Balance Year 1 Year 2 Year 3

$ 75,000.00 52,120.89 27,182.66

Balance $ 29,629.11 29,629.11 29,629.10

$ 6,750.00 4,690.88 2,446.44

$ 22,879.11 24,938.23 27,182.66

$ 52,120.89 27,182.66 0

*All computations are rounded to the nearest cent. To fully liquidate the liability, the final payment is one cent less than the others because of rounding differences. b) $4,690.88 c) $27,182.66 Interest expense each year is equal to the beginning principal balance times 9%. The amount applied to principal each year is equal to the difference between the payment ($29,629.11) and the interest expense. 46) Date Year 1 Year 2 Year 3

Beginning Balance $ 100,000.00 69,196.65 35,929.03

Payment

Interest

Principal

$ 38,803.35 38,803.35 38,803.35

$ 8,000.00 5,535.73 2,874.32

$ 30,803.35 33,267.62 35,929.03

Ending Balance $ 69,196.65 35,929.03 0

Interest expense each year is equal to the beginning principal balance times 8%. The amount applied to principal each year is equal to the difference between the payment ($38,803.35) and the interest expense. 47) $250,000 Issue price of $256,250 = Face value (the unknown) × 102.5 Face value = $256,250 ÷ 1.025 = $250,000 48) a) Account Titles Long-term liabilities:

Debit

Bonds payable

$ 500,000

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Credit

Less: Discount on bonds payable Total Liabilities

(9,000) $ 491,000

b) $41,000 c) Cash flow from operating activities: Payment of interest $(40,000) The issue price of the bonds is $500,000 × 98% = $490,000. The issuance increases the cash account by $490,000, increases the discount on bonds payable (contra-liability account) by $10,000, and increases the bonds payable account by $500,000 (the face value of the bonds). The interest payment is equal to the $500,000 face value × 8% stated rate, or $40,000. The amortization of the discount is equal to $10,000 discount/10 years, or $1,000. a) At the end of Year 1, the carrying value of the bond liability is equal to the face value of $500,000, less the remaining balance in discount on bonds payable, $9,000. b) Interest expense = $41,000 (see feedback for part b) c) The interest payment of $40,000 will be reported as a cash outflow from operating activities.

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49) a) (1) $8,800 a) (2) $17,600 b) (1) Zero b) (2) $16,000 Issue price = Face value of $200,000 × 92% = $184,000 Discount = Face value of $200,000 − Issue price of $184,000 = $16,000 Semiannual amortization of discount = Discount of $16,000 ÷ 20 = $800 (which increases interest expense) Semiannual interest payment = Face value of $200,000 × 8% × 1/2 = $8,000 a) Interest expense for Year 1 is for 6 months and $8,800. Interest expense for Year 2 is for 12 months and $17,600. b) The first interest payment is not made until July 1, Year 2, so there are no payments made in Year 1. In Year 2, the company makes two $8,000 interest payments to the bondholders totaling $16,000. 50) a) $196,000 b) $760,000 c) $410,000 d) $103,000 a) Issue price = Face value of $200,000 × 98% = $196,000 b) Issue price = Face value of $800,000 × 95% = $760,000 c) Issue price = Face value of $400,000 × 102.5% = $410,000 d) Issue price = Face value of $100,000 × 103% = $103,000

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51) $8,475 Issue price = Face value of $150,000 × 103.5% = $155,250 Premium = Issue price of $155,250 − Face value of $150,000 = $5,250 Annual amortization of premium = $5,250 ÷ 10 years = $525 Cash interest payment = Face value of $150,000 × Stated rate of 6% = $9,000 Interest expense = Cash interest payment of $9,000 − Amortization of premium of $525 = $8,475

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52) a) $8,000 b) (1) $7,491.65 b) (2) $508.35 b) (3) $106,515.23 c) (1) $7,456.07 c) (2) $543.93 c) (3) $105,971.30 d) $72,976.42 a) Annual interest payment = Face value of $100,000 × Stated rate of 8% = $8,000 b) (1) Year 1 Interest expense = Carrying value at beginning of Year 1 of $107,023.58 × Market rate of 7% = $7,491.65 (rounded) b) (2) Year 1 Amortization of premium = Interest payment of $8,000 − Interest expense of $7,491.65 = $508.35 b) (3) Carrying value at end of Year 1 = Carrying value at beginning of Year 1 of $107,023.58 − Amortization of premium of $508.35 = $106,515.23 c) (1) Year 2 Interest expense = Carrying value at beginning of Year 2 of $106,515.23 × Market rate of 7% = $7,456.07 (rounded) c) (2) Year 2 Amortization of premium = Interest payment of $8,000 − Interest expense of $7,456.07 = $543.93 c) (3) Carrying value at end of Year 2 = Carrying value at end of Year 1 of = $106,515.23 − Amortization of premium of $543.93 = $105,971.30 d) Total interest = ($8,000 annual payment × 10 years) − Premium of $7,023.58 = $72,976.42

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53) a) $7,000 b) (1) $7,242.60 b) (2) $242.60 b) (3) $96,810.54 c) (1) $7,260.79 c) (2) $260.79 c) (3) $97,071.33 d) $73,432.06 Amortization table: Years

Beginning Annual Interest Discount Balance Payment Expense Amortization Year 1 $ 96,567.94 $ 7,000.00 $ 7,242.60 $ 242.60 Year 2 96,810.54 7,000.00 7,260.79 260.79 Year 3 97,071.33 7,000.00 7,280.35 280.35 Year 4 97,351.68 7,000.00 7,301.38 301.38 Year 5 97,653.06 7,000.00 7,323.98 323.98 Year 6 97,977.04 7,000.00 7,348.28 348.28 Year 7 98,325.32 7,000.00 7,374.40 374.40 Year 8 98,699.72 7,000.00 7,402.48 402.48 Year 9 99,102.20 7,000.00 7,432.67 432.67 Year 10 99,534.87 7,000.00 7,465.11 465.13*

Ending Balance $ 96,810.54 97,071.33 97,351.68 97,653.06 97,977.04 98,325.32 98,699.72 99,102.20 99,534.87 100,000.00

*rounded for final payment a) Annual interest payment = Face value of $100,000 × Stated rate of 7% = $7,000 b) (1) Year 1 Interest expense = $7,242.60 b) (2) Discount amortization = $242.60 b) (3) Carrying value at December 31, Year 1 = $96,810.54 c) (1) Year 2 interest expense = $7,260.79 c) (2) Year 2 discount amortization = $260.79 c) (3) Carrying value on December 31, Year 2 = $97,071.33 d) Total interest expense = ($7,000 annual payment × 10 years) + Discount of $3,432.06 = $73,432.06

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54) a) $10,500 b) (1) $21,735 b) (2) $760 c) $309,740 d) $21,682 a) Issue price = Face value of $300,000 × 103.5% = $310,500 Premium = Issue price of $310,500 − Face value of $300,000 = $10,500 b) (1) Year 1 Interest expense = Carrying value at beginning of year of $310,500 × Market rate of 7% = $21,735 b) (2) Year 1 Amortization of premium = Interest payment of $22,495 (given) − Interest expense of $21,735 = $760 c) Carrying value at end of Year 1 = Carrying value at beginning of year of $310,500 − Amortization of premium of $760 = $309,740 d) Year 2 Interest expense = Carrying value at end of Year 1 of $309,740 × Market rate of 7% = $21,682 (rounded)

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CHAPTER 10 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Loans that require payment of interest at regular intervals and payment of principal at maturity are installment notes. ⊚ true ⊚ false

2) For a long-term note payable, repaying a portion of principal along with interest payments is called loan amortization. ⊚ true ⊚ false

3) Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a 10-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. The amount of the payment for Year 1 that is interest expense is $4,500. ⊚ true ⊚ false

4) Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a 10-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. The amount of the payment for Year 1 that is repayment of principal is $3,587. ⊚ true ⊚ false

5) Davis Corporation borrowed $50,000 on January 1, Year 1. The loan is for a 10-year period and has an annual interest rate of 9%. At the end of each year, Davis will make a payment of $7,791, which includes both principal and interest. With this loan, the amount of interest expense that Davis reports on its income statement will be the same for each year of the loan. ⊚ true ⊚ false

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6) A line of credit is an agreement that allows a company to borrow a set amount of money for a period of one year or more. ⊚ true ⊚ false

7) A line of credit typically has an interest rate that is fixed (constant) for the length of the agreement. ⊚ true ⊚ false

8) Companies that issue bonds are required to pay the face value of the bonds at maturity and to make fluctuating periodic interest payments based on the market interest rate. ⊚ true ⊚ false

Serial bonds are issued based on the overall strength of the borrower's credit. ⊚ true ⊚ false

10)

Bonds sold as separate components of a single issue may have different maturity dates. ⊚ true ⊚ false

11) If a company chooses to call some of its callable bonds before their maturity, generally it will have to pay an amount that is greater than the carrying value of the bonds. ⊚ true ⊚ false

12) If a bond issuer's bond ratings drop, the company probably will have to pay higher interest rates on bonds that have already been issued. ⊚ true ⊚ false

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13)

Amortization of a discount on bonds payable is an asset use transaction. ⊚ true ⊚ false

14) Peak Enterprises issued bonds with a face value of $500,000, and received cash of $508,000. In recording this transaction, the liability account, Bonds Payable, will be increased by $500,000. ⊚ true ⊚ false

15) Park Enterprises issued bonds with a face value of $500,000, a stated rate of interest of 7%, and a 5-year term to maturity. The proceeds from the issuance were $508,000. Interest is payable in cash on December 31 of each year. Assuming straight-line amortization, the amount of interest expense for the first year would be $31,600. ⊚ true ⊚ false

16) If the stated interest rate for bonds is the same as the effective interest rate, the bonds will be issued at their face value. ⊚ true ⊚ false

17) On January 1, Year 1, Daniels Company issued bonds with a face value of $500,000, receiving $496,000 cash. These bonds were issued at a discount. ⊚ true ⊚ false

18) On January 1, Year 1, Daniels Company issued bonds with a face value of $500,000, receiving $496,000 cash. When the bonds mature, Daniels will have to pay the face value of the bonds to the bondholders. ⊚ true ⊚ false

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19) If a company has issued bonds at a premium, the amount of interest expense reported on the income statement each year will be greater than the amount of cash paid to bondholders for interest. ⊚ true ⊚ false

20) If bonds with a face value of $200,000 are issued at 98, the amount of cash received from issuing the bonds is $204,082. ⊚ true ⊚ false

21) If bonds are issued at a premium, the bond issuer will pay the bondholders an amount lower than the issue price at maturity. ⊚ true ⊚ false

22) The effective rate of interest for a particular bond issue is the market rate of interest for other investments with similar levels of risk. ⊚ true ⊚ false

23) The effective interest rate method of amortizing bond discounts and premiums results in a constant amount of interest expense every period. ⊚ true ⊚ false

24) If a bond discount is amortized using the effective interest method, the total amount of interest recognized over the life of the bond is the same as if the straight-line method is used. ⊚ true ⊚ false

25) The tax deductibility of interest expense on bonds makes the effective cost of borrowing less than the amount of cash paid for interest.

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⊚ ⊚

26)

true false

The after-tax interest cost of debt equals total interest expense multiplied by the tax rate. ⊚ true ⊚ false

27) The times-interest-earned ratio is usually calculated as the ratio of net income to interest expense. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 28) Chico Company borrowed $40,000 on a four-year, 8% installment note. How will this transaction affect Chico’s financial statements? A) Cash and notes payable increase by $43,200 B) Cash and interest payable increase by $40,000 C) Cash and interest payable increase by $43,200 D) Cash and notes payable increase by $40,000

29)

Which of the following correctly describes an installment note?

A) An installment note requires interest payments with the entire principal balance paid at maturity. B) An installment note requires payments of interest and principal in which the amount of interest decreases over the life of the note. C) An installment note requires payments of interest and principal in which the amount of interest increases over the life of the note. D) The installment note requires decreasing payments of interest and principal in which the amount of interest remains constant over the life of the note.

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30) Regardless of the specific type of long-term debt, which of the following is normally an expectation with regards to debt transactions? A) Repayment of the debt B) Payment of dividends C) Payment of interest D) Payment of interest and repayment of the debt

31) On January 1, Year 1, Platte Corporation issues a 5-year note payable for $5,000. The interest rate is 5% and the annual payment of $1,156, due each December 31, includes both interest and principal. Which of the following correctly shows the effect of the issuance of the note on Platte's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 5,000 n/a 5,000 5,000 n/a 5,000 5,000 FA B. 5,000

n/a

5,000

n/a

5,000

5,000 IA

C. (5,000)

(5,000)

n/a

D. 5,000

5,000

n/a

(5,000) IA 5,000 FA

A) Option A B) Option B C) Option C D) Option D

32) On January 1, Year 1, Platte Corporation issues a 5-year note payable for $5,000. The interest rate is 5% and the annual payment of $1,156, due each December 31, includes both interest and principal. Which of the following shows the effect of the December 31, Year 1 payment? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (1,156) (1,156) n/a n/a n/a n/a (1,156)

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B. (1,156)

(906)

(250)

n/a

250

C. (1,156)

n/a

(1,156)

n/a

1,156

D. (1,156)

(906)

(250)

n/a

250

FA (250) (906) FA/(250) OA (1,156) (1,156) OA (250) (1,156) FA

A) Option A B) Option B C) Option C D) Option D

33) On January 1, Year 1, Platte Corporation issues a 5-year note payable for $5,000. The interest rate is 5% and the annual payment of $1,156, due each December 31, includes both interest and principal. Which of the following correctly shows the effects of the December 31, Year 2 payment (rounded to the nearest whole dollar)? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (1,156) (951) (205) n/a 205 (205) (1,156) FA B. (1,156)

(906)

(250)

n/a

250

C. (1,156)

(951)

(205)

n/a

205

D. (1,156)

(951)

(205)

n/a

205

(250)

(906) FA/(250) OA (205) (951) FA/(205) OA (205) (1,156) OA

A) Option A B) Option B C) Option C D) Option D

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34) On January 1, Year 1, Mahoney Company borrowed $166,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $41,576. What is the amount of principal repayment included in the payment made on December 31, Year 1? A) $13,280 B) $28,296 C) $37,421 D) $40,675

35) On January 1, Year 1, Mahoney Company borrowed $324,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $81,150. What is the amount of principal repayment included in the payment made on December 31, Year 1? A) $25,920 B) $81,150 C) $74,658 D) $55,230

36) On January 1, Year 1, Mahoney Company borrowed $324,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $81,150. Which of the following shows the effects on the financial statement of the cash payment on December 31, Year 1? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. − − − n/a + − −FA/−OA B.

−

n/a

−FA

−

n/a

−

−FA/−OA

Version 1

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

37) How does the amortization of the principal balance on an installment note payable affect the amount of interest expense recorded each succeeding year? A) Reduces the amount of interest expense each year B) Increase the amount of interest expense each year C) Has no effect on interest expense each year D) Cannot be determined from the information provided

38) Currie Company borrowed $22,000 from Sierra Bank by issuing a 11% three-year note. Currie agreed to repay the principal and interest by making annual payments in the amount of $9,003. Based on this information, what is the amount of the interest expense associated with the second payment? (Round your answer to the nearest dollar.) A) $1,571 B) $1,696 C) $2,420 D) $9,003

39) Currie Company borrowed $20,000 from Sierra Bank by issuing a 10% three-year note. Currie agreed to repay the principal and interest by making annual payments in the amount of $8,042. Based on this information, what is the amount of the interest expense associated with the second payment? (Round your answer to the nearest dollar.) A) $730 B) $1,396 C) $2,000 D) $8,042

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40) On January 1, Year 1, Niagara Corporation arranges a $6,000 line of credit with Centennial Bank. It accepted the bank's offer of 1% above the prime rate with interest payments on December 31 of each year. All borrowings and repayments are to take place on January 1 of each year. Niagara begins its loan transactions with Centennial Bank by borrowing $2,000 on January 1, Year 1. Which of the following shows the effect of this event on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 2,000 2,000 n/a n/a n/a n/a 2,000 IA B. 2,000

n/a

2,000

n/a

2,000

2,000 IA

C. 2,000

n/a

2,000

n/a

2,000

2,000 OA

D. 2,000

2,000

n/a

2,000 FA

A) Option A B) Option B C) Option C D) Option D

41) On January 1, Year 1, Niagara Corporation arranges a $6,000 line of credit with Centennial Bank. It accepted the bank's offer of 1% above the prime rate with interest payments on December 31 of each year. All borrowings and repayments are to take place on January 1 of each year. Niagara begins its loan transactions with Centennial Bank by borrowing $2,000 on January 1, Year 1. Niagara records the first year's interest payment on December 31, Year 1. Centennial's prime rate is 4% for Year 1. Which of the following shows the effect of this event on the financial statements? Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income A. (100) n/a (100) n/a 100 (100)

(100) OA

B. (100)

(100)

n/a

(100) FA

C. (80)

(80)

n/a

(80) FA

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Statement of Cash Flows

D. (80)

n/a

(80)

n/a

(80)

(80) OA

A) Option A B) Option B C) Option C D) Option D

42) North Woods Company has a line of credit with Olympia State Bank. North Woods agreed to pay interest at an annual rate equal to 3% above the bank's prime rate. Funds are borrowed or repaid on the first day of each month and interest is paid in cash on the last day of each month. Borrowing is shown as a positive amount, and repayments are shown as negative amounts indicated by parentheses. Activity to date is given as follows: Month January February March

Amount Borrowed (Repaid) $ 53,000 84,000 (53,000)

Prime Rate for the Month 7% 4% 3%

What is the amount of interest paid at the end of March? (Do not round your intermediate calculations.) A) $210.00 B) $420.00 C) $442.00 D) $490.00

43) North Woods Company has a line of credit with Olympia State Bank. North Woods agreed to pay interest at an annual rate equal to 2% above the bank's prime rate. Funds are borrowed or repaid on the first day of each month and interest is paid in cash on the last day of each month. Borrowing is shown as a positive amount, and repayments are shown as negative amounts indicated by parentheses. Activity to date is given as follows: Month January February March

Amount Borrowed (Repaid) $ 40,000 60,000 (40,000)

Prime Rate for the Month 6% 5% 3%

What is the amount of interest paid at the end of March?

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A) $150 B) $300 C) $267 D) $250

44) Franklin Company obtained a $155,000 line of credit from State Bank on January 1, Year 1. The company agreed to accept a variable interest rate that was set at 2% above the bank's prime lending rate. The bank's prime rate of interest and the amounts borrowed or repaid during the first three months of Year 1 are shown in the following table. Assume that Franklin borrows or repays on the first day of each month.

1-January 1-February 1-March

Amount Borrowed (Repaid) $ 50,000 (20,000) 50,000

Prime Rate for the Month 4.0% 4.5% 5.0%

What is the amount of interest expense recognized in March? (Do not round your intermediate calculations. Roundyour final answer to the nearest dollar.) A) $267 B) $300 C) $333 D) $467

45) Franklin Company obtained a $160,000 line of credit from State Bank on January 1, Year 1. The company agreed to accept a variable interest rate that was set at 2% above the bank's prime lending rate. The bank's prime rate of interest and the amounts borrowed or repaid during the first three months of Year 1 are shown in the following table. Assume that Franklin borrows or repays on the first day of each month.

1-January 1-February 1-March

Amount Borrowed (Repaid) $ 40,000 (10,000) 40,000

Prime Rate for the Month 4.0% 4.5% 5.0%

What is the amount of interest expense recognized in March? (Round your answer to the nearest dollar.)

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A) $232 B) $262 C) $292 D) $408

46) On January 1, Year 1, Burton Corporation issued bonds with a face value of $200,000 for $196,000 cash.: Which of the following correctly describes the related transaction? A) Burton issued bonds at 102. B) Burton issued bonds at 98. C) Burton issued bonds at a $4,000 premium. D) Burton signed a note payable for $196,000.

47) What is the name used for the type of secured bond that requires a pledge of a designated piece of property in case of default? A) Debenture bond B) Indenture bond C) Mortgage bond D) Registered bond

48)

Which of the following describes the characteristics of a convertible bond? A) Bonds mature at specified intervals throughout the life of the total issuance. B) Bonds may be exchanged for stock at the discretion of the bondholder. C) Bonds mature on a specified date in the future. D) Bonds may be exchanged for stock at the discretion of the issuer.

49)

Which of the following describes a callable bond?

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A) Can be called for early retirement at the option of the issuer B) Can be called for early retirement at the option of the bondholder C) Convertible to common stock at the option of the bondholder D) Convertible to common stock at the option of the issuer

50)

How are bonds payable usually classified on the balance sheet? A) Current liabilities B) Long-term liabilities C) Investments and funds D) Other assets

51)

What is another term used to describe unsecured bonds? A) Discount bonds B) Coupon bonds C) Debentures D) Par value bonds

52) Spokane Company called in bonds at a price that was above the carrying value of the bond liability. Which of the following shows how this event will affect the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + n/a n/a n/a n/a +FA B.

−

n/a

−

−IA

−

n/a

−

−FA

−

n/a

−

−FA

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A) Option A B) Option B C) Option C D) Option D

53) Johansen Company issued a bond at a discount. Which of the following shows how the issuance of the bonds affects the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + n/a n/a + − +OA B.

n/a

+FA

−

n/a

−

+FA

n/a

+OA

A) Option A B) Option B C) Option C D) Option D

54) On January 1, Year 1, Bluestone Company issued bonds with a face value of $500,000 at 90. How will this transaction affect Bluestone Company’s cash account? A) Cash will increase by $450,000 B) Cash will increase by $500,000 C) Cash will increase by $470,000 D) Cash will increase by $50,000

55) On January 1, Year 1, Williams Corporation issued $200,000 of callable bonds at face value. The bonds carried a 2% call premium. If Williams calls the bonds, how would this event affect the company’s accounting equation?

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A) Decrease stockholders’ equity by $4,000. B) Decrease liabilities by $200,000. C) Decrease assets by $204,000. D) All of these answer choices are correct.

56) Pace Company issued bonds with a face value of $200,000 at 97. How does the issuance affect the company’s accounting equation? A) Assets and liabilities would both increase by $200,000. B) Assets and liabilities would both increase by $194,000. C) Assets would increase by $194,000 and liabilities would increase by $200,000. D) Assets would increase by $200,000, and liabilities would increase by $194,000.

57) Which of the following describes what happens when bonds are issued when the market interest rate is less than the stated interest rate? A) The bonds are issued at a premium. B) The bonds are issued at less than their face value. C) It raises the effective interest rate above the stated rate of interest. D) The bonds are issued at a premium and the effective interest rate is higher than the stated rate.

58) Which of the following is the term used to describe bonds that mature at specified intervals throughout the life of the issuance? A) Term bonds B) Registered bonds C) Coupon bonds D) Serial bonds

59) Which of the following is not a common restrictive covenant included in bond indentures to reduce risk to the investor?

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A) Restrictions on increases in executive salaries B) Restrictions on additional borrowing activities C) Requirements that the names and addresses of the bondholders be registered with the bond issuer D) Limitations on the payment of dividends

60) Marvin Company issues $125,000 of bonds at face value on January 1. The bonds carry a 6% annual stated rate of interest. Interest is payable in cash on December 31 of each year. Which of the following shows the effect of the first interest payment on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (7,500) (7,500) n/a n/a n/a n/a (7,500) FA B. (7,500) n/a (7,500) n/a 7,500 (7,500) (7,500) FA C. (7,500) (7,500) n/a n/a n/a n/a (7,500) OA D. (7,500) n/a (7,500) n/a 7,500 (7,500) (7,500) OA

A) Option A B) Option B C) Option C D) Option D

61) On January 1, Year 1, Jones Company issued bonds with a $110,000 face value, a stated rate of interest of 8.0%, and a 5-year term to maturity. The bonds were issued at 98. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the amount of interest expense shown on Jones' income statement for the year ending December 31, Year 1?

Version 1

A) $8,360 B) $9,680 C) $8,800 D) $9,240

62) On January 1, Year 1, Jones Company issued bonds with a $200,000 face value, a stated rate of interest of 7.5%, and a 5-year term to maturity. The bonds were issued at 97. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the amount of interest expense shown on Jones' income statement for the year ending December 31, Year 1? A) $16,200 B) $21,000 C) $15,000 D) $13,800

63) On January 1, Year 1, Jones Company issued bonds with a $250,000 face value, a stated rate of interest of 7.0%, and a 5-year term to maturity. The bonds were issued at 97. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the total amount of liabilities shown on Jones' balance sheet at December 31, Year 2? A) $245,500 B) $242,500 C) $239,500 D) $244,000

64) On January 1, Year 1, Jones Company issued bonds with a $200,000 face value, a stated rate of interest of 7.5%, and a 5-year term to maturity. The bonds were issued at 97. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the total amount of liabilities shown on Jones' balance sheet at December 31, Year 2?

Version 1

A) $191,600 B) $194,000 C) $196,400 D) $195,200

65) On January 1, Year 1, Jones Company issued bonds with a $180,000 face value, a stated rate of interest of 7.5%, and a 5-year term to maturity. The bonds were issued at 99. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the amount of cash outflow from operating activities shown on Jones' statement of cash flows for the year ending December 31, Year 2? A) $13,500 B) $13,860 C) $13,140 D) $14,220

66) On January 1, Year 1, Jones Company issued bonds with a $200,000 face value, a stated rate of interest of 7.5%, and a 5-year term to maturity. The bonds were issued at 97. Interest is payable in cash on December 31st of each year. The company amortizes bond discounts and premiums using the straight-line method. What is the amount of cash outflow from operating activities shown on Jones' statement of cash flows for the year ending December 31, Year 2? A) $15,000 B) $16,200 C) $13,800 D) $17,400

67) On January 1, Year 1, Eureka Company issued $270,000 of 6-year, 4% bonds at face value. The annual cash payment for interest is due on January 1 of each year beginning January 1, Year 2. Based on this information, what is the total amount of liabilities related to these bonds that will be reported on the balance sheet at December 31, Year 1?(Hint: Consider the interest that might be owed to bondholders at December 31, Year 1.) Version 1

A) $270,000 B) $280,800 C) $268,920 D) $10,800

68) On January 1, Year 1, Eureka Company issued $100,000 of five-year, 7% bonds at face value. The annual cash payment for interest is due on January 1 of each year beginning January 1, Year 2. Based on this information, what is the total amount of liabilities related to these bonds that will be reported on the balance sheet at December 31, Year 1?(Hint: Consider the interest that might be owed to bondholders at December 31, Year 1.) A) $100,000 B) $7,000 C) $99,300 D) $107,000

69) Kier Company issued $560,000 in bonds on January 1, Year 1. The bonds were issued at face value and carried a 3-year term to maturity. The bonds have a 5.50% stated rate of interest and interest is payable in cash on December 31 each year. Based on this information alone, what are the amounts of interest expense and cash flows from operating activities, respectively, that will be reported in the financial statements for the year ending December 31, Year 1? A) $30,800 and Zero B) Zero and $30,800 C) $30,800 and $30,800 D) Zero and Zero

70) Kier Company issued $200,000 in bonds on January 1, Year 1. The bonds were issued at face value and carried a 4-year term to maturity. The bonds have a 6.5% stated rate of interest and interest is payable in cash on December 31 each year. Based on this information alone, what are the amounts of interest expense and cash flows from operating activities, respectively, that will be reported in the financial statements for the year ending December 31, Year 1?

Version 1

A) $13,000 and Zero B) Zero and $13,000 C) $13,000 and $13,000 D) Zero and Zero

71) On January 1, Year 1, Pierce Corporation issued $25,000 in 8%, 5-year bonds payable at 102. Interest payments are due each December 31. Pierce uses the straight-line method to amortize bond discounts and premiums. Which of the following shows the effect of the bond issuance on January 1, Year 1? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 25,500 25,500 n/a n/a n/a n/a 25,500 FA B. 25,500

25,500

n/a

25,500 OA

C. 25,500

24,500

500

n/a

500

25,500 OA

D. 25,500

24,500

500

n/a

500

25,500 FA

A) Option A B) Option B C) Option C D) Option D

72) On January 1, Year 1, Pierce Corporation issued $25,000 in 8%, 5-year bonds payable at 102. Interest payments are due each December 31. Pierce uses the straight-line method to amortize bond discounts and premiums. Which of the following shows the effect of the interest payment and amortization on December 31, Year 1? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (2,000) (160) (1,840) (1,840) n/a (1,840) (2,000) FA B. (2,000)

Version 1

(100)

(1,900)

n/a

1,900

(1,900)

(100) FA/(1,900)

C. (2,000)

(100)

(1,900)

n/a

1,900

D. (2,000)

n/a

OA (1,900) (2,000) OA n/a

(2,000) OA

A) Option A B) Option B C) Option C D) Option D

73) On January 1, Year 1, Pierce Corporation issued $25,000 in 8%, 5-year bonds payable at 102. Interest payments are due each December 31. Pierce uses the straight-line method to amortize bond discounts and premiums. On January 1, Year 2, Pierce Corporation called the bonds payable at a price of $25,450. Which of the following shows the effect of this transaction on the financial statements?

A . B . C . D .

Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders Revenu − Expens = Net Cash s ’ Equity e e Income Flows (25,450 (25,400) (50) n/a 50 (50) (25,450) ) FA (25,450 (25,400) (50) n/a 50 (50) (25,450) ) FA/(50) OA (25,450 (25,450) n/a n/a n/a n/a (25,450) ) FA (25,450 n/a n/a n/a 25,450 (25,450 (25,450) ) ) OA

A) Option A B) Option B C) Option C D) Option D

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74) On January 1, Year 1, Hanover Corporation issued bonds with a $54,000 face value, a stated rate of interest of 8%, and a 5-yearterm to maturity. The bonds were issued at 97. Hanover uses the straight-line method to amortize bond discounts and premiums. Interest is payable in cash on December 31 each year. How much interest expense will Hanover report on its income statement on December 31, Year 1? A) $324 B) $1,620 C) $4,320 D) $4,644

75) On January 1, Year 1, Hanover Corporation issued bonds with a $70,500 face value, a stated rate of interest of 8%, and a 5-year term to maturity. The bonds were issued at 97. Hanover uses the straight-line method to amortize bond discounts and premiums. Interest is payable in cash on December 31 each year. How much interest expense will Hanover report on its income statement on December 31, Year 1? A) $423 B) $2,115 C) $5,640 D) $6,063

76) On January 1 Year 1, Gordon Corporation issued bonds with a face value of $70,000, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds were issued at 98. Interest is payable in cash on December 31 each year. Gordon uses the straight-line method to amortize bond discounts and premiums. Which of the following shows the effect of the bond issuance on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. 70,000 70,000 n/a n/a n/a n/a 70,000 FA B. 68,600

Version 1

68,600

n/a

68,600 FA

C. 68,600

70,000

(1,400)

n/a

1,400

(1,400) 68,600 FA

D. 70,000

68,600

1,400

n/a

(1,400)

1,400

70,000 FA

A) Option A B) Option B C) Option C D) Option D

77) On January 1 Year 1, Gordon Corporation issued bonds with a face value of $70,000, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds were issued at 98. Interest is payable in cash on December 31 each year. Gordon uses the straight-line method to amortize bond discounts and premiums. Which of the following shows the effect of the first interest payment and amortization of the premium or discount on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. (4,200) (4,200) n/a n/a n/a n/a (4,200) FA B. (4,480) (280) (4,200) n/a 4,200 (4,200) (4,480) FA C. (4,480) (280) (4,200) n/a 4,200 (4,200) (4,200) OA/(280) FA D. (4,200) 280 (4,480) n/a 4,480 (4,480) (4,200) OA

A) Option A B) Option B C) Option C D) Option D

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78) On January 1 Year 1, Gordon Corporation issued bonds with a face value of $70,000, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds were issued at 98. Interest is payable in cash on December 31 each year. Gordon uses the straight-line method to amortize bond discounts and premiums. On December 31, Year 5, Gordon Corporation records interest and amortization. Immediately after that, Gordon pays off the bonds as scheduled. Which of the following shows the effect of the bond payoff on the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilitie + Stockholders Revenu − Expens = Net Flows s ’ Equity e e Income A. (68,600 (68,600) n/a n/a n/a n/a (68,600) ) FA B. (68,600 (68,600) n/a n/a n/a n/a (68,600) ) OA C. (70,000 (68,600) (1,400) n/a 1,400 (1,400 (68,600) ) ) FA/(1,400 ) OA D. (70,000 (70,000) n/a n/a n/a n/a (68,600) ) FA/(1,400 ) OA

A) Option A B) Option B C) Option C D) Option D

79)

Why are bonds sometimes issued at a discount?

A) The stated rate of interest is higher than the rate being paid on investments in the securities market with comparable risk. B) The stated rate of interest is the same as the rate being paid on investments in the securities market with comparable risk. C) The stated rate of interest is lower than the rate being paid on investments in the securities market with comparable risk. D) The bonds are being issued between interest payment dates.

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80) On January 1, Year 1, Denver Company issued bonds with a face value of $75,000, a statedrate of interest of 8%,and a 5-year term to maturity. The bonds were sold at 102.5. Denver uses the straight-line method to amortize bond discounts and premiums. What is the amount of interest expense during Year 1? A) $6,000 B) $5,625 C) $6,375 D) $6,150

81) On January 1, Year 1, Denver Company issued bonds with a face value of $100,000, a stated rate of interest of 8%, and a 5-year term to maturity. The bonds were sold at 102.5. Denver uses the straight-line method to amortize bond discounts and premiums. What is the amount of interest expense during Year 1? A) $7,500 B) $8,500 C) $8,000 D) $8,200

82) Which of the following statements regarding the stated rate of interest is true if a bond is sold at 101? A) The stated rate equals the market rate. B) The state rate is unrelated to the market rate. C) The stated rate is higher than the market rate. D) The stated rate is lower than the market rate.

83) On January 1, Year 1, Strang Incorporated issued bonds with a face value of $500,000, a stated rate of interest of 8%, and a 5-year term to maturity. The effective rate of interest was 10%. Interest is payable in cash on June 30 and December 31 of each year. Which of the following statements is true?

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A) This bond was issued at a premium, and each semiannual cash payment is $25,000. B) This bond was issued at a discount, and each semiannual cash payment is $20,000. C) This bond was issued at a discount, and the annual interest expense is $40,000. D) This bond was issued at a premium, and the annual interest expense is $40,000.

84) Which of the following shows how the cash payment and recognition of interest expense affects the financial statements when a bond is issued at a discount? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. − − n/a n/a n/a n/a −IA B.

−

n/a

−

−OA

−

n/a

−

−IA

−

n/a

−

n/a

−

−OA

A) Option A B) Option B C) Option C D) Option D

85) King Company experienced an accounting event that affected its financial statements as indicated below: Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income − − − NA + − −FA/−OA

Which of the following accounting events could have caused these effects on King's statements? A) Repaid a bond issued at a discount. B) Borrowed funds through a line-of-credit. C) Made a payment on an installment loan. D) Issued a bond at a discount.

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86) On January 1, Year 1, Sheffield Company issued bonds with a face value of $240,000, a term of ten years, and a stated interest rate of 7%. The bonds were issued at 106, and interest is payable each December 31. Sheffield uses the straight-line method to amortize bond discounts and premiums. What is the carrying value of the bonds at December 31, Year 4? A) $245,760 B) $248,640 C) $247,200 D) $240,000

87) On January 1, Year 1, Sheffield Company issued bonds with a face value of $200,000, a term of ten years, and a stated interest rate of 6%. The bonds were issued at 105, and interest is payable each December 31. Sheffield uses the straight-line method to amortize bond discounts and premiums. What is the carrying value of the bonds at December 31, Year 4? A) $204,000 B) $200,000 C) $205,000 D) $206,000

88) Jacobs Company issued bonds with a $186,000 face value on January 1, Year 1. The bonds were issued at 105 and carried a 5-year term to maturity. They had a 9% stated rate of interest that was payable in cash on December 31st of each year. Jacobs uses the straight-line method to amortize bond discounts and premiums. Based on this information alone, how does the recognition of interest expense during Year 1 affect the company’s accounting equation? A) Decreases stockholders’ equity by $14,880, decreases liabilities by $1,860, and decreases assets by $16,740 B) Decreases both assets and stockholders’ equity by $16,740 C) Decreases both assets and stockholders’ equity by $14,880 D) Increases liabilities by $1,860, decreases assets by $14,880, and decreases stockholders’ equity by $16,740

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89) Jacobs Company issued bonds with a $300,000 face value on January 1, Year 1. The bonds were issued at 102 and carried a 5-year term to maturity. They had a 9% stated rate of interest that was payable in cash on December 31st of each year. Jacobs uses the straight-line method to amortize bond discounts and premiums. Based on this information alone, how does the recognition of interest expense during Year 1 affect the company’s accounting equation? A) Decreases stockholders' equity by $25,800, decreases liabilities by $1,200, and decreases assets by $27,000 B) Decreases both assets and stockholders’ equity by $2,700 C) Decreases both assets and stockholders’ equity by $25,800 D) Increases liabilities by $1,200, decreases assets by $25,800, and decreases stockholders’ equity by $27,000

90) A discount or premium on bonds payable can be defined by which of the following statements? A) The difference between the market price on the issue date and the face value. B) The difference between the call price and the face value of the bond. C) The market rate of interest on the date of the bond issuance. D) The difference between the interest rate and the market price of the bond.

91) On January 1, Year 1, Victor Company issued bonds with a $675,000 face value, a stated rate of interest of 5%, and a 5-year term to maturity. The bonds sold at 96. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums. What is the carrying value of the bond liability at December 31, Year 3? A) $664,200 B) $658,800 C) $669,600 D) $653,400

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92) On January 1, Year 1, Victor Company issued bonds with a $250,000 face value, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds sold at 95. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums. What is the carrying value of the bond liability at December 31, Year 3? A) $241,000 B) $242,500 C) $237,500 D) $245,000

93) On January 1, Year 1, Victor Company issued bonds with a $525,000 face value, a stated rate of interest of 5%, and a 5-year term to maturity. The bonds sold at 96. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums.

What is the amount of interest expense appearing on the income statement for the year ending December 31, Year 3? A) $26,250 B) $30,450 C) $25,200 D) $21,000

94) On January 1, Year 1, Victor Company issued bonds with a $250,000 face value, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds sold at 95. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums. What is the amount of interest expense appearing on the income statement for the year ending December 31, Year 3?

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A) $17,500 B) $12,500 C) $14,250 D) $15,000

95) On January 1, Year 1, Victor Company issued bonds with a $825,000 face value, a stated rate of interest of 5%, and a 5-year term to maturity. The bonds sold at 96. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums.

What is the amount of cash flow from operating activities on the statement of cash flows for the year ending December 31, Year 3? A) $41,250 B) $47,850 C) $39,600 D) $33,000

96) On January 1, Year 1, Victor Company issued bonds with a $250,000 face value, a stated rate of interest of 6%, and a 5-year term to maturity. The bonds sold at 95. Interest is payable in cash on December 31 of each year. Victor uses the straight-line method to amortize bond discounts and premiums. What is the amount of cash flow from operating activities on the statement of cash flows for the year ending December 31, Year 3? A) $17,500 B) $15,000 C) $14,250 D) $12,500

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97) On January 1, Year 1, Wayne Company issued bonds with a face value of $600,000, a 6% stated rate of interest, and a 10-year term. Interest is payable in cash on December 31 of each year. Wayne uses the straight-line method to amortize bond discounts and premiums. Which of the following statements is true if Wayne issued the bonds for 96? A) The market rate of interest was equal to the stated rate of interest. B) The market rate of interest was lower than the stated rate of interest. C) The market rate of interest was higher than the stated interest rate. D) The bonds carried a variable or floating rate that changed in response to market conditions.

98) On January 1, Year 1, Wayne Company issued bonds with a face value of $720,000, a 11% stated rate of interest, and a 10-year term. Interest is payable in cash on December 31 of each year. Wayne uses the straight-line method to amortize bond discounts and premiums.

Assuming Wayne issued the bonds for 104, what is the carrying value of the bonds on the December 31, Year 1 balance sheet? A) $745,920 B) $722,880 C) $751,680 D) $748,800

99) On January 1, Year 1, Wayne Company issued bonds with a face value of $600,000, a 6% stated rate of interest, and a 10-year term. Interest is payable in cash on December 31 of each year. Wayne uses the straight-line method to amortize bond discounts and premiums. Assuming Wayne issued the bonds for 102.5, what is the carrying value of the bonds on the December 31, Year 1 balance sheet? A) $601,500 B) $613,500 C) $615,000 D) $616,500

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100) On January 1, Year 1, Wayne Company issued bonds with a face value of $1,020,000, a 10% stated rate of interest, and a 10-year term. Interest is payable in cash on December 31 of each year. Wayne uses the straight-line method to amortize bond discounts and premiums.

Assuming Wayne issued the bond for 106, what is the amount of interest expense that will be reported on the income statement for the year ending December 31, Year 1? A) $108,120 B) $102,000 C) $95,880 D) $61,200

101) On January 1, Year 1, Wayne Company issued bonds with a face value of $600,000, a 6% stated rate of interest, and a 10-year term. Interest is payable in cash on December 31 of each year. Wayne uses the straight-line method to amortize bond discounts and premiums. Assuming Wayne issued the bond for 102.5, what is the amount of interest expense that will be reported on the income statement for the year ending December 31, Year 1? A) $34,500 B) $36,000 C) $37,500 D) $15,000

102) Which of the following statements is true regarding the straight-line method of amortizing discounts and premiums on bonds? A) It assigns variable amounts of interest over the term of the liability. B) It uses compound interest principles. C) It assigns the same amount of interest to each interest period over the life of the bond. D) It accurately reports the amount of interest expense incurred during each interest period.

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103)

Which of the following statements is true when bonds are issued at a premium?

A) The carrying value decreases by equal amounts each year if straight-line amortization is used. B) The carrying value decreases by equal amounts each year if effective interest amortization is used. C) The carrying value decreases by larger and larger amounts each year if effective interest amortization is used. D) The carrying value decreases by equal amounts each year if straight-line amortization is used and decreases by increasing amounts each year if effective interest amortization is used.

104) On January 1, Year 1, Weller Company issued bonds with a $380,000 face value, a stated rate of interest of 10.00%, and a 10-year term to maturity. Weller uses the effective interest method to amortize bond discounts and premiums. The market rate of interest on the date of issuance was 8.00%. Interest is paid annually on December 31. Assuming Weller issued the bonds for $430,997, what is the carrying value of the bonds on the December 31, Year 3? (Round your intermediate calculations and final answer to the nearest whole dollar amount.) A) $419,569 B) $427,477 C) $423,675 D) $418,000

105) On January 1, Year 1, Weller Company issued bonds with a $400,000 face value, a stated rate of interest of 10%, and a 10-year term to maturity. Weller uses the effective interest method to amortize bond discounts and premiums. The market rate of interest on the date of issuance was 8%. Interest is paid annually on December 31. Assuming Weller issued the bonds for $453,681, what is the carrying value of the bonds on the December 31, Year 3? (Round the final answer to the nearest dollar.)

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A) $420,615 B) $426,495 C) $441,651 D) $404,800

106) On January 1, Year 1, Weller Company issued bonds with a $330,000 face value, a stated rate of interest of 10.50%, and a 10-year term to maturity. Weller uses the effective interest method to amortize bond discounts and premiums. The market rate of interest on the date of issuance was 8.50%. Interest is paid annually on December 31.

Assuming Weller issued the bond for $373,305, what is the amount of interest expense that will be recognized during Year 3? (Round your intermediate calculations and final answer to the nearest whole dollar amount.) A) $34,650 B) $31,731 C) $31,214 D) $39,629

107) On January 1, Year 1, Weller Company issued bonds with a $400,000 face value, a stated rate of interest of 10%, and a 10-year term to maturity. Weller uses the effective interest method to amortize bond discounts and premiums. The market rate of interest on the date of issuance was 8%. Interest is paid annually on December 31. Assuming Weller issued the bond for $453,681, what is the amount of interest expense that will be recognized during Year 3? (Round the final answer to the nearest dollar.) A) $35,678 B) $20,000 C) $34,120 D) $46,350

108) A company uses the effective interest method to amortize a bond discount. Which of the following statements is true regarding the interest expense that is recognized each year? Version 1

A) It will be greater than the interest payment. B) It will increase from year to year. C) It will remain the same from year to year. D) It will be greater than the interest payment and it will also increase from year to year.

109) A company uses the effective interest method to amortize a bond premium. Which of the following statements is true regarding the carrying value of the bond? A) The carrying value will decrease by equal amounts each year. B) The carrying value will decrease by smaller amounts each year. C) The carrying value will decrease by larger amounts each year. D) The carrying value will be lower than the face value of the bond until maturity.

110) Which of the following is one of the main advantages of using long-term debt financing instead of equity financing? A) Not having to pay back the principal B) Ability to raise large amounts of capital C) Tax-deductibility of interest D) Tax-deductibility of dividends

111)

The times-interest-earned ratio is calculated by which of the following? A) Total assets divided by interest expense. B) Net income divided by interest expense. C) Earnings before interest and taxes divided by interest expense. D) None of these answer choices are correct.

112) Company A and Company B are identical in all regards except that during Year 1 Company A borrowed $22,000 at an interest rate of 10%. In contrast, Company B obtained financing by acquiring $22,000 from sale of common stock. Company B agreed to pay a $2,200 cash dividend each year. Both companies are in a 30% tax bracket. Which company would show the greater retained earnings at the end of Year 1, and by what amount? Version 1

A) Company A's retained earnings would be higher by $2,200. B) Company B's retained earnings would be higher by $1,540. C) Company A's retained earnings would be higher by $660. D) Both would show the same retained earnings.

113) Company A and Company B are identical in all regards except that during Year 1 Company A borrowed $40,000 at an interest rate of 10%. In contrast, Company B obtained financing by acquiring $40,000 from sale of common stock. Company B agreed to pay a $4,000 cash dividend each year. Both companies are in a 30% tax bracket. Which company would show the greater retained earnings at the end of Year 1, and by what amount? A) Company A's retained earnings would be higher by $4,000. B) Company B's retained earnings would be higher by $2,800. C) Company A's retained earnings would be higher by $1,200. D) Both would show the same retained earnings.

114) On January 1, Year 1, Bluefield Company issued bonds with a face value of $112,000, a stated rate of interest of 10%, and a 20-year term to maturity. The bonds were issued at face value. If Bluefield's tax rate is 40%, what is the after-tax cost of borrowing related to these bonds for Year 1? A) $4,480 B) $6,720 C) $11,200 D) $15,680

115) On January 1, Year 1, Bluefield Company issued bonds with a face value of $200,000, a stated rate of interest of 10%, and a 20-year term to maturity. The bonds were issued at face value. If Bluefield's tax rate is 40%, what is the after-tax cost of borrowing related to these bonds for Year 1?

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A) $12,000 B) $8,000 C) $20,000 D) $28,000

116) Which of the following conditions indicate a company has a relatively high level of financial risk? A) A low times-interest-earned ratio B) A low debt to assets ratio C) A high return on equity D) A high current ratio

117) Gates, Incorporated and Markham, Incorporated each had the same financial position on January 1, Year 2. The following is a summary of each of their balance sheets on that date: Current assets Non-current assets Current liabilities Non-current liabilities Common stock Retained earnings

$ 330,000 2,970,000 165,000 1,815,000 907,500 412,500

Gates is about to raise $200,000 in cash by issuing bonds. Markham is going to raise $200,000 on the same day by issuing common stock. Immediately after these transactions, which of the following statements will be correct? A) Gates' current ratio will be higher than Markham's. B) Gates' current ratio will be lower than Markham's. C) Gates' debt to asset ratio will be higher than Markham's. D) Gates' debt to asset ratio will be lower than Markham's.

118) Thrasher Company reported income before taxes of $180,000. The company is in a 30% income tax bracket. Also, Thrasher's income statement contained a charge for interest expense amounting to $60,000. Based on this information alone, what is the company's times-interestearned ratio?

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A) 2.1 B) 3.0 C) 3.1 D) 4.0

119) On January 1, Year 1, Echols Company borrowed $100,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $25,045.65. Which of the following shows how the borrowing of cash from Sun Bank on January 1, Year 1, affects the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + n/a n/a n/a n/a +IA B.

n/a

−

−IA

−

n/a

−

−FA

n/a

+FA

A) Option A B) Option B C) Option C D) Option D

120) On January 1, Year 1, Echols Company borrowed $100,000 cash from Sun Bank by issuing a 5-year, 8% term note. The principal and interest are repaid by making annual payments beginning on December 31, Year 1. The annual payment on the loan equals $25,045.65. What is the amount of principal repayment included in the payment made on December 31, Year 1?

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A) $20,000.00 B) $8,000.00 C) $25,045.65 D) $17,045.65

121) On January 1, Year 1, Jack Incorporated borrows $38,000 to purchase a new company car by agreeing to a 6%, 5-year note with the bank. Payments of $734.65 are due at the end of each month with the first installment due on January 31, Year 1. What are the amounts of interest and principal, respectively, that will be paid in the first month? A) $544.65 and $190.00 B) $190.00 and $544.65 C) $2,280.00 and $544.65 D) $190.00 and $734.65

122) On January 1, Year 1, The Palms borrowed $200,000 to purchase a warehouse by agreeing to an 8%, 5-year note with the bank. Payments of $50,091.29 are due at the end of each year. The first payment will be made on December 31, Year 1. What is the interest expense for Year 1 and Year 2, respectively? (Round your final answers to the nearest dollar.) A) $3,200 and $14,000 B) $16,000 and $16,350 C) $16,000 and $13,273 D) $20,625 and $16,000

123) On January 1, Year 1, The Palms borrowed $200,000 to purchase a warehouse by agreeing to an 8%, 5-year note with the bank. Payments of $50,091.29 are due at the end of each year. The first payment will be made on December 31, Year 1. How much will the company still owe on the loan at the end of Year 2? (Round your final answer to the nearest dollar.)

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A) $186,727 B) $184,000 C) $129,090 D) $165,910

124)

Which of the following statements about installment notes is correct?

A) With each subsequent payment on an installment note, the amount of interest expense decreases. B) With each subsequent payment on an installment note, the amount of interest expense increases. C) With each subsequent payment on an installment note, the amount of the principal paid decreases. D) With each subsequent payment on an installment note, the amount of the principal paid remains unchanged.

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Answer Key Test name: Chap 10_2e_Test Bank_MCQs_TF 1) FALSE Installment notes require payments of principal and interest at regular intervals. 2) TRUE Loan amortization describes repaying the principal of a loan, along with interest, over the life of the loan. 3) TRUE Year 1 Interest expense = Principal balance on January 1 of $50,000 × 9% = $4,500 4) FALSE Year 1 Interest expense = Principal balance on January 1 of $50,000 × 9% = $4,500 Year 1 Principal repayment = Cash payment of $7,791 − Interest of $4,500 = $3,291 5) FALSE Interest expense decreases each year on an installment note as the carrying value of the loan liability declines. 6) FALSE Lines of credit allow companies to borrow flexible, not set, amounts of money as needed, typically for periods of less than one year. 7) FALSE The interest rate on a line of credit fluctuates, depending on when the funds are withdrawn. 8) FALSE Issuers of bonds pay the face value at maturity, and make fixed, not fluctuating, interest payments. Version 1

9) FALSE Serial bonds are bonds that have a series of maturity dates. Debentures are bonds that are issued based on the overall strength of the borrower's credit. 10) TRUE There is no requirement that all bonds within a single issue have the same maturity date. 11) TRUE Generally, companies will record a loss on bond redemption when calling bonds because they must pay the bondholders more than the carrying value of the bond liability. 12) FALSE A company's bond rating influences the interest rate the company must pay on future bonds. However, the rating will not affect the interest on bonds already issued. 13) FALSE Amortizing a discount increases liabilities (decreases the contra-liability discount on bonds payable) and decreases stockholders’ equity (retained earnings). 14) TRUE Issuing these bonds will increase cash by $508,000, increase bonds payable by $500,000, and increase the premium on bonds payable by $8,000. 15) FALSE Premium = Issue price of $508,000 − Face value of $500,000 = $8,000 Annual amortization of premium = $8,000 ÷ 5 years = $1,600 Cash payment for interest = Face value of $500,000 × Stated rate of 7% = $35,000 Interest expense = Cash payment of $35,000 − Premium amortization of $1,600 = $33,400 Version 1

16) TRUE Bonds are only issued at face value if their stated rate of interest is equal to the market, or effective, rate. 17) TRUE If bonds are issued for less than their face value, they are issued at a discount. 18) TRUE The face value is the amount paid to bondholders at maturity, whether the bonds were issued at a premium, a discount, or face value. 19) FALSE If bonds are issued at a premium, the interest paid to bondholders will exceed the interest expense reported on the income statement. 20) FALSE Cash received from issuance = Face value of $200,000 × 98% = $196,000 21) TRUE The bond issuer will pay the face value to the bondholders at maturity, an amount lower than the issue price. 22) TRUE Bonds are issued at a premium or at a discount when the stated rate is not equal to the rate of similar investments in order to produce an effective rate equal to that of those similar investments. 23) FALSE The effective interest rate method produces a different amount of interest expense every period as the carrying value of the bond liability increases or declines. 24) TRUE The total amount of interest expense is the same regardless of whether the effective interest method or the straight-line method is used. 25) TRUE Version 1

Because of the tax benefits of interest, the effective cost of borrowing is less than the cash paid for interest. This is a benefit of debt financing compared with equity financing. 26) FALSE The after-tax interest cost of debt equals total interest expense multiplied by one minus the tax rate. 27) FALSE The times-interest-earned ratio is usually calculated as the ratio of earnings before interest and taxes (EBIT) to interest expense. 28) D Issuing a long-term installment note increases the asset account, Cash, and increases the liability account, Notes Payable, for the face value of the note. 29) B Loans that require payments of principal and interest at regular intervals (amortizing loans) are typically represented by installment notes. As the principal balance of the note decreases over time the portion of the payment that is applied to interest expense decreases. However, the amount of the payment remains constant. 30) D When a company issues debt, whether notes or bonds, the company is normally expected to repay the debt, as well as to pay interest to the lender. 31) D Issuing a long-term installment note will increase assets (Cash) and increase liabilities (Notes Payable). The cash proceeds will be reported as a cash inflow from financing activities on the statement of cash flows. 32) B

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Interest expense for Year 1 = $5,000 × 5% = $250. The first annual payment of $1,156 will decrease assets (Cash) by $1,156, decrease liabilities (the carrying value of Notes Payable) by $906, which the difference between the payment of $1,156 and the interest expense of$250,and decrease stockholders’ equity (Retained Earnings) by $250. It will increase expenses (interest expense) by $250, which will decrease net income. The principal portion of $1,156 of the payment is reported as a cash outflow from financing activities, while the interest portion of $250 will be reported as a cash outflow from operating activities. 33) C Carrying value of the note at the beginning of Year 2: $5,000 − $906 (the amount of principal repayment in Year 1) Interest expense for Year 2 = ($5,000 − $906) × 5% = $205 The second annual payment of $1,156 will decrease assets (Cash) by $1,156, decrease liabilities (Notes Payable) by $951, which is the difference between the cash payment of $1,156 and the interest expense of $205,and decrease stockholders’ equity (Retained Earnings) by $205. It willincrease expenses (interest expense)by $205, which will decrease net income. The principal portion of $951 of the payment is reported as a cash outflow from financing activities, while the interest portion of $205 will be reported as a cash outflow from operating activities. 34) B Year 1 Interest expense = Principal balance on January 1 of $166,000 × 8% = $13,280 Year 1 Principal repayment = Payment of $41,576 − Interest portion of $13,280 = $28,296 35) D

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Year 1 Interest expense = Principal balance on January 1 of $324,000 × 8% = $25,920 Year 1 Principal repayment = Payment of $81,150 − Interest portion of $25,920 = $55,230 36) A The cash payment will decrease assets (Cash), decrease liabilities (Notes Payable) for the amount of the principal repayment, and decreases stockholders’ equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. The principal repayment is reported as a cash outflow from financing activities, while the interest payment is reported as a cash outflow from operating activities. 37) A As the principal balance declines each year, the interest expense becomes smaller, and the amount of principal repayment becomes larger with each subsequent payment. 38) B Year 1 Interest expense = Principal balance on January 1 of $22,000 × 11% = $2,420 Year 1 Principal repayment = Payment of $9,003 − Interest expense of $2,420 = $6,583 Principal balance at beginning of year 2 = Principal balance on January 1 of $22,000 − Principal repayment in Year 1 of $6,583 = $15,417 Year 2 Interest expense = Principal balance on January 1 of $15,417 × 11% = $1,696 39) B

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Year 1 Interest expense= Principal balance on January 1 of $20,000 × 10% = $2,000 Year 1 Principal repayment = Payment of $8,042 −Interest expense of $2,000 = $6,042 Principal balance at beginning of year 2 = Principal balance on January 1 of $20,000 −Principal repayment in Year 1 of $6,042 = $13,958 Year 2 Interest expense = Principal balance on January 1 of $13,958 × 10% = $1,396 40) D Borrowing against a line of credit will increase assets (Cash) and increases liabilities (Line of Credit). It is reported as a cash inflow from financing activities. 41) A Year 1 Interest expense = Principal balance on January 1 of $2,000 × (4% + 1%) = $100 The interest payment decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. It is reported as a cash outflow from operating activities on the statement of cash flows. 42) B Balance outstanding at March 31 = $53,000 + $84,000 − $53,000 = $84,000 March Interest expense = Amount outstanding on March 31 of $84,000 × (3% + 3%) × 1/12 = $420.00 43) D Balance outstanding at March 31 = $40,000 + $60,000 − $40,000 = $60,000 March Interest expense = Amount outstanding on March 31 of $60,000 × (2% + 3%) × 1/12 = $250 44) D Version 1

Balance outstanding at March 31 = $50,000 − $20,000 + $50,000 = $80,000 March Interest expense = Amount outstanding on March 31 of $80,000 × (5% + 2%) × 1/12 = $467 45) D Balance outstanding at March 31 = $40,000 − $10,000 + $40,000 = $70,000 March Interest expense = Amount outstanding on March 31 of $70,000 × (5% + 2%) × 1/12 = $408 46) B Proceeds of $196,000 = Face value of $200,000 × Issue price Issue price = $196,000 ÷ $200,000 = 98 A $200,000 bond issued at 98 will increase cash by $196,000, the issue price, increase discount on bonds payable (a contra liability) for $4,000, and increase the liability account, bonds payable, by $200,000, the bond’s face value. 47) C Secured bonds grant their holders a priority legal claim on specified identifiable assets should the issuer default. A common type of secured bond is a mortgage bond, which conditionally transfers the title of designated property to the bondholder until the bond is paid. 48) B Convertible bonds are liabilities that can be exchanged at the option of the bondholder for common stock or some other specified ownership interest. 49) A Callable bonds allow the issuing company to redeem (pay off) the bond debt before the maturity date. This is at the option of the issuer (rather than the bondholder). 50) B Version 1

Unless they are within one year of maturity, bonds payable are usually classified as long-term on the balance sheet. 51) C Unsecured bonds, also called debentures, are issued based on the general strength of the borrower’s credit. 52) C If bonds are called at a price above the carrying value of the bond liability, the difference is the call premium. Calling the bonds decreases assets (Cash) by the amount of the call price, decreases liabilities (bonds payable plus any discount or premium remaining) by the amount of the carrying value of the bonds, and decreases stockholders’ equity (Retained Earnings). It increases expenses (loss on bond redemption) by the amount of the call premium, which decreases net income. The cash outflow is classified as a financing activity on the statement of cash flows. 53) B Issuing a bond at a discount increases assets (Cash) for the issue price of the bond and increases liabilities (Carrying Value of Bond Liability). The carrying value is calculated as bonds payable less the discount on bonds payable. In this transaction, there is an increase to bonds payable for the face value less increase to contra-liability discount on bonds payable for the discount. It is reported as a cash inflow from financing activities. 54) A Proceeds = Face value of $500,000 × 90% = $450,000 Discount = Face value of $500,000 − Proceeds from issuance of $450,000 = $50,000 The issuance will increase cash by $450,000, increase discount on bonds payable, a contra liability account, by $50,000, and increase bonds payable by $500,000. Version 1

55) D Call premium = Face value of $200,000 × 2% = $4,000 Call price = Face value of $200,000 + Call premium of $4,000 = $204,000 When the bonds are called, Williams must pay the bondholders the $200,000 face value of the bonds, plus a 2% call premium, or $4,000. The event will decrease assets (Cash) by $204,000, decrease liabilities (Bonds Payable) by $200,000, and decrease stockholders’ equity (Retained Earnings) by $4,000. 56) B Proceeds = Face value of $200,000 × 97% = $194,000 Assets (cash) increase by $194,000. Liabilities (bonds payable)increase by $200,000 and liabilities (discount on bonds payable, a contra liability account) increase by $6,000 for a net increase in liabilities of $194,000. 57) A When the market rate of interest is lower than the stated rate of interest, bonds will sell at a premium so as to reduce the effective rate to the market rate. On the other hand, when the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. 58) D Serial bonds have a series of maturity dates so that the repayment of the bonds is accomplished over time. 59) C In addition to requiring collateral, creditors often obtain additional protection by including restrictive covenants in loan agreements. Such covenants may restrict additional borrowing, limit dividend payments, or restrict salary increases. 60) D

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Interest payment = Face value of $125,000 × Stated rate of 6% rate = $7,500 The payment of interest when bonds are issued at face value decreases assets (Cash) and decreases stockholders’ equity (Retained Earnings). It increases expenses (interest expense), which decreases net income. It is reported as a cash outflow from operating activities. 61) D Issue price = Face value of $110,000 × 98% = $107,800 Discount = Face value of $110,000 − Issue price of $107,800 = $2,200 Annual amortization of discount = $2,200 ÷ 5 years = $440 Cash interest payment = Face value of $110,000 × 0.080 = $8,800 Interest expense = Cash payment of $8,800 + Amortization of discount of $440 = $9,240 62) A Issue price = Face value of $200,000 × 97% = $194,000 Discount = Face value of $200,000 − Issue price of $194,000 = $6,000 Annual amortization of discount = $6,000 ÷ 5 years = $1,200 Cash interest payment = Face value of $200,000 × 0.075 = $15,000 Interest expense = Cash payment of $15,000 + Amortization of discount of $1,200 = $16,200 63) A Issue price = Face value of $250,000 × 97% = $242,500 Discount = Face value of $250,000 − Issue price of $242,500 = $7,500 Annual amortization of discount = $7,500 ÷ 5 years = $1,500 Carrying value at December 31, Year 2 = Issue price of $242,500 + Year 1 amortization of discount of $1,500 + Year 2 amortization of discount of $1,500 = $245,500 64) C

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Issue price = Face value of $200,000 × 97% = $194,000 Discount = Face value of $200,000 − Issue price of $194,000 = $6,000 Annual amortization of discount = $6,000 ÷ 5 years = $1,200 Carrying value at December 31, Year 2 = Issue price of $194,000 + Year 1 amortization of discount of $1,200 + Year 2 amortization of discount of $1,200 = $196,400 65) A Annual interest payment = Face value of $180,000 × 7.5% = $13,500 66) A Annual interest payment = Face value of $200,000 × 7.5% = $15,000 67) B Accrued interest expense at December 31, Year 1 = Face value of $270,000 × 4% = $10,800 Total liabilities relating to bonds = Bonds payable of $270,000 + Interest payable of $10,800 = $280,800 68) D Accrued interest expense at December 31, Year 1 = Face value of $100,000 × 7% = $7,000 Total liabilities relating to bonds = Bonds payable of $100,000 + Interest payable of $7,000 = $107,000 69) C Since the bonds were issued at face value, the cash payment for interest equals the interest expense. Payment of interest = Face value of $560,000 × 0.055 = $30,800 The payment of interest on December 31, Year 1, increases interest expense by $30,800 and is reported as a cash outflow from operating activities.

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70) A 70) C 70) A 70) C Since the bonds were issued at face value, the cash payment for interest equals the interest expense. Payment of interest = Face value of $200,000 × 0.065 = $13,000 The payment of interest on December 31, Year 1, increases interest expense by $13,000 and is reported as a cash outflow from operating activities. 71) A Issue price = Face value of $25,000 × 102% = $25,500 Premium = Issue price of $25,500 − Face value of $25,000 = $500 The bond issuance increases assets (Cash) by $25,500. It also increases liabilities (Bonds Payable) by $25,000 and increases liabilities (Premium on Bonds Payable) by $500, which equals a total increase in liabilities of $25,500. The proceeds are reported as a cash inflow from financing activities. 72) C

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Cash interest payment = Face value of $25,000 × 8% = $2,000 Issue price = Face value of $25,000 × 102% = $25,500 Premium = Issue price of $25,500 − Face value of $25,000 = $500 Annual amortization of premium = Premium of $500 premium ÷ 5 years = $100 Annual interest expense = Cash payment of $2,000 − Amortization of premium of $100 = $1,900 The transaction decreases assets (Cash) by $2,000, decreases liabilities (Premium on Bonds Payable) by $100, and decreases stockholders' equity (Retained Earnings) by $1,900. It increases expenses (interest expense) by $1,900, which decreases net income. The cash payment of $2,000 is reported as a cash outflow from operating activities. 73) A Issue price = Face value of $25,000 × 102% = $25,500 Premium = Issue price of $25,500 − Face value of $25,000 = $500 Annual amortization of premium = Premium of $500 premium ÷ 5 years = $100 Carrying value of the bonds payable on January 1, Year 2 = Bonds payable of $25,000 + Premium on bonds payable ($500 − Year 1 amortization of $100) = $25,400 Gain (Loss) on early redemption = Call price of $25,450 − Carrying value of $25,400 = ($50) This transaction decreases assets (cash) by $25,450, decreases liabilities (bonds payable and premium on bonds payable) by $25,400, and decreases stockholders’ equity (retained earnings) by $50. It increases expenses (loss on bond redemption) by $50, which decreases net income. The cash payment of $25,450 is reported as a cash outflow from financing activities on the statement of cash flows. 74) D

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Issue price = Face value of $54,000 × 97% = $52,380 Discount = Face value of $54,000 − Issue price of $52,380 = $1,620 Annual amortization of discount = $1,620 ÷ 5 years = $324 Cash interest payment = Face value of $54,000 × 8% = $4,320 Interest expense = Cash payment of $4,320 + Amortization of discount of $324 = $4,644 75) D Issue price = Face value of $70,500 × 97% = $68,385 Discount = Face value of $70,500 − Issue price of $68,385 = $2,115 Annual amortization of discount = $2,115 ÷ 5 years = $423 Cash interest payment = Face value of $70,500 × 8% = $5,640 Interest expense = Cash payment of $5,640 + Amortization of discount of $423 = $6,063 76) B Proceeds from issuance = Face value of $70,000 × 98% = $68,600 Discount = Face value of $70,000 − Proceeds of $68,600 = $1,400 The bond issuance increases assets (Cash) by $68,600. It increases liabilities (Bonds Payable) by $70,000 and decreases liabilities (by increasing discount on bonds payable) by $1,400, for a net increase in liabilities of $68,600. The cash proceeds of $68,600 are reported as a cash inflow from financing activities on the statement of cash flows. 77) D

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Issue price = Face value of $70,000 × 98% = $68,600 Discount = Face value of $70,000 − Issue price of $68,600 = $1,400 Annual amortization of discount = $1,400 ÷ 5 years = $280 Cash interest payment = Face value of $70,000 × 6% = $4,200 Interest expense = Cash payment of $4,200 + Amortization of discount of $280 = $4,480 This transaction decreases assets (Cash) by $4,200, increases liabilities (by decreasing discount on bonds payable, a contra-liability account) by $280, and decreases stockholders’ equity (Retained Earnings) by $4,480. It increases expenses (interest expense) by $4,480 and decreases net income by the same amount. The cash interest payment of $4,200 is reported as a cash outflow from operating activities. 78) D Once the final amortization has been recorded, the carrying value of the bond liability is equal to the face value of $70,000. The payment to retire the bonds decreases assets (Cash) and decreases liabilities (Bonds Payable) by $70,000. For reporting purposes, the cash outflow is separated into two parts on the statement of cash flows: $68,600 of the cash outflow is reported in the financing activities section because it represents repaying the principal amount borrowed; the remaining $1,400 cash outflow is reported in the operating activities section because it represents the interest arising from issuing the bonds at a discount. 79) C Discounting is necessary to increase the interest on the bond so that the effective rate is equal to the market rate of interest. 80) B

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Proceeds from issuance = Face value of $75,000 × 102.5% = $76,875 Premium = Proceeds of $76,875 − Face value of $75,000 = $1,875 Annual amortization of premium = Premium of $1,875 ÷ 5 years = $375 Annual interest payment = $75,000 × Stated rate of 8% = $6,000 Annual interest expense = Cash payment of $6,000 − Amortization of premium of $375 = $5,625 81) A Proceeds from issuance = Face value of $100,000 × 102.5% = $102,500 Premium = Proceeds of $102,500 − Face value of $100,000 = $2,500 Annual amortization of premium = Premium of $2,500 ÷ 5 years = $500 Annual interest payment = $100,000 × Stated rate of 8% = $8,000 Annual interest expense = Cash payment of $8,000 − Amortization of premium of $500 = $7,500 82) C These bonds are sold at a premium since they were issued at 101. When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate. 83) B When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. Semiannual interest payment = Face value of $500,000 × 8% × ½ = $20,000 84) B When interest expense is recognized the asset Cash decreases, the carrying value of the bond liability increases (through a decrease in the bond discount), and stockholders’ equity (Retained Earnings) decreases. On the income statement, interest expense increases which decreases net income. The payment of cash for interest is reported as a cash outflow from operating activities. Version 1

85) C Making a payment on an installment note decreases assets (Cash), decreases liabilities (Notes Payable) for the amount of the principal repayment, and decreases stockholders’ equity (Retained Earnings). It increases expenses (interest expense) for the amount of interest expense, which decreases net income. The principal repayment is reported as a cash outflow from financing activities, while the interest portion of the payment is reported as a cash outflow from operating activities. 86) B Issue price = $240,000 × 106% = $254,400 Premium = Issue price of $254,400 − Face value of $240,000 = $14,400 Annual amortization of bond premium = Premium of $14,400 ÷ 10 years = $1,440 Amortization for years Year 1 through Year 4 = $1,440 × 4 years = $5,760 Unamortized premium at end of Year 4 = $14,400 − $5,760 = $8,640 Carrying value on December 31, Year 4 = Face value of $240,000 + Unamortized premium of $8,640 = $248,640 87) D Issue price = $200,000 × 105% = $210,000 Premium = Issue price of $210,000 − Face value of $200,000 = $10,000 Annual amortization of bond premium = Premium of $10,000 ÷ 10 years = $1,000 Amortization for years Year 1 through Year 4 = $1,000 × 4 years = $4,000 Unamortized premium at end of Year 4 = $10,000 − $4,000 = $6,000 Carrying value on December 31, Year 4 = Face value of $200,000 + Unamortized premium of $6,000 = $206,000 88) A

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Issue price = Face value of $186,000 × 105% = $195,300 Premium = Issue price of $195,300 − Face value of $186,000 = $9,300 Annual amortization of premium = Premium of $9,300 ÷ 5 years = $1,860 $186,000 × 9% = $16,740 interest payment; $16,740 − $1,860 = $14,880 interest expense; The event will decrease assets (cash) by $16,740, decrease liabilities (premium on bonds payable) by $1,860, and decrease stockholders’ equity (retained earnings) by $14,880. 89) A Issue price = Face value of $300,000 × 102% = $306,000 Premium = Issue price of $306,000 − Face value of $300,000 = $6,000 Annual amortization of premium = Premium of $6,000 ÷ 5 years = $1,200 $300,000 × 9% = $27,000 interest payment; $27,000 − $1,200 = $25,800 interest expense; The event will decrease assets (cash) by $27,000, decrease liabilities (premium on bonds payable) by $1,200, and decrease stockholders’ equity (retained earnings) by $25,800. 90) A When the market rate of interest is higher than the stated rate of interest, bonds will sell at a discount so as to increase the effective rate of interest to the market rate. When the market rate is lower than the stated rate, bonds will sell at a premium so as to reduce the effective rate to the market rate. 91) A

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Proceeds from issuance = Face value of $675,000 × 96% = $648,000 Discount = Face value of $675,000 − Proceeds of $648,000 = $27,000 Annual amortization = Discount of $27,000 ÷ 5 years = $5,400 Unamortized discount at December 31, Year 3 = $27,000 − ($5,400 × 3) = $10,800 Carrying value at December 31, Year 3 = Bonds payable of $675,000 − Unamortized discount of $10,800 = $664,200 92) D Proceeds from issuance = Face value of $250,000 × 95% = $237,500 Discount = Face value of $250,000 − Proceeds of $237,500 = $12,500 Annual amortization = Discount of $12,500 ÷ 5 years = $2,500 Unamortized discount at December 31, Year 3 = $12,500 − ($2,500 × 3) = $5,000 Carrying value at December 31, Year 3 = Bonds payable of $250,000 − Unamortized discount of $5,000 = $245,000 93) B Issue price = Face value of $525,000 × 96% = $504,000 Discount = Face value of $525,000 − Proceeds of $504,000 = $21,000 Annual amortization = Discount of $21,000 ÷ 5 years = $4,200 Cash interest payment = Face value of $525,000 × Stated rate of 5% = $26,250 Year 3 Interest expense = Cash payment of $26,250 + Amortization of discount of $4,200 = $30,450 94) A

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Issue price = Face value of $250,000 × 95% = $237,500 Discount = Face value of $250,000− Proceeds of $237,500 = $12,500 Annual amortization = Discount of $12,500 ÷ 5 years = $2,500 Cash interest payment = Face value of $250,000 × Stated rate of 6% = $15,000 Year 3 Interest expense = Cash payment of $15,000 + Amortization of discount of $2,500 = $17,500 95) A Cash interest payment (cash outflow from operating activities) = Face value of $825,000 × Stated interest rate of 5% = $41,250 96) B Cash interest payment (cash outflow from operating activities) = Face value of $250,000 × Stated interest rate of 6% = $15,000 97) C Bonds that are issued at 96 are issued at only 96% of their face value. Bonds are issued at a discount if the market rate of interest for bonds of similar risk is higher than the stated rate of interest. 98) A Issue price = Face value of $720,000 × 104% = $748,800 Premium = Issue price of $748,800 − Face value of $720,000 = $28,800 Annual amortization of premium = $28,800 ÷ 10 years = $2,880 Carrying value at December 31, Year 1 = Issue price of $748,800 − Year 1 amortization of premium $2,880 = $745,920 99) B Issue price = Face value of $600,000 × 102.5% = $615,000 Premium = Issue price of $615,000 − Face value of $600,000 = $15,000 Annual amortization of premium = $15,000 ÷ 10 years = $1,500 Carrying value at December 31, Year 1 = Issue price of $615,000 − Year 1 amortization of premium $1,500 = $613,500 100) C Version 1

Issue price = Face value of $1,020,000 × 106% = $1,081,200 Premium = Issue price of $1,081,200 − Face value of $1,020,000 = $61,200 Annual amortization of premium = $61,200 ÷ 10 years = $6,120 Annual interest payment = $1,020,000 × Stated rate of 10% = $102,000 Interest expense = Cash payment of $102,000 − Amortization of premium of $6,120 = $95,880 101) A Issue price = Face value of $600,000 × 102.5% = $615,000 Premium = Issue price of $615,000 − Face value of $600,000 = $15,000 Annual amortization of premium = $15,000 ÷ 10 years = $1,500 Annual interest payment = $600,000 × Stated rate of 6% = $36,000 Interest expense = Cash payment of $36,000 − Amortization of premium of $1,500 = $34,500 102) C The straight-line method amortizes the discount equally over the life of the bond. While the straight-line method is easy to understand, it is inaccurate because it does not show the correct amount of interest expense incurred during each accounting period. This straight-line recognition pattern is irrational because the amount of interest expense recognized should increase as the carrying value of the bond liability increases. A more accurate recognition pattern can be accomplished by using an approach called the effective interest rate method. 103) D Straight-line amortization of a bond premium decreases the premium by equal amounts each year. As the remaining premium balance decreases, so does the carrying value of the bond. If effective interest amortization is used, the interest expense is smaller each year, so the premium decreases by larger and larger amounts each year. 104) A Version 1

Year 1 Interest expense = $430,997 × Market rate of 8.00% = $34,479.76 Annual interest payment = $380,000 × Stated rate of 10.00% = $38,000 Year 1 Amortization of premium = Interest payment of $38,000 − Interest expense of $34,479.76 = $3,520.24 Carrying value at end of Year 1 = Issue price of $430,997 − Amortization of premium of $3,520.24 = $427,476.76 Year 2 Interest expense = Carrying value at end of Year 1 of $427,477 × Market rate of 8.00% = $34,198.14 Year 2 Amortization of premium = Interest payment of $38,000 − Interest expense of $34,198.14 = $3,801.86 Carrying value at end of Year 2 = Carrying value at end of Year 1 of $427,476.76 − Amortization of premium of $3,801.86 = $423,674.90 Year 3 Interest expense = Carrying value at end of Year 2 of $423,674.90 × Market rate of 8.00% = $33,893.99 Year 3 Amortization of premium = $38,000 − $33,893.99 = $4,106 amortization in Year 3 Carrying value at end of Year 3 = Carrying value at end of Year 2 of $423,674.90 − Amortization of premium of $4,106.01 = $419,569 105) C

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Year 1 Interest expense = $453,681 × Market rate of 8% = $36,294.48 Annual interest payment = $400,000 × Stated rate of 10% = $40,000 Year 1 Amortization of premium = Interest payment of $40,000 − Interest expense of $36,294.48 = $3,705.52 Carrying value at end of Year 1 = Issue price of $453,681 − Amortization of premium of $3,705.52 = $449,975.48 Year 2 Interest expense = Carrying value at end of Year 1 of $449,975.48 × Market rate of 8% = $35,998.04 Year 2 Amortization of premium = Interest payment of $40,000 − Interest expense of $35,998.04 = $4,001.96 Carrying value at end of Year 2 = Carrying value at end of Year 1 of $449,975.48 − Amortization of premium of $4,001.96 = $445,973.52 Year 3 Interest expense = Carrying value at end of Year 2 of $445,973.52 × Market rate of 8% = $35,677.88 Year 3 Amortization of premium = $40,000 − $35,677.88 = $4,322.12 amortization in Year 3 Carrying value at end of Year 3 = Carrying value at end of Year 2 of $445,973.52 − Amortization of premium of $4,322.12 = $441,651.40 106) C

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Year 1 Interest expense = $373,305 × Market rate of 8.50% = $31,730.93 Annual interest payment = $330,000 × Stated rate of 10.50% = $34,650 Year 1 Amortization of premium = Interest payment of $34,650 − Interest expense of $31,730.93 = $2,919.08 Carrying value at end of Year 1 = Issue price of $373,305 − Amortization of premium of $2,919 = $370,385.93 Year 2 Interest expense = Carrying value at end of Year 1 of $370,385.93 × Market rate of 8.50% = $31,482.80 Year 2 Amortization of premium = Interest payment of $34,650 − Interest expense of $31,482.80 = $3,167.20 Carrying value at end of Year 2 = Carrying value at end of Year 1 of $370,385.93 − Amortization of premium of $3,167.20 = $367,218.73 Year 3 Interest expense = Carrying value at end of Year 2 of $367,218.73 × Market rate of 8.50% = $31,213.59 107) A Year 1 Interest expense = $453,681 × Market rate of 8% = $36,294.48 Annual interest payment = $400,000 × Stated rate of 10% = $40,000 Year 1 Amortization of premium = Interest payment of $40,000 − Interest expense of $36,294.48 = $3,705.52 Carrying value at end of Year 1 = Issue price of $453,681 − Amortization of premium of $3,705.52 = $449,975.48 Year 2 Interest expense = Carrying value at end of Year 1 of $449,975.48 × Market rate of 8% = $35,998.04 Year 2 Amortization of premium = Interest payment of $40,000 − Interest expense of $35,998.04 = $4,001.96 Carrying value at end of Year 2 = Carrying value at end of Year 1 of $449,975.48 − Amortization of premium of $4,001.96 = $445,973.52 Year 3 Interest expense = Carrying value at end of Year 2 of $445,973.52 × Market rate of 8% = $35,677.88 Version 1

108) D Whenever a bond is issued at a discount, the interest expense recognized each year will be greater than the interest payment since the discount is an additional cost of borrowing. When the effective interest method is used, the interest expense increases from year to year as the carrying value of the bond liability increases. 109) C When the effective interest method is used to amortize a bond premium, the amount of interest expense recognized decreases each year as the carrying value of the bond liability decreases. Because interest expense is smaller each year, the amortization of the bond premium increases each year, the carrying value of the bond decreases by larger and larger amounts each year. 110) C One of the main advantages of debt financing is that interest paid on bonds and notes is tax-deductible, while dividends paid on equity financing are not tax-deductible. 111) C The times-interest-earned ratio equals earnings before interest and taxes (called EBIT) divided by interest expense. 112) C Company A: Interest expense = Face value of bonds of $22,000 × 10.0% = $2,200 After-tax cost of debt = Total interest expense of $2,200 × (1.0 − 0.30) = $1,540 Tax savings = $2,200 − $1,540 = $660 The $2,200 cash dividend has no tax savings. Therefore, Company A's retained earnings at the end of Year 1 would be $660 higher than Company B’s. 113) C Version 1

Company A: Interest expense = Face value of bonds of $40,000 × 10% = $4,000 After-tax cost of debt = Total interest expense of $4,000 × (1.0 − 0.30) = $2,800 Tax savings = $4,000 − $2,800 = $1,200 The $4,000 cash dividend has no tax savings. Therefore, Company A's retained earnings at the end of Year 1 would be $1,200 higher than Company B's. 114) B Annual interest expense = Face value of $112,000 × 10% = $11,200 After-tax cost of debt = Total interest expense of $11,200 × (1.0 − 0.40) = $6,720 115) A Annual interest expense = Face value of $200,000 × 10% = $20,000 After-tax cost of debt = Total interest expense of $20,000 × (1.0 − 0.40) = $12,000 116) A The times-interest-earned ratio is based on EBIT rather than net income because it is the amount of earnings before interest and taxes that is available to pay interest. The higher the ratio, the more likely a company will be able to make its interest payments. Higher times-interest-earned ratios suggest lower levels of risk. So, a low times-interest-earned ratio indicates that the company may be at risk of being unable to make required interest payments on its debt. 117) C

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When Gates issues bonds, both assets and liabilities will increase by the same amount. Assuming debt was lower than assets before the bond issuance, Gates’ debt-to-assets ratio will go up. When Markham issues common stock, assets and stockholders’ equity will increase. This will cause Markham’s debt-to-assets ratio to go down. 118) D EBIT = Income before taxes of $180,000 + Interest expense of $60,000 = $240,000 Times-interest-earned ratio = EBIT of $240,000 ÷ Interest expense of $60,000 = 4.0 119) D Borrowing cash from Sun Bank will increase assets (Cash) and liabilities (Note payable) on the balance sheet. It has no effect on the income statement. On the statement of cash flows, it is a cash inflow from financing activities. 120) D Year 1 Interest expense = Principal balance on January 1 of $100,000 × 8% = $8,000 Year 1 Principal repayment = Payment of $25,045.65 − Interest expense of $8,000 = $17,045.65 121) B For the month of January, Year 1: Interest Expense = Principal balance on January 1 of $38,000 × 6% × 1/12 = $190 Principal repayment = Payment of $734.65 − Interest expense of $190 = $544.65 122) C

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Year 1 Interest expense = Principal balance on January 1 of $200,000 × 8% = $16,000 Year 1 Principal repayment = Payment of $50,091.29 − Interest expense of $16,000 = $34,091.29 Principal balance at end of Year 1 = Principal balance on January 1 of $200,000 − Principal repayment of $34,091.29 = $165,908.71 Year 2 Interest expense = Principal balance on January 1 of $165,908.71 × 8% = $13,272.6968 (rounded to $13,273) 123) C Year 1 Interest expense = Principal balance on January 1 of $200,000 × 8% = $16,000 Year 1 Principal repayment = Payment of $50,091.29 − Interest expense of $16,000 = $34,091.29 Principal balance at end of Year 1 = Principal balance on January 1 of $200,000 − Principal repayment of $34,091.29 = $165,908.71 Year 2 Interest expense = Principal balance on January 1 of $165,908.71 × 8% = $13,272.6968 (rounded to $13,272.70) Year 2 Principal repayment = Payment of $50,091.29 − Interest expense of $13,272.70 = $36,818.59 Principal balance at end of Year 2 = Principal balance on January 1 of $165,908.71 − Principal repayment of $36,818.59 = $129,090.12 (rounded to $129,090) 124) A Over the term of the installment note, the amount of the interest expense decreases each year and the amount of principal paid increases each year.

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CHAPTER 11: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Increase = I Decrease = D Not Affected = NA Cooper Corporation purchased 500 shares of its own stock as treasury stock for $35 per share. The no-par stock had originally been issued by Cooper at $26 per share.

3) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Fort Worth Co. declared a cash dividend but has not yet paid the money to the shareholders.

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4) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Atlantic Oil Company had 10,000,000 common shares outstanding. The shares had been issued at $14 per share. The stock of Atlantic Oil Co. was trading at $14 per share on March 27 when the company announced that it had recently discovered a large oil reserve. The market value of the company's stock immediately went up to $28 per share.

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8) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Jack Grimes agreed to purchase 8% of Preston Corporation's outstanding common stock from Todd Barbour, one of Preston's major stockholders. (Note: Consider the effects of the transaction on Preston's financial statements.)

9) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Wheaton Company reissued 100 shares of treasury stock, which had been purchased by Wheaton at $18 per share. The treasury shares were reissued at a price of $20 per share.

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13) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Taylor Bennett began his sole proprietorship by contributing $25,000 of his own money to the business.

14) Indicate how each event affects thefinancial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA.You do not need to enter dollar amounts Jim Caldwell and Pam Ennis, both CPAs, began their new partnership by each contributing $50,000 to their business.

15) What is meant by "double taxation"? Which type of organizational form is more likely to be subject to double taxation?

16) What are the purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934?

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17) Discuss some of the information items normally included in a corporation's articles of incorporation.

18)

Identify the primary characteristics of sole proprietorships, partnerships and corporations.

19) Explain how the equity section of a balance sheet differs among sole proprietorships, partnerships, and corporations.

20)

Which type of stock is issued by all corporations?

21)

What is meant by "cumulative dividends"?

22)

What is the meaning of "par value" of stock?

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23) Explain the differences in recording the initial issue of stock for (a) par-value, (b) statedvalue, and (c) no-par stock in terms of the effect of each on the Common Stock account.

24) Will the number of shares of stock issued and the number of shares of stock outstanding always be the same? Why or why not?

25)

In which section of the balance sheet would Treasury Stock be reported?

26)

What is treasury stock?

27) Cash dividends are affected by three significant dates. On which of the dates do dividends become a legal obligation of a corporation?

28) What is the importance of the date of record for a corporation that has declared dividends?

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29) Garber Corporation had 20,000 shares of $12 par value common stock outstanding and declared a four-for-one stock split. How many new shares of stock would then be outstanding and what would be the par value of the new stock?

30) Show the effect of a stock dividend on the accounting equation.(Use "+" for increase and "−" for decrease. If there is no effect, leave that cell blank.) Total Paid in Capital includes Common Stock and Paid-in Capital in Excess of Par.

31)

What is a reason that a corporation might choose to "split" its stock?

32)

Why might a board of directors appropriate an amount of retained earnings?

33)

Why is the market price of a corporation's common stock likely to increase?

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34)

What is a reason that a corporation might choose to "split" its stock?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 35) A sole proprietorship was formed on January 1, Year 1, when it received $90,000 cash from Kaitlyn Conrad, the owner. During Year 1, the business earned $138,000 in cash revenues and paid $102,400 in cash expenses. Conrad withdrew $16,000 in cash during the year. Required: Prepare an income statement, capital statement, and balance sheet.

36) A sole proprietorship was established on January 1, Year 1, when it received $30,000 cash from Connor Howard, the owner. During Year 1, the business earned $80,000 in cash revenues and paid $62,000 in cash expenses. Howard withdrew $9,000 from the business during Year 1. Required: Indicate how each of the transactions and events for the Howard sole proprietorship affects the financial statements model, below. Indicate dollar amounts of increases and decreases. With regards to the statement of cash flows, indicate whether each is an operating activity (OA), investing activity (IA), or financing activity (FA). Indicate NA if an element is not affected by a transaction.

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37) The Mason-Dixon partnership was formed on January 1, Year 1, when Rebecca Mason and Steve Dixon contributed cash of $40,000 and $60,000, respectively. During Year 1, the partnership earned $160,000 in cash revenues and paid $108,000 in cash expenses. Mason withdrew $12,000 cash and Dixon withdrew $8,000 cash from the business. Net income was allocated to the partners' capital accounts in proportion to their initial investment in the business. Required: Prepare an income statement, capital statement, and balance sheet.

38) The Bristol-Fuller partnership was formed on January 1, Year 1, when Bristol and Fuller invested $40,000 and $30,000 cash in the partnership, respectively. During Year 1, the partnership earned $75,000 in cash revenues and paid $52,000 in cash expenses. Bristol withdrew $5,000 cash from the business during the year, and Fuller withdrew $4,000. The partnership agreement specified that net income should be allocated equally to the partners' capital accounts. Required: Indicate how each of the transactions and events for the Bristol partnership affects the financial statements model, below. Indicate dollar amounts of increases and decreases. With regards to the statement of cash flows, indicate whether each is an operating activity (OA), investing activity (IA), or financing activity (FA). Indicate NA if an element is not affected by a transaction.

39) On January 1, Year 1, Charlotte Curtis started Curtis Company as a sole proprietorship with an initial investment of $80,000. During Year 1, the business earned $60,000 in cash revenue and paid $45,000 in cash expenses. During Year 1, Ms. Curtis withdrew $7,000 for her personal use. Required: Using the above information, prepare an income statement, a capital statement, and a balance sheet for the Curtis Company.

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40) The Rubble-Flintstone Company was started on January 1, Year 1 as a partnership. The initial investments from the two partners were $50,000 from Rubble and $30,000 from Flintstone. During Year 1, Rubble-Flintstone Company earned $70,000 in cash revenue, paid $42,000 in cash expenses and the partners withdrew $5,000 each for their personal use. The partnership agreement calls for equal sharing of net income or loss. Required: Using only the above information, prepare an income statement, a capital statement, and a balance sheet for the Rubble-Flintstone Company.

41) On January 1, Year 1, the organizers of Fredonia Corporation obtained their charter authorizing 400,000 shares of $2 par common stock. Fredonia issued 30,000 shares of $2 par common stock for $8 per share. During Year 1, the corporation earned $820,000 in cash revenue and paid $700,000 in cash expenses, not including income tax. The company declared and paid cash dividends totaling $28,000. Fredonia Corporation is in the 30% tax bracket. Required: Using the above information, prepare an income statement and a balance sheet for the Fredonia Corporation.

42)

Loudoun Corporation's balance sheet reflected the following information:

Common stock, $2 par

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$ 140,000

Paid-in capital in excess of par value—common

210,000

The stock listed on the balance sheet was issued in a single transaction. Required: What was the issue price per share of the stock?

43) Vortex Corp. has 250,000 shares of common stock authorized. The company issued 85,000 shares and reacquired 9,000 of those shares as treasury stock. The board of directors subsequently declared a cash dividend of $6 per share.

Required: What is the total amount of dividends that were declared?

44)

Green Corporation has the following stock outstanding:

4% cumulative preferred stock, $20 stated value Common stock, $12 par

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$ 400,000 2,400,000

No dividends were paid in Year 1 or Year 2. During Year 3, Green paid $100,000 in dividends. Required: 1.a) Compute the total amounts of dividends that were paid in Year 3 to: 1.1) Preferred stockholders 2.2) Common stockholders 1.b) Compute the amounts of dividends per share for: 1.1) Preferred stock 2.2) Common stock

45) The corporate charter of Pinkston Corporation authorizes the issuance of 25,000 shares of 5% cumulative, preferred stock, $20 par, and 200,000 shares of $10 par common stock. At the end of the current year, the titles and balances of stockholders' equity accounts are as follows: Pinkston declared dividends of $120,000 for the current year. Common stock,200,000 shares authorized, 50,000 shares issued and outstanding Paid-in capital in excess of par - common stock Preferred stock 25,000 shares issued and outstanding Paid-in capital in excess of par - preferred stock Total Paid-in capital Retained earnings Total dividends declared

$ 500,000 300,000 500,000 100,000 1,400,000 850,000 $ 2,250,000

Required: a) What is the amount of the annual dividend per share for preferred stock? b) If there are two years of preferred dividends in arrears at the beginning of the current year, what total amount of dividends will be paid to the preferred shareholders? c) What total amount will be paid to the common shareholders if there are two years of preferred dividends in arrears at the beginning of the year? Version 1

46) Jalisco, Inc., had 300,000 shares issued and 250,000 shares outstanding of its $8 par value common stock and its Retained Earnings account balance was $750,000 on December 31, Year 1. On January 1, Year 2, the board of directors declared a 12% stock dividend to its common shareholders when the market value of the stock was $17 per share.

Required: 1.a) Determine the decrease in retained earnings as a result of the stock dividend. 2.b) How many shares are outstanding after the stock dividend?

47) Garber Corporation had 40,000 shares of $10 par common stock outstanding on January 1, Year 2. On June 1, Year 2, Garber purchased 5,000 shares of its own stock on the open market for $22 per share and held it as treasury stock. On October 1, Year 2, Garber declared and issued a 10% stock dividend. The market value of Garber's stock was $24 per share on October 1, Year 2. Garber's board of directors declared and paid a cash dividend of $57,750 on December 15, Year 2.

Required: 1.a) What was the cash dividend per share that was paid on December 15?

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48) On December 15, Year 1, Binghamton Corporation established a retained earnings appropriation of $20,000 for future expansion. The balance of the retained earnings account prior to the transaction was $60,000. At December 31, Year 1, Binghamton had 2,000 shares of $10 par common stock (issued at par) outstanding. The corporate charter indicates 20,000 shares of common stock are authorized and there is no treasury stock.

Required: 1.a) Indicate the effect of the appropriation on the financial statements. 2.b) Prepare the Stockholders’ Equity section of the Binghamton Corporation's Balance sheet of December 31, Year 1.

49) During Year 1, Hollowell Corporation and Chester Corporation reported net incomes of $260,000 and $480,000 respectively. Both companies had 200,000 shares of common stock issued and outstanding. At December 31, Year 1, the market price per share of Hollowell's stock was $39 and Chester's stock was $36.

Required: 1.a) Calculate the price-earnings ratio for: 1.1) Hollowell 2.2) Chester 1.b) Based on the price-earnings ratios computed in part (a), which company do investors believe has more potential for future income growth? Explain your answer.

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50) Jessup Company was founded in Year 1. It acquired $45,000 cash by issuing stock to investors and an additional $15,000 cash by borrowing from creditors. During Year 1 it received $25,000 cash revenues and paid $32,000 in cash expenses. The company then went out of business.

Required: a) Explain the term, "business liquidation." b) What amount of cash should Jessup Company have had on hand immediately before going out of business? c) What amount of cash will Jessup's creditors receive? d) What amount of cash will Jessup's stockholders receive?

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Answer Key Test name: Chap 11_2e_Problem Materials 1) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D N/A D N/A N/A N/A D

Conceptually, purchasing treasury stock is the reverse of issuing stock. When a business purchases treasury stock, the assets and stockholders’ equity of the business decrease. The Treasury Stock account is a contra equity account. It is deducted from the other equity accounts in determining total stockholders’ equity. It is reported as a cash outflow in the financing activities section of the statement of cash flows. 2) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A N/A I/D N/A N/A N/A N/A

Declaring and distributing stock dividends increases one stockholders' equity account, common stock (and possibly paid-in capital in excess of par value—common) and decreases another stockholders' equity account, retained earnings, so it has no net effect on Miller's financial statements. 3) Version 1

Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A I D N/A N/A N/A N/A

Declaring a cash dividend increases liabilities (Dividends Payable) and decreases stockholders' equity (Retained Earnings). Declaring a cash dividend has no effect on the statement of cash flows. 4) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A N/A N/A N/A N/A N/A N/A

The price an investor must pay to purchase a share of stock is the market value. Published financial statements report historical information; in this case, the company's paid-in capital is recorded at the issue price of $14 per share. A change in the market price of the company's common stock has no impact on the company's financial statements. 5) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I N/A I N/A N/A N/A I

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The stock issuance will increase assets (Cash) and increase stockholders' equity (Common Stock and Paid-In Capital in excess of par value—common). It is reported as a cash inflow in the financing activities section of the statement of cash flows. 6) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A N/A N/A N/A N/A N/A N/A

Stock splits have no effect on the dollar amounts of assets, liabilities, and stockholders' equity. They only affect the number of shares of stock outstanding and the par value per share. 7) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income D D N/A N/A N/A N/A D

Paying a dividend that was declared at an earlier date decreases assets (Cash) and decreases liabilities (Dividends Payable). It is reported as a cash outflow in the financing activities section of the statement of cash flows. 8) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A N/A N/A N/A N/A N/A N/A

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A corporation is a separate legal entity created by the authority of a state government. This transaction is between Grimes and Barbour; it is not between either of those parties and Preston Corporation. As such, this transaction has no effect on Preston's financial statements. Stock trades on the secondary market have no impact on a company's financial statements. 9) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I N/A I N/A N/A N/A I

When treasury stock is reissued at a price greater than its cost, assets (Cash) increase and stockholders' equity increases (Treasury Stock decreases by the amount of the original cost and Paid-In Capital in excess of cost of treasury stock increases for the difference). It is reported as a cash inflow in the financing activities section of the statement of cash flows. 10) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income N/A N/A I/D N/A N/A N/A N/A

A retained earnings restriction, often called an appropriation, is an equity exchange event. It transfers a portion of existing retained earnings to appropriated retained earnings. Total stockholders' equity (that is, total retained earnings) remains unchanged. 11) Balance Sheet

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Income Statement

Statement

Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I N/A I N/A N/A N/A

of Cash Flows I

Issuing no-par common stock increases assets (Cash) and increases stockholders' equity (Common Stock). It does not affect the income statement. The cash inflow is reported in the financing activities section of the statement of cash flows. 12) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I N/A I N/A N/A N/A I

Issuing common stock for an amount greater than par value increases assets (Cash) and increases stockholders' equity (Common Stock and Paid-In Capital in excess of par value—common). It is reported as a cash inflow in the financing activities section of the statement of cash flows. 13) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income I N/A I N/A N/A N/A I

The contribution will increase the proprietorship's assets (Cash) and its owner's equity (Bennett, capital). It is reported as a cash inflow in the financing activities section of the statement of cash flows. 14) Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income

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N/A

The cash contributions increase the partnership's assets (Cash) and partners' equity (Caldwell, capital and Ennis, capital). The cash contributions are reported as a cash inflow in the financing activities section of the statement of cash flows. 15) Double taxation is when the same income is taxed to different taxpayers. Corporate earnings are taxed once when the income is earned and again when dividends are paid to shareholders. 16) Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934 to regulate issuing stock and to govern the exchanges. The 1934 act also created the Securities and Exchange Commission (SEC) to enforce the securities laws. The Sarbanes-Oxley Act of 2002 imposed further regulation on public companies and established the Public Company Accounting Oversight Board. 17) The articles of incorporation normally include the following information: (1) the corporation's name and proposed date of incorporation; (2) the purpose of the corporation; (3) the location of the business and its expected life (which can be perpetuity, meaning endless); (4) provisions for capital stock; and (5) the names and addresses of the members of the first board of directors, the individuals with the ultimate authority for operating the business.

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18) 1.Sole Proprietorships are owned by one person and usually are fairly small. The owner is personally accountable for actions taken in the name of the business. 2.A partnership has the benefit of two or more people joining together to share their talents, their capital and the risks of business. Like proprietorships, the owners of partnerships are personally accountable for the actions taken in the name of the business. A partner is often responsible for the actions of the other partners as well. 3.Unlike proprietorships and partnerships, a corporation is designated as a separate legal entity by the state in which it is incorporated. The corporate form allows the potential of obtaining larger sums of capital than other forms. Other advantages of the corporate form are limited liability, continuity, transferability of ownership and professional management. Disadvantages include double taxation, excessive governmental regulation, and complexities in formation. 19) Owner contributions and retained earnings are combined in a single Capital account on the balance sheets of proprietorships. The financial statement format for reporting partnership equity is similar to that used for proprietorships in that contributed capital and retained earnings are combined. However, a separate capital account is maintained for each partner in the business to reflect each partner's ownership interest. The stockholders' equity section of the balance sheet of a corporation is more complex than proprietorships and partnerships. It includes: (1) dollar amounts of the total par value of the various stock accounts, (2) disclosure of other pertinent details, such as number of shares authorized, issued, and outstanding, (3) the paid-in excess account balances, (4) the amount of retained earnings, as well as any appropriations of retained earnings, if applicable, and (5) the cost of any treasury stock, if applicable. Version 1

20) Common stock All corporations issue common stock. Only a fraction of corporations choose to issue preferred stock. 21) Cumulative preferred stock is stock whose dividends accumulate from year to year when dividends are not declared. If dividends are declared, the preferred shareholders must first be paid both current year and any dividends in arrears before the common shareholders can be paid dividends. 22) "Par value" is an arbitrary value assigned to stock when it is authorized. Historically, par value represented the maximum liability of the investor and represents the minimum amount of assets that should be maintained as protection for creditors. 23) 1.When par value common stock is issued, the Common Stock account is increased by the product of the number of shares issued times the par value per share. 2.When stated value common stock is issued, the Common Stock account is increased by the product of the number of shares issued times the stated value per share 3.When no-par stock is issued, the entire amount of the proceeds from the stock issue is recorded in the Common Stock account with no Paidin Excess account required. 24) The number of shares of stock issued and the number of shares of stock outstanding will not always be the same. Authorized stock that has been sold to the public is called issued stock. Outstanding stock (or total issued stock minus treasury stock) is stock owned by investors outside the corporation. The number of shares of stock outstanding will be less than the number issued if a corporation has purchased its own stock as treasury stock. Version 1

25) Stockholders’ Equity Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders' equity on the balance sheet. 26) When a company buys its own stock, the stock purchased is called treasury stock. 27) Declaration date Although corporations are not required to declare dividends, they are legally obligated to pay dividends once they have been declared. 28) Cash dividends are paid to investors who own the stock on the date of record. 29) After the stock split, the corporation will have 80,000 shares outstanding at a par value of $3.00 per share. After a four-for-one stock split, the number of shares will be four times the number before the split (or 20,000 × 4 = 80,000) and the par value will be one-fourth of what it was before the split (or $12 × 1/4 = $3). 30) Assets = Liabilities + Stockholders' Equity Total paid-in Capital +

Retained Earnings −

A stock dividend is an equity exchange transaction. The company makes a transfer from retained earnings to paid-in capital. Thus, a stock dividend has no overall impact on the accounting equation. 31) Increasing the number of shares of stock can decrease the market price and make it more attractive to investors.

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32) A retained earnings restriction is often called an appropriation. The board of directors may restrict the amount of retained earnings available to distribute as dividends. The restriction may be required by credit agreements, or it may be discretionary. 33) Stock prices for the market as a whole tend to increase when the economy is good and when interest rates are low and/or falling. Future economic expectations also play a role in changes in market prices. The expectations of future success of a company play a major role in the behavior of stock prices. To a lesser degree, financial statement information sometimes has an effect on stock prices. 34) Stock prices for the market as a whole tend to increase when the economy is good and when interest rates are low and/or falling. Future economic expectations also play a role in changes in market prices. The expectations of future success of a company play a major role in the behavior of stock prices. To a lesser degree, financial statement information sometimes has an effect on stock prices. 35) Conrad Sole Proprietorship Income Statement For the Year Ended December 31, Year 1 Revenue $ 138,000 Less: Expenses 102,400 Net Income Conrad Sole Proprietorship Income Statement For the Year Ended December 31, Year 1 Beginning capital balance Add: Investments by owner Add: Net Income

Less: Withdrawals by owner

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$ 35,600

$ 90,000 35,600 125,600 (16,000)

Ending capital balance

$ 109,600

Conrad Sole Proprietorship Balance Sheet For the Year Ended December 31, Year 1 Assets Cash Liabilities and Owner's Equity

$ 109,600

Conrad, Capital

$ 109,600

36) Assets = Liabili + ties 30,00 0 80,00 0 (62,0 00)

(9,00 0)

NA NA

Equity: Howard Capital 30,00 0 80,00 0 (62,0 00)

Reve − Expe = Net Income nue nse

Statement of Cash Flows

8,00 0 NA

NA 62,0 00

80,00 0 (62,0 00)

(9,00 0)

30,00 0 FA 80,00 0 OA (62,0 00) OA (9,00 0) FA

The cash contribution by the owner is reported as a cash inflow and the withdrawal by the owner is reported as a cash outflow in the financing activities section of the statement of cash flows. 37) Mason-Dixon Partnership Income Statement For the Year Ended December 31, Year 1 Revenue $ 160,000 Less: Expenses 108,000 Net Income

$ 52,000 Mason-Dixon Partnership Income Statement

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For the Year Ended December 31, Year 1 Beginning capital balance $ Add: Investments by owner 100,000 Add: Net Income 52,000 Less: Withdrawals by owner (20,000) Ending capital balance

$ 132,000

Mason-Dixon Partnership Balance Sheet For the Year Ended December 31, Year 1 Assets Cash Equity

$ 132,000

Mason, Capital Dixon, Capital

$ 48,800 83,200

Total Capital

$ 132,000

Ending Mason, Capital = $40,000 − $12,000 + [$52,000 × ($40,000 ÷ $100,000)] = $48,800 Ending Dixon, Capital = $60,000 − $8,000 + [$52,000 × ($60,000 ÷ $100,000)] = + $83,200 38) Assets =Liabiliti + Equity: es Howard Capital 70,00 40,0 30,00 0 00 0 75,00 37,5 37,50 0 00 0 (52,0 (26,0 (26,0 00) 00) 00)

Reve − Expe =Net Income Statement of Cash nue nse Flows

(9,00 0)

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(5,00 0)

(4,00 0)

75,0 00 NA

NA 52,0 00

75,00 0 (52,0 00)

70,00 0 FA 75,00 0 OA (52,0 00) OA (9,00 0) FA

The cash investments by the partners are reported as cash inflows and the cash withdrawals by the partners are reported as cash outflows in the financing activities section of the statement of cash flows. 39) Curtis Sole Proprietorship Income Statement For the Year Ended December 31, Year 1 Revenue Less: Expenses

$ 60,000 45,000

Net Income

$ 15,000

Curtis Sole Proprietorship Income Statement For the Year Ended December 31, Year 1 Beginning capital balance Add: Investments by owner Add: Net Income

Less: Withdrawals by owner Ending capital balance

$ 80,000 15,000 95,000 (7,000) $ 88,000

Curtis Sole Proprietorship Balance Sheet For the Year Ended December 31, Year 1 Assets Cash Liabilities and Owner's Equity

$ 88,000

Curtis, Capital

$ 88,000

40) Rubble-Flintstone Partnership Income Statement For the Year Ended December 31, Year 1 Revenue Less: Expenses

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$ 70,000 42,000

Net Income

$ 28,000

Rubble-Flintstone Partnership Income Statement For the Year Ended December 31, Year 1 Beginning capital balance $ Add: Investments by owner 80,000 Add: Net Income 28,000 Less: Withdrawals by owner (10,000) Ending capital balance

$ 98,000

Rubble-Flintstone Partnership Balance Sheet For the Year Ended December 31, Year 1 Assets Cash

$ 98,000

Equity Rubble, Capital Flintstone, Capital

$ 59,000 39,000

Total Capital

$ 98,000

Ending Rubble, Capital = $50,000 − $5,000 + ($28,000 × 1/2) = $59,000 Ending Flintstone, Capital = $30,000 − $5,000 + ($28,000 × 1/2) = $39,000 41) Fredonia Corporation Income Statement For the Year Ended December 31, Year 1 Revenue $ 820,000 Less: Expenses 700,000 Income before taxes 120,000 Income tax expense 36,000 Net Income

$ 84,000 Fredonia Corporation Balance Sheet For the Year Ended December 31, Year 1

Assets

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Cash

$ 296,000

Stockholders' Equity Common stock Paid-in capital in excess of par value— common Retained earnings

$ 60,000 180,000

Total Stockholders' Equity

$ 296,000

56,000

Income tax expense = Income before taxes of $120,000 × 30% = $36,000 Common stock = 30,000 shares × Par value of $2 = $60,000 Paid-in capital in excess of par value—common = 30,000 shares × (Issue price of $8 per share − Par value of $2 per share) = $180,000 Retained Earnings = Net Income $84,000 – Dividends $28,000 = $56,000 42) $5 per share Common stock account balance of $140,000 = Number of shares (unknown) × $2 Par value per share Number of shares issued = $140,000 ÷ $2 = 70,000 Issue price per share = (Common stock account balance of $140,000 + Paid-in capital in excess of par—Common account balance of $210,000) ÷ 70,000 shares = $5 per share 43) $456,000 Shares issued Treasury stock Shares outstanding Cash dividend declared per share

$ 85,000 (9,000) 76,000 × $6

Total dividends declared

$ 456,000

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44) 1.a) 2. 3.(1) $48,000 4.Amount of preferred dividend = Par value of $400,000 × 4% = $16,000 5.Dividend paid to preferred shareholders = Dividends in arrears of $32,000 (or $16,000 per year × 2 years) + Current year's dividends of $16,000 = $48,000 1.(2) $52,000 2.Dividend paid to common shareholders = Total dividend of $100,000 − Dividends paid to Preferred stockholders of $48,000 = $52,000 b) 1.(1) $2.40 per share 2.Number of shares of preferred stock = Preferred stock account balance of $400,000 ÷ Stated value of $20 per share = 20,000 3.Preferred dividend per share = Preferred dividends of $48,000 ÷ 20,000 shares = $2.40 per share 1.(2) $0.26 per share 2.Number of shares of common stock = Common stock account balance of $2,400,000 ÷ Par value of $12 per share = 200,000 3.Common dividend per share = Common dividend of $52,000 ÷ 200,000 shares = $0.26 per share

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45) a) $1 per share Dividend per share of preferred stock = Par value of $20 per share × 5% = $1 per share b) $75,000 Cumulative dividends that have not been paid are called dividends in arrears. Since no dividends were paid to preferred stockholders in Year 1 or 2, there are two years of dividends in arrears. Amount of preferred dividend = Par value of $20 × 5% × 25,000 shares = $25,000 Dividend paid to preferred shareholders = Dividends in arrears of $50,000 (or $25,000 per year × 2 years) + Current year's dividends of $25,000 = $75,000 46) 1.a) $510,000 2.Dividends apply to outstanding shares only. 3.Shares distributed as stock dividend = Outstanding shares of 250,000 × Stock dividend of 12% = 30,000 shares 4.Decrease in retained earnings = 30,000 Shares distributed as stock dividend × Market value of $17 per share = $510,000 1.b) 280,000 2.Shares outstanding after stock dividend = Share previously outstanding of 250,000 + Stock dividend of 30,000 shares = 280,000

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47) 1.a) $1.50 Shares outstanding on October 1 = 40,000 Shares outstanding on January 1 − 5,000 Shares of treasury stock purchased on June 1 = 35,000 Shares distributed in stock dividend on October 1 = 35,000 Shares outstanding on October 1 × Stock dividend of 10% = 3,500 Shares outstanding on December 15 = 35,000 Shares outstanding on October 1 + 3,500 Shares issued in stock dividends on October 1 = 38,500 shares Cash dividend per share on December 15 = Dividend of $57,750 dividend ÷ 38,500 Shares outstanding on December 15 = $1.50 48) a) Stockholders' Equity Statemen t of Asset = Liabiliti + Commo Retaine + Appropriat Revenu − Expens = Net s es n d ed e e Incom Cash Flows Stock Earning Retained e s Earnings NA NA NA (20,000 20,000 NA NA NA D )

b) Common stock, $10 par value, 20,000 shares authorized, 2,000 shares issued and outstanding Retained earnings

$ 20,000

Appropriated

20,000

Unappropriated Total Stockholders' Equity

40,000

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60,000 $ 80,000

49) 1.a) (1) 30 1.(2) 15 Earnings per share = Net income ÷ Number of shares of common stock outstanding Hollowell: $260,000 ÷ 200,000 = $1.30 per share Chester: $480,000 ÷ 200,000 = $2.40 per share Price-earnings ratio = Market price per share ÷ Earnings per share Hollowell: $39 ÷ $1.30 = 30 Chester: $36 ÷ $2.40 = 15 b) Based on the price-earnings (P/E) ratio, investors believe that Hollowell has more potential for future income growth. While a lower P/E ratio might indicate a relative bargain for an investor, this measurement indicates that investors are willing to pay a relatively higher price (compared to earnings) for Hollowell's stock. While there are many reasons why the price of certain stocks is higher relative to earnings, one of the main reasons is confidence in future growth in earnings. 50) 1.a) Liquidation is the process of dividing up assets and allocating them to resource providers (creditors and investors). 2.b) Amount of cash on hand = $53,000 3.c) $15,000 4.d) $38,000 1.b) Amount of cash on hand = $45,000 + 15,000 + 25,000 − 32,000 = $53,000 2.c) Creditors would have first claim on Jessup's cash. Therefore, they would receive $15,000. 3.d) Stockholders would receive the remaining cash, or a total of $38,000 (or $53,000 − $15,000) Version 1

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CHAPTER 11 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Establishing a sole proprietorship generally requires the owner to get a charter from the state government. ⊚ true ⊚ false

2) A corporation is a legal entity created by the authority of a state government, separate and distinct from its owners. ⊚ true ⊚ false

3) Articles of incorporation, prepared by a business that wishes to incorporate, normally include, but are not limited to, the corporation's name and purpose, its location, and provisions for capital stock. ⊚ true ⊚ false

4) An advantage of the corporate form of business organization is that corporations are free from double taxation. ⊚ true ⊚ false

5) In a closely held corporation, exchanges of stock are limited to transactions between individuals. ⊚ true ⊚ false

All corporations are subject to extensive government regulation. ⊚ true ⊚ false

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7) The stock market crash in 1929 led to the beginning of the extensive regulation of trading stock on stock exchanges. ⊚ true ⊚ false

8) The Securities and Exchange Commission (SEC) has the authority to set and enforce auditing, attestation, quality control, and ethics standards for auditors of public companies. ⊚ true ⊚ false

9) Personal liability is a significant disadvantage of the partnership form of business organization. ⊚ true ⊚ false

10) The earnings of sole proprietorships are taxable to the owners rather than the company itself. ⊚ true ⊚ false

11) A partner is responsible for his/her own actions, but not for actions taken by another partner on behalf of the partnership. ⊚ true ⊚ false

12) Lack of ease in transferability of ownership is one of the disadvantages of the corporate form of business organization. ⊚ true ⊚ false

13) The balance sheet of a sole proprietorship will report two equity accounts: one for amounts contributed by the owner, and one for the earnings of the business. ⊚ true ⊚ false

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14)

A distribution by a sole proprietorship to the owner is called a withdrawal. ⊚ true ⊚ false

15)

A separate capital account is maintained for each partner in a partnership. ⊚ true ⊚ false

16)

The book value of a share of stock is equal to the market or selling price of the stock. ⊚ true ⊚ false

17) The number of shares of stock outstanding generally is greater than the number of shares of stock issued. ⊚ true ⊚ false

18)

The class or type of stock that every corporation must have is preferred stock. ⊚ true ⊚ false

19)

Preferred stockholders generally have no voting rights in a corporation. ⊚ true ⊚ false

20) Preferred stockholders' claims to a corporation's assets take precedence over the claims of some creditors. ⊚ true ⊚ false

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21) Van Buren Corporation issued 5,000 shares of $6 par common stock for $24 per share. For this transaction, Common Stock should be increased by $120,000. ⊚ true ⊚ false

22) Chisolm Corporation issued 10,000 shares of $5 par common stock for $22 per share. As a result of this transaction, Chisolm's legal capital increased by $50,000. ⊚ true ⊚ false

23) Weller Corporation issued 10,000 shares of no-par common stock for $25 per share. For this transaction, Common Stock should be increased by $250,000. ⊚ true ⊚ false

24) A corporation might buy some of its own stock to help keep the market price from falling. ⊚ true ⊚ false

25)

A purchase of treasury stock is an asset use transaction. ⊚ true ⊚ false

26)

Treasury Stock is a contra equity account.. ⊚ true ⊚ false

27) Treasury Stock is reported on the balance sheet between the liabilities and stockholders’ equity sections. ⊚ true ⊚ false

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28)

A corporation must record a liability for cash dividends on the date of record. ⊚ true ⊚ false

29) Powell Corporation had $10 par stock with a market price of $60, when it declared a 2for-1 stock split. After the stock split, the number of shares outstanding will double, and the market price of the stock should drop to about $30. ⊚ true ⊚ false

30) An appropriation of retained earnings restricts the amount of dividends that a corporation can declare in the future. ⊚ true ⊚ false

31)

The most commonly reported measure of a company's value is earnings per share. ⊚ true ⊚ false

32) A high price-earnings ratio generally means that investors are optimistic about a company's future growth. ⊚ true ⊚ false

33) The stockholders of a business have a priority claim to its assets in the event of liquidation. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 34) Which form of business organization is established as a separate legal entity?

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A) Sole proprietorship B) Partnership C) Corporation D) None of these answer choices are correct.

35)

What is meant by the term "double taxation"?

A) Corporations must pay income taxes on their net income, and their stockholders must pay income taxes on their dividends. B) In a partnership, both partners are required to claim their share of net income on their tax returns. C) A sole proprietorship must pay income taxes on its net income and the owner is also required to pay income taxes on withdrawals. D) A sole proprietorship must pay income taxes to both the state government and the federal government.

36) Which of the following is not considered an advantage of the corporate form of business organization? A) Ability to raise capital B) Continuity of existence C) Ease of transferability of ownership D) Lack of government regulation

37) Fred and Barney started a partnership. During Year 1, Fred invested $8,000 in the business and Barney invested $16,500. The partnership agreement called for each partner to receive an annual distribution equal to 10% of his capital contribution. Any further earnings were to be retained in the business and divided equally between the partners. The partnership reported net income of $20,000 during Year 1. How will the $20,000 of net income be split between Fred and Barney respectively? (Hint: Consider both the cash withdrawals and allocation of remaining income.) Fred A

Version 1

$ 7,975

Barney $ 7,125

B C D

$ 8,000 $ 10,000 $ 9,575

$ 12,000 $ 10,000 $ 10,425

A) Option A B) Option B C) Option C D) Option D

38) Fred and Barney started a partnership. During Year 1, Fred invested $20,000 in the business and Barney invested $32,000. The partnership agreement called for each partner to receive an annual distribution equal to 15% of his capital contribution. Any further earnings were to be retained in the business and divided equally between the partners. The partnership reported net income of $38,000 during Year 1. How will the $38,000 of net income be split between Fred and Barney respectively? (Hint: Consider both the cash withdrawals and allocation of remaining income.) Fred A B C D

Barney

$ 20,500 $ 20,000 $ 19,000 $ 18,100

$ 17,500 $ 18,000 $ 19,000 $ 19,900

A) Option A B) Option B C) Option C D) Option D

39)

Which of the following is a disadvantage of a sole proprietorship? A) Entrenched management B) Double taxation C) Personal liability D) Excessive regulation

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40) Which of the following entities would have a "Paid-in Capital in Excess" account in the equity section of the balance sheet? A) A corporation B) A municipality C) A sole proprietorship D) A partnership

41) Which of the following entities would report income tax expense on its income statement? A) Sole proprietorship. B) Corporation. C) Partnership. D) All of these answer choices are correct.

42) Which of the following statements is the most common explanation as to why a company might have a negative amount of total stockholders’ equity on its balance sheet? A) Its total assets exceed its total liabilities. B) Its total revenues are less than its total expenses in the current period. C) Its cash is segregated in a separate bank account designated for emergency uses. D) It has a negative balance in its Retained Earnings account.

43)

Which of the following statements about types of business entities is true? A) For accounting purposes, a sole proprietorship is not a separate entity from its owner. B) Ownership in a partnership is represented by having shares of capital stock. C) One advantage of the corporation form is the ability to raise capital. D) Sole proprietorships are subject to double taxation.

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44) Blair Scott started a sole proprietorship by depositing $27,000 cash in a business checking account. During the accounting period, the business borrowed $10,000 from a bank, earned $3,200 of net income, and Scott withdrew $4,400 cash from the business. Based on this information, what is the balance in Scott’s capital account at the end of the accounting period? A) $30,200 B) $28,200 C) $35,800 D) $25,800

45) Blair Scott started a sole proprietorship by depositing $75,000 cash in a business checking account. During the accounting period, the business borrowed $30,000 from a bank, earned $18,000 of net income, and Scott withdrew $12,000 cash from the business. Based on this information, what is the balance in Scott’s capital account at the end of the accounting period? A) $93,000 B) $111,000 C) $72,000 D) $81,000

46) Which of the following terms designates the maximum number of shares of stock that a corporation may issue? A) Number of shares issued B) Number of shares authorized C) Par value D) Number of shares outstanding

47)

Which of the following statements best describes the term "par value"? A) The number of shares currently in the hands of stockholders B) The amount that must be paid to purchase a share of stock C) Determined by dividing total stockholders' equity by the number of shares of stock D) An amount used in determining a corporation's legal capital

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48) Which of the following is not normally a preference given to the holders of preferred stock? A) The right to receive a specified amount of dividends prior to any being paid to common stockholders. B) The right to vote before the common stockholders at the corporation's annual meeting. C) The right to receive preference over common stockholders as to the distribution of assets during a liquidation process. D) All of these are preferences given to preferred stock.

49)

Which of the following statements about par value is true? A) Par value dictates the initial price of the stock. B) Par value may be revised each time a company issues more shares of stock. C) Par value is generally greater than market value. D) Par value has little connection to the market value of the stock.

50) Ogilvie Corporation issued 20,000 shares of no-par stock for $40 per share. Ogilvie was authorized to issue 43,000 shares. What effect will this event have on the company's financial statements? A) Increase assets and increase stockholders’ equity by $1,720,000 B) Increase assets and increase stockholders’ equity by $800,000 C) Increase cash inflows from investing activities by $800,000 D) None of these answer choices are correct.

51) Ogilvie Corporation issued 12,000 shares of no-par stock for $40 per share. Ogilvie was authorized to issue 35,000 shares. What effect will this event have on the company's financial statements?

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A) Increase assets and increase stockholders’ equity by $1,400,000. B) Increase assets and increase stockholders’ equity by $480,000. C) Increase cash inflows from investing activities by $480,000. D) None of these answer choices are correct.

52) On January 2, Year 1, Torres Corporation issued 23,000 shares of $15 par-value common stock for $17 per share. Which of the following statements is true? A) The Common Stock account will increase by $391,000. B) The Cash account will increase by $345,000. C) Total stockholders’ equity will increase by $345,000. D) The Paid-in Capital in Excess of Par Value account will increase by $46,000.

53) On January 2, Year 1, Torres Corporation issued 20,000 shares of $10 par-value common stock for $11 per share. Which of the following statements is true? A) The Common Stock account will increase by $220,000. B) The Cash account will increase by $200,000. C) Total stockholders’ equity will increase by $200,000. D) The Paid-in Capital in Excess of Par Value account will increase by $20,000.

54) On January 12, Year 1, Gilliam Corporation issued 550 shares of $12 par-value common stock for $15 per share. The number of shares authorized is 5,000, and the number of shares outstanding prior to this transaction was 1,200. Which of the following describes the effect of the January 12 transaction on the financial statements? Balance Sheet Income Statement Statemen t of Assets = Liabiliti + Stockholder Cash es s’ Equity Flows Cash + Accounts = Accounts + Commo + PIC Revenu − Expens = Net Receivab Payable n in e e Incom le Stock Exce e s A (6,600 N/A N/A 6,600 N/A N/A N/A N/A 6,600 FA . )

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B (8,250 . ) C (8,250 . ) D (8,250 . )

N/A

8,250

N/A

N/A 8,250 FA

N/A

6,600

N/A

N/A 8,250 FA

N/A

6,600

1,65 0 1,65 0

N/A

N/A 6,600 IA

A) Option A B) Option B C) Option C D) Option D

55) On February 2, Year 1, Farmer Corporation issued 9,000 shares of no-par stock for $17 per share. Within two hours of the issue, the stock's price jumped on the New York Stock Exchange to $21 per share. Which of the following answers describes the effect of the February 2 transaction on the financial statements? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cash + Accounts = Accounts + Commo + Retain Revenu − Expen = Net Receivab Payable n ed e se Incom le Stock Earnin e gs A 153,0 N/A N/A 153,0 N/A N/A N/A N/A 153,000 . 00 00 FA B 189,0 N/A N/A 189,0 N/A N/A N/A N/A 189,000 . 00 00 IA C 153,0 N/A N/A 153,0 N/A N/A N/A N/A 153,000 . 00 00 IA D 189,0 N/A N/A 189,0 N/A N/A N/A N/A 189,000 . 00 00 FA

A) Option A B) Option B C) Option C D) Option D

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56) Which of the following best describes how each share of par value stock issued is reported in the Common Stock account? A) Current market value B) Average issue price C) Par or stated value D) Lower of cost or market

57) Fixit Corporation issued 48,000 shares of $10 par value common stock at its current market price of $37. How does this event affect total stockholders' equity? A) It increases by $1,296,000. B) It is unaffected. C) It increases by $1,776,000. D) It increases by $480,000.

58) Fixit Corporation issued 20,000 shares of $20 par value common stock at its current market price of $32. How does this event affect total stockholders’ equity? A) It increases by $640,000. B) It is unaffected. C) It increases by $240,000. D) It increases by $400,000.

59)

How is treasury stock reported on a corporation’s balance sheet? A) As an addition to total paid-in capital B) As a deduction in determining total stockholders’ equity C) As a deduction from total paid-in capital D) As a deduction from retained earnings

60) Flagler Corporation shows a total of $1,295,000 in its Common Stock account and $1,400,000 in its Paid-in Capital Excess account. The par value of Flagler's common stock is $7. How many shares of Flagler stock have been issued? Version 1

A) 185,000 B) 200,000 C) 385,000 D) The number of shares cannot be determined using the information provided.

61) Flagler Corporation shows a total of $660,000 in its Common Stock account and $1,600,000 in its Paid-in Capital Excess account. The par value of Flagler's common stock is $8. How many shares of Flagler stock have been issued? A) 117,500 B) 200,000 C) 82,500 D) The number of shares cannot be determined using the information provided.

62) At the end of the accounting period, Houston Company had $7,200 of common stock, paid-in capital in excess of par value–common of $9,100, retained earnings of $8,000, and $5,000 of treasury stock. What is the total amount of stockholders' equity? A) $19,300 B) $29,300 C) $11,300 D) $22,100

63) At the end of the accounting period, Houston Company had $12,000 of common stock, paid-in capital in excess of par value–common of $11,000, retained earnings of $12,000, and $4,000 of treasury stock. What is the total amount of stockholders' equity? A) $37,000 B) $39,000 C) $19,000 D) $31,000

64)

Which of the following statements about Treasury Stock is correct?

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A) The balance in the Treasury Stock account increases paid-in capital. B) The balance in the Treasury Stock account reduces paid-in capital. C) The balance in the Treasury Stock account reduces total Stockholders' Equity. D) The balance in the Treasury Stock reduces Retained Earnings.

65) Kellogg, Incorporated purchased 200 shares of its own $20 par value stock for $30 cash per share. Which of the following answers reflects how this purchase of treasury stock would affect Kellogg's financial statements? Balance Sheet Income Statement Stateme nt of Assets = Liabiliti + Stockholders’ Cash es Equity Flows Cash + Investme = Accounts + Other − Treasu Revenu − Expen = Net nt Payable Equity ry e se Inco Accoun Stock me ts A (4,00 N/A N/A N/A 4,000 N/A N/A N/A (4,000) . 0) FA B (6,00 6,000 N/A N/A N/A N/A N/A N/A 6,000 . 0) IA C (6,00 N/A N/A N/A 6,000 N/A N/A N/A (6,000) . 0) FA D (4,00 4,000 N/A N/A N/A N/A N/A N/A 4,000 . 0) IA

A) Option A B) Option B C) Option C D) Option D

66) Voiles Company reissued 200 shares of its treasury stock. The treasury stock originally cost $25 per share and was reissued for $35 per share. Select the answer that accurately reflects how the reissue of the treasury stock would affect Voiles financial statements. Balance Sheet Income Statement Stateme nt of Assets =Liabilit + Stockholders’ Equity Cash ies Flows Cas + Account =Accounts + Other − Treas + Paid- Reven − Expen = Net

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s Receiva ble

Payable

Equit y Accou nts

ury Stock

A 7,0 + . 00 B 7,0 + . 00 C 7,0 + . 00 D 5,0 + . 00

N/A

+ N/A

N/A

+ N/A

N/A

+ N/A

in Capit al from Treas ury Stock − (5,00 + 2,000 0) − 5,000 + (2,00 0) − N/A + 7,000

N/A

+ N/A

− N/A

+ 5,000

ses

Inco me

N/A − N/A

= N/A

N/A − N/A N/A − N/A N/A − N/A

7,000 FA = N/A 7,000 IA = N/A (7,000) FA = N/A 5,000 FA

A) Option A B) Option B C) Option C D) Option D

67)

Which of the following statements is a reason why a company would buy treasury stock? A) Because management believes the market price of the stock is undervalued. B) To have stock available to issue to employees in stock option plans. C) To avoid a hostile takeover. D) All of these are reasons a company would buy treasury stock.

68) During the year, Todd Corporation issued 200 shares of $20 par value common stock for $50 a share. A total of 500 shares were authorized. In addition, the company purchased 75 shares of treasury stock at $44 a share. Which of the following best presents the related lines in the stockholders’ equity section of the company’s balance sheet? A)

Common stock, $20 par value, 500 shares authorized, 200 shares issued, 125 outstanding

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4,000

Paid in capital in excess of par - Common

6,000

Less: Treasury stock, 75 shares @ $44 per share

(3,300 )

Common stock, $20 par value, 500 shares authorized, 200 shares issued and outstanding Paid in capital in excess of par - Common

4,000 6,000

Less: Treasury stock, 75 shares @ $20 par

(1,500 )

Common stock, $20 par value, 500 shares authorized, 200 shares issued, 425 outstanding Paid in capital in excess of par - Common Less: Treasury stock, 75 shares @ $44 per share

8,500 11,050 (3,300 )

Common stock, $50 market value, 500 shares authorized, 200 shares issued, 125 outstanding Less: Treasury stock, 75 shares @ $44 per share

69)

$ 10,000 (3,300 )

Which of the following is a contra equity account?

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A) Retained Earnings B) Paid-in Capital in Excess of Par Value C) Treasury Stock D) Appropriated Retained Earnings

70) Montana Company was authorized to issue 145,000 shares of common stock. The company had issued 66,000 shares of stock when it purchased 10,500 shares of treasury stock. After the purchase of treasury stock, the number of outstanding shares of common stock was which of the following? A) 134,500 B) 76,500 C) 66,000 D) 55,500

71) Montana Company was authorized to issue 200,000 shares of common stock. The company had issued 50,000 shares of stock when it purchased 10,000 shares of treasury stock. After the purchase of treasury stock, the number of outstanding shares of common stock was which of the following? A) 190,000 B) 60,000 C) 40,000 D) 50,000

72) The board of directors of Chandler Company declared a cash dividend. Which of the following choices accurately reflects how this event would affect the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. N/A + − N/A + − N/A B.

−

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N/A

−

N/A

−FA

−

N/A

−

N/A

−OA

N/A

−

N/A

A) Option A B) Option B C) Option C D) Option D

73) On March 1, Year 1, Gilmore Incorporated declared a cash dividend on its 1,500 outstanding shares of $50 par value, 6% preferred stock. The dividend will be paid on May 1, Year 1 to the stockholders of record as of April 1, Year 1. How will the entry to record the declaration of the dividend on March 1 affect the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income A. N/A (9,000) (9,000) N/A 9,000 (9,000) N/A B.

N/A

9,000

(9,000)

N/A

C. (4,500)

N/A

(4,500)

N/A

4,500

(4,500)

N/A

(4,500) FA N/A

N/A

A) Option A B) Option B C) Option C D) Option D

74) On March 1, Year 1, Gilmore Incorporated declared a cash dividend on its 1,500 outstanding shares of $50 par value, 6% preferred stock. The dividend will be paid on May 1, Year 1 to the stockholders of record as of April 1, Year 1. How will the May 1 payment of the dividend affect the financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders' Revenue − Expense = Net Flows Equity income

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N/A

4,500

(4,500)

N/A

B. (4,500)

(4,500)

N/A

C. (9,000)

(9,000)

N/A

(4,500) FA (4,500) FA (9,000) IA N/A

A) Option A B) Option B C) Option C D) Option D

75) How would the declaration of a cash dividend affect the calculation of a company’s priceearnings ratio? (Hint: Do not consider any change in the market price of the stock that might occur because of the declaration of the dividend.) A) It will have no effect on the price-earnings ratio. B) The effect depends on the market price of the stock at the time the dividend is declared. C) It will decrease the price-earnings ratio. D) It will increase the price-earnings ratio.

76) Curtain Company paid dividends of $10,500, $16,500, and $30,500 during Year 1, Year 2, and Year 3, respectively. The company had 1,900 shares of 5.0%, $200 par value preferred stock outstanding that paid a cumulative dividend. What is the total amount of dividends paid to common shareholders during Year 3? A) $8,500 B) $500 C) $19,500 D) $19,000

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77) Curtain Company paid dividends of $6,000, $12,000, and $20,000 during Year 1, Year 2, and Year 3, respectively. The company had 1,000 shares of 5%, $200 par value preferred stock outstanding that paid a cumulative dividend. What is the total amount of dividends paid to common shareholders during Year 3? A) $4,000 B) $6,000 C) $8,000 D) $10,000

78) How does the payment of a previously declared cash dividend affect the financial statements? A) Decreases assets and stockholders’ equity B) Increases liabilities and decreases stockholders’ equity C) Decreases liabilities and increases stockholders’ equity D) None of these answer choices are correct.

79) Helena Corporation declared a 2-for-1 stock split on 8,000 shares of $6 par value common stock. If the market price of the stock had been $25 a share before the split, the par value, number of shares, and approximate market value after the split would be: Par Value A. B. C. D.

$ 6.00 $ 6.00 $ 3.00 $ 3.00

Number of Shares 16,000 8,000 16,000 16,000

Market Value $ 12.50 $ 25.00 $ 12.50 $ 25.00

A) Option A B) Option B C) Option C D) Option D

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80) For Year 2, the Sacramento Corporation had beginning and ending Retained Earnings balances of $148,900 and $196,900, respectively. Also during Year 2, the board of directors declared cash dividends of $18,500, which were paid during Year 2. The board alsodeclared a stock dividend,which was issued and required a transfer in the amount of $14,500 to paid-in capital. Total expenses during Year 2 were $35,916. Based on this information, what was the amount of total revenue for Year 2? A) $142,484 B) $116,916 C) $102,416 D) $130,400

81) For Year 2, the Sacramento Corporation had beginning and ending Retained Earnings balances of $208,054 and $231,012, respectively. Also during Year 2, the board of directors declared cash dividends of $29,000, which were paid during Year 2. The board also declared a stock dividend, which was issued and required a transfer in the amount of $16,000 to paid-in capital. Total expenses during Year 2 were $32,916. Based on this information, what was the amount of total revenue for Year 2? A) $68,158 B) $143,154 C) $100,874 D) $179,132

82) How does the issuance of a common stock dividend normally impact the calculation of a company’s price-earnings (P/E) ratio? A) It decreases the P/E ratio. B) It would not be expected to impact the P/E ratio. C) It increase the P/E ratio. D) The impact on the P/E ratio cannot be determined.

83) What effect will the declaration and distribution of a stock dividend have on net income and cash flows? Net Income

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Cash Flows

A. B. C. D.

None None Increase Decrease

None Decrease None Decrease

A) Option A B) Option B C) Option C D) Option D

84) Which of the following describes, in part, how the declaration of a stock dividend affects the financial statements? A) Decreases total assets B) Increases total stockholders’ equity C) Decreases paid-in capital in excess of par value–common D) No effect on total stockholders’ equity

85)

What is the expected impact of a 2-for-1 stock split? A) A decrease in the market price of the stock B) Increased protection of the interest of creditors C) An increase in the par value of the stock D) The absorption of treasury stock

86) Gilligan Corporation was established on February 15, Year 1. Gilligan is authorized to issue 450,000 shares of $15 par value common stock. As of December 31, Year 3, Gilligan's stockholders' equity accounts report the following balances:

Common stock, $15 par, 450,000 shares authorized, 45,000 shares issued and outstanding Paid-in capital in excess of par - Common

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$ 675,000

90,000

$ 765,000 Retained earnings

1,695,000

Total stockholders' equity

$ 2,460,000

A) $19,125 B) $58,500 C) $100,125 D) $39,375

87) Gilligan Corporation was established on February 15, Year 1. Gilligan is authorized to issue 500,000 shares of $6.00 par value common stock. As of December 31, Year 3, Gilligan's stockholders' equity accounts report the following balances: Common stock, $6 par, 500,000 shares authorized, 55,000 shares issued and outstanding Paid-in capital in excess of par - Common

$ 330,000

440,000 $ 770,000

Retained earnings Total stockholders' equity

1,400,000 $ 2,170,000

At the end of Year 3, Gilligan decides to issue a 5% stock dividend. At the time of issue, the market price of the stock was $22 per share. What is the amount of retained earnings that will be transferred to paid-in capital as a result of the stock dividend issued by Gilligan Corporation? A) $60,500 B) $16,500 C) $44,000 D) $108,500

88) Gilligan Corporation was established on February 15, Year 1. Gilligan is authorized to issue 400,000 shares of $12 par value common stock. As of December 31, Year 3, Gilligan's stockholders' equity accounts report the following balances: Version 1

Common stock, $12 par, 400,000 shares authorized, 40,000 shares issued and outstanding Paid-in capital in excess of par - Common

$ 480,000

80,000 $ 560,000

Retained earnings

1,470,000

Total stockholders' equity

$ 2,030,000

At the end of Year 3, Gilligan decides to issue a 5% stock dividend. At the time of issue, the market price of the stock was $24 per share.

What is the number of shares outstanding after the stock dividend is issued? A) 38,000 B) 40,000 C) 42,000 D) 402,000

89) Gilligan Corporation was established on February 15, Year 1. Gilligan is authorized to issue 500,000 shares of $6.00 par value common stock. As of December 31, Year 3, Gilligan's stockholders' equity accounts report the following balances: Common stock, $6 par, 500,000 shares authorized, 55,000 shares issued and outstanding Paid-in capital in excess of par - Common

$330,000

440,000 $770,000

Retained earnings

1,400,000

Total stockholders' equity

$2,170,000

At the end of Year 3, Gilligan decides to issue a 5% stock dividend. At the time of issue, the market price of the stock was $22 per share. What is the number of shares outstanding after the stock dividend is issued?

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A) 57,750 B) 55,000 C) 52,250 D) 525,000

90) At the time that Kirby Company issued a 3-for-1 stock split, the company had 1,000 shares of $12 par value common stock outstanding. Stockholders' equity also included $16,000 ofpaid in capital in excess of par value–common and $18,000 of retained earnings. Which of the following statements regarding the impact of the stock split is true? A) The number of outstanding shares of common stock will be 36,000. B) The amount of paid-in capital in excess of par–common will become $16,000. C) The balance in the retained earnings account will become $6,000. D) The balance of the common stock account will be $12,000.

91) At the time that Kirby Company issued a 2-for-1 stock split, the company had 5,000 shares of $6 par value common stock outstanding. Stockholders' equity also included $15,000 of paid in capital in excess of par value–common and $22,000 of retained earnings. Which of the following statements regarding the impact of the stock split is true? A) The balance of the common stock account will be $30,000. B) The amount of paid-in capital in excess of par–common will become $150,000. C) The balance in the retained earnings account will become $11,000. D) The number of outstanding shares of common stock will be 2,500.

92) On July 1, Year 1, Village Bookstore, Incorporated appropriated retained earnings in the amount of $36,000 for a future remodeling project in the basement of the bookstore. On June 30, Year 1, the balance of Retained Earnings was $82,800 and the Cash balance was $43,200. Which of the following answers shows the effect of the July 1 event on the financial statements? Balance Sheet

Stateme nt of Assets = Liabilit + Stockholders’ Income Statement Cash ies Equity Flows Cash + Account = Account + Retain − Appropria Reven − Expen = Net Receiva Payable ed ted ue se Inco

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ble A N/A . B (36,00 . 0) C N/A . D N/A .

N/A

Earnin gs (36,00 0) (36,00 0) N/A

Retained Earnings 36,000

me N/A

N/A

N/A (36,000 ) FA N/A (36,000 ) FA N/A N/A

(36,00 0)

36,000

N/A

A) Option A B) Option B C) Option C D) Option D

93) On September 1, Year 1, Orville Corporation has unappropriated retained earnings of $7,700,000, appropriated retained earnings of $4,700,000, cash of $9,200,000, and accounts payable of $1,200,000. What is the maximum amount that can be used for cash dividends? A) $9,200,000 B) $7,700,000 C) $9,400,000 D) $3,000,000

94) On September 1, Year 1, Orville Corporation has unappropriated retained earnings of $600,000, appropriated retained earnings of $400,000, cash of $850,000, and accounts payable of $50,000. What is the maximum amount that can be used for cash dividends? A) $850,000 B) $600,000 C) $800,000 D) $450,000

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95) Rocco Corporation decides to issue a 7.5% stock dividend on 20,000 outstanding shares of $10 stated value common stock. The distribution is made at the time the market value of the stock is $50 a share. How will the entry to record this transaction affect the company's stockholders’ equity accounts? Common Stock

A. B. C. D.

$ 200,000 $ 15,000 $ 15,000 $ 100,000

Paid-in Capital in Excess of Par Value–Common $ 300,000 Not affected $ 60,000 Not affected

Retained Earnings

$(50,000) $(15,000) $(75,000) $(100,000)

A) Option A B) Option B C) Option C D) Option D

96) Chadwick Associates retained $850,000 of net income in the business in Year 1. If $75,000 was appropriated to satisfy the restrictive covenant of a loan agreement, what are the effects of the appropriation on the financial statements? Balance Sheet Income Statement Statemen t of Assets = Liabilitie + Stockholders Revenu − Expense = Net Cash s ' Equity e income Flows A N/A N/A N/A N/A N/A N/A N/A . B (75,000 N/A (75,000) N/A N/A N/A (75,000) . ) FA C (75,000 N/A (75,000) N/A (75,000 (75,000 (75,000) . ) ) ) FA D (75,000 N/A (75,000) N/A N/A N/A N/A . )

A) Option A B) Option B C) Option C D) Option D

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97) Franklin Corporation reported net income of $81,750 in Year 1. The company had 109,000 shares of $12 par value common stock outstanding and a market price of $45 per share. What is Franklin's price-earnings ratio? A) 60 B) 6.0 C) 40 D) 5.1

98) Franklin Corporation reported net income of $75,000 in Year 1. The company had 100,000 shares of $12 par value common stock outstanding and a market price of $18 per share. What is Franklin's price-earnings ratio? A) 2.4 B) 24 C) 16.6 D) 1.5

99) Ben Weaver is planning to invest in one of the following companies based on their average performance over the past five years, summarized below. Company

Galax, Incorporated Apex, Incorporated Bendex, Incorporated Curex, Incorporated

Net Income

$ 2,500,000 $ 1,500,000 $ 6,000,000 $ 4,400,000

PriceEarnings Ratio 18.00 16.00 15.50 12.00

Cash Dividend per share $ 0.36 $ 1.20 $ 0.50 $ 0.30

If Ben is looking for a company that is likely to achieve rapid growth in revenues and profitability, which one should he choose? A) Galax, Incorporated B) Apex, Incorporated C) Bendex, Incorporated D) Curex, Incorporated

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100) Napoli Industries had net income for Year 2 of $517,500. Napoli had an average number of shares outstanding at the end of the year of 575,000 shares. On January 1, Year 2, the market price of Napoli's stock was $36 per share. On December 31, Year 2, the market price was $39 per share. What is the price-earnings ratio for Napoli at the end of Year 2? A) 43.33 B) 40.00 C) 32.40 D) None of these answer choices are correct.

101) Napoli Industries had net income for Year 2 of $650,000. Napoli had an average number of shares outstanding at the end of the year of 500,000 shares. On January 1, Year 2, the market price of Napoli’s stock was $20 per share. On December 31, Year 2, the market price was $22 per share. What is the price-earnings ratio for Napoli at the end of Year 2? A) 16.9 B) 16.2 C) 15.4 D) None of these answer choices are correct.

102) On June 10, Year 1, Burton Builders, Incorporated, a publicly traded company, announced that it had been awarded a contract to build a football stadium at a contract price of $500 million. This contract would increase its projected revenues by 20% over the next three years. Which of the following statements is correct with regard to this announcement? A) The market price of Burton's stock will probably be higher on June 11, Year 1 than on June 10th. B) Burton's net cash flow from operations will increase by 20% over the next three years. C) Burton's assets should be increased by $500 million on June 10, Year 1 to recognize this contract. D) Burton's net income will increase by 20% over the next three years.

103) Which of the following statements about why companies choose not to pay cash dividends is (are) true?

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A) The board and management prefer to reinvest all net income for future growth. B) The corporation does not have sufficient cash. C) The corporation does not have sufficient retained earnings. D) All of these statements are true.

104) Which of the following would not be a reason to expect an increase in the market price of the stock of Carlyle Corporation? A) Carlyle Corporation has a history of earnings growth. B) Investors expect that revenue and earnings growth in the future will not be as great as revenue and earnings growth has been in the past. C) The market price has been influenced by positive financial information that is not provided in the financial statements. D) Investors believe Carlyle Corporation has potential for earnings growth.

105)

How is the price-earnings ratio calculated?

A) Market price per share of stock divided by earnings per share B) The interest rate on borrowed money divided by the current prime rate C) The price of a company's products as compared to its net income D) The market value of a company’s stock divided by average earnings over the past three years

106) At the time of liquidation, Fairchild Company reported assets of $200,000, liabilities of $120,000, common stock of $70,000 and retained earnings of $10,000. What is the maximum amount of Fairchild’s assets that the shareholders are entitled to receive? A) $200,000 B) $80,000 C) $90,000 D) $100,000

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107) What is the process of dividing up assets and allocating them to resource providers (creditors and investors)? A) Equity distribution B) Stock repayment C) Liquidation D) Utilization

108)

What does negative retained earnings indicate? A) The company has lost some or all of the owners’ investment B) The company experienced a large cash outflow during the year C) The company’s liabilities are greater than its assets D) The company’s common stock is negative

109)

A net loss occurs when A) expenses are greater than revenues. B) liabilities are greater than assets. C) cash inflow is less than cash outflow. D) the ending cash balance is lower than the beginning cash balance.

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Answer Key Test name: Chap 11_2e_Test Bank_MCQs_TF 1) FALSE Sole proprietorships do not require registration with state government. 2) TRUE A corporation is a separate legal entity from its owners, while a sole proprietorship is not. A corporation must be registered with the state government. 3) TRUE Articles of incorporation normally include the following information: (1) the corporation’s name and proposed date of incorporation; (2) the purpose of the corporation; (3) the location of the business and its expected life (which can be perpetuity, meaning endless); (4) provisions for capital stock; and (5) the names and addresses of the members of the first board of directors, the individuals with the ultimate authority for operating the business. 4) FALSE Double taxation is a significant disadvantage of the corporate form of business organization. 5) TRUE As long as the exchanges (buying and selling of shares of stock, often called trading) are limited to transactions between individuals, a company is defined as a closely held corporation. 6) FALSE The extent of government regulation depends on the size and distribution of ownership interests of the corporation. 7) TRUE

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The extensive regulation of trading on stock exchanges began in the 1930s. The 1929 stock market crash led to the Securities Act of 1933 and the Securities Exchange Act of 1934. 8) FALSE The Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) to enforce the securities laws. Congress gave the SEC legal authority to establish accounting principles for corporations that are registered on the exchanges. The Sarbanes–Oxley Act of 2002 established the Public Company Accounting Oversight Board (PCAOB). The PCAOB has the authority to set and enforce auditing, attestation, quality control, and ethics standards for auditors of public companies. 9) TRUE Unlike corporate stockholders, the owners of proprietorships and partnerships are personally liable for actions they take in the name of their companies. In fact, partners are responsible not only for their own actions but also for those taken by any other partner on behalf of the partnership. The benefit of limited liability is one of the most significant reasons limited liability companies and corporations are so popular. 10) TRUE Because proprietorships are not separate taxable entities, company earnings are taxable to the owners rather than the company itself. 11) FALSE Unlike corporate stockholders, the owners of proprietorships and partnerships are personally liable for actions they take in the name of their companies. In fact, partners are responsible not only for their own actions but also for those taken by any other partner on behalf of the partnership. 12) FALSE

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The transferability of corporate ownership is an advantage of the corporate form of business organization. 13) FALSE There is only one equity account in a sole proprietorship, the owner’s capital account. Earnings and contributions increase this account and withdrawals decrease it. 14) TRUE Withdrawals are distributions to the owners of sole proprietorships. Dividends are distributions to corporate stockholders. 15) TRUE A separate capital account is maintained for each partner in the business to reflect each partner’s ownership interest. 16) FALSE The book value of a share of stock is calculated as total stockholders’ equity divided by number of shares owned by investors. 17) FALSE The number of shares issued is normally equal to or greater than the number of shares outstanding. 18) FALSE All corporations issue common stock. Many corporations issue preferred stock in addition to common stock. 19) TRUE In exchange for special privileges in some areas, preferred stockholders give up rights in other areas. Preferred stockholders usually have no voting rights. 20) FALSE Preferred stock often has a liquidation value. In case of bankruptcy, preferred stockholders must be paid the liquidation value before any assets are distributed to common stockholders. However, preferred stockholder claims still fall behind creditor claims. Version 1

21) FALSE The common stock account should only be increased by $30,000 (or 5,000 shares × Par value of $6 per share) 22) TRUE Legal capital is the amount of assets that should be maintained as protection for creditors. It is the number of shares multiplied by the par value. Legal capital = Par value of $5 per share × Number of shares issued of 10,000 = $50,000 23) TRUE When no-par common stock is issued, the common stock account is increased by the entire amount received in the stock issue, which in this case is $250,000 (or 10,000 Shares × Issue price of $25 per share). 24) TRUE Reducing the number of outstanding shares of stock is a way to elevate the market price. 25) TRUE The purchase of treasury stock is an asset use transaction that decreases assets (cash) and decreases stockholders’ equity (by increasing treasury stock, a contra equity account). 26) TRUE Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders’ equity. 27) FALSE Treasury stock is reported within the stockholders’ equity section of the balance sheet after retained earnings. 28) FALSE Although corporations are not required to declare dividends, they are legally obligated to pay dividends once they have been declared. They must recognize a liability on the declaration date. Version 1

29) TRUE In a 2-for-1 stock split, the par value and market price per share will be cut in half, and the number of outstanding shares will double. 30) TRUE The board of directors may restrict the amount of retained earnings available to distribute as dividends. A retained earnings restriction, often called an appropriation, is an equity exchange event. It transfers a portion of existing retained earnings to appropriated retained earnings. 31) FALSE The price-earnings ratio is the most commonly reported measure of a company’s value. 32) TRUE A high price-earnings ratio is the result of a high market price relative to a company’s earnings per share, and indication that investors are optimistic about the company’s future earnings. 33) FALSE This is false. Creditors have priority in business liquidations. This means the business uses its assets first to settle the obligations to the creditors. Any assets remaining after the creditors have been paid are then distributed to the investors. 34) C A corporation is a separate legal entity created by the authority of a state government. 35) A

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Corporations pay income taxes on their earnings and then owners pay income taxes on distributions (dividends) received from corporations. As a result, distributed corporate profits are taxed twice—first when income is reported on the corporation's income tax return and a second time when distributions are reported on individual owners’ tax returns. This phenomenon is commonly called double taxation and is a significant disadvantage of the corporate form of business organization. 36) D Few laws specifically affect the operations of proprietorships and partnerships. Corporations, however, are heavily regulated. 37) D Cash withdrawals (that is, annual distributions): Fred: $8,000 × $10% = $800 Barney: $16,500 × $10% = $1,650 Allocation of remaining income of $17,550 (or $20,000 − $800 − $1,650): Fred: $17,550 × 50% = $8,775 Barney: $17,550 × 50% = $8,775 Split of net income of $20,000: Fred: $8,775 + $800 = $9,575 Barney: $8,775 + $1,650 = $10,425 38) D

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Cash withdrawals (that is, annual distributions): Fred: $20,000 × 15% = $3,000 Barney: $32,000 × 15% = $4,800 Allocation of remaining income of $30,200 (or $38,000 − $3,000 − $4,800): Fred: $30,200 × 50% = $15,100 Barney: $30,200 × 50% = $15,100 Split of net income of $38,000: Fred: $3,000 + $15,100 = $18,100 Barney: $4,800 + $15,100 = $19,900 39) C Unlike corporate stockholders, the owners of proprietorships and partnerships are personally liable for actions they take in the name of their companies. The benefit of limited liability is one of the most significant reasons limited liability companies and corporations are so popular. 40) A When stock is issued, any amount received above the par or stated value is recorded in an account called Paid-in Capital in Excess of Par (or Stated) Value. Only a corporation issues stock; thus, only corporations have this type of account. 41) B Corporations are separate legal entities and pay income taxes on their earnings. Since sole proprietorships and partnerships are not separate legal entities, company earnings are taxable to the owners rather than to the company itself. 42) D When a company has negative shareholders’ equity, it is usually because of a negative balance in Retained Earnings. 43) C Version 1

Corporations are more able to raise capital because they can issue common stock to a large number of potential investors. In contrast, the capital resources of proprietorships and partnerships are limited to a relatively small number of private owners. Although proprietorships and partnerships can also obtain resources by borrowing, the amount creditors are willing to lend them is usually limited by the size of the owners’ net worth. Of the three business forms, only corporations are separate legal entities that continue to exist regardless of changes in ownership. Only corporations are subject to double taxation. And, only corporations issue capital stock. 44) D Ending capital = Beginning capital + Contributions− Withdrawals + Net income Ending capital = $0 + $27,000 − $4,400 + $3,200 = $25,800 45) D Ending capital = Beginning capital + Contributions − Withdrawals + Net income Ending capital = $0 + $75,000 − $12,000 + $18,000 = $81,000 46) B As part of the regulatory function, states approve the maximum number of shares of stock that corporations are legally permitted to issue. This maximum number is called authorized stock. 47) D Par value is an arbitrary value assigned to stock by the board of directors; like stated value, par value designates legal capital. 48) B Preferred stockholders do not have voting rights. 49) D

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Par value is an arbitrary value assigned to stock by the board of directors; like stated value, par value designates legal capital. On the other hand, market value is the price at which securities sell in the secondary market. Thus, par value has little connection to market value. 50) B Assets (Cash) andstockholders’ equity (Common Stock) increase by $800,000 (or 20,000 shares × $40 per share). The cash inflow is reported in the financing activities section of the statement of cash flows. 51) B Assets (Cash) and stockholders’ equity (Common Stock) increase by $480,000 (or 12,000 shares × $40 per share). The cash inflow is reported in the financing activities section of the statement of cash flows. 52) D The cash account will increase by $391,000 (23,000 × $17), the common stock account will increase by $345,000 (23,000 × $15 par value), and the paid-in capital in excess of par value account will increase by $46,000 (23,000 × $2). 53) D The cash account will increase by $220,000 (20,000 × $11), the common stock account will increase by $200,000 (20,000 × $10 par value), and the paid-in capital in excess of par value account will increase by $20,000 (20,000 × $1). 54) C The event increases assets (cash) and stockholders’ equity. Assets (Cash) increase by $8,250 (550 shares × $15). The increase in stockholders’ equity is divided into two parts. Common stock increases by $6,600 (550 shares × $12 par value) and paid-in excess of par value − common increases by $1,650 ($8,250 − $6,600). The cash inflow is a financing activity. 55) A Version 1

Assets (Cash) and stockholders’ equity (Common Stock) increase by $153,000 (or 9,000 shares × $17 per share). The cash inflow of $153,000 is reported in the financing activities section of the statement of cash flows. The price an investor must pay to purchase a share of stock is the market value. Published financial statements report historical information, in this case, the company’s paid-in capital is recorded at the issue price of $17 per share. In other words, the increase in market price following the issuance does not affect the company’s financial statements. 56) C The par value (or stated value) of the stock is recorded in the Common Stock account. Any amount received above the par value (or stated value) is recorded in the Paid-in Capital in Excess of Par (or Stated) Value account. 57) C The event increases assets and stockholders’ equity by $1,776,000 (or $37 per share × 48,000 shares). The increase in stockholders’ equity is divided into two parts, $480,000 of par value (or $10 per share × 48,000 shares) and $1,296,000 ($1,776,000 − $480,000) received in excess of par value. 58) A The event increases assets and stockholders’ equity by $640,000 (or $32 per share × 20,000 shares). The increase in stockholders’ equity is divided into two parts, $400,000 of par value (or $20 per share × 20,000 shares) and $240,000 ($640,000 − $400,000) received in excess of par value. 59) B Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders’ equity. 60) A Version 1

Common stock account balance of $1,295,000 = Number of shares issued (the unknown) × Par value of $7 per share Number of shares issued = $1,295,000 ÷ $7 = 185,000 61) C Common stock account balance of $660,000 = Number of shares issued (the unknown) × Par value of $8 per share Number of shares issued = $660,000 ÷ $8 = 82,500 62) A Stockholders’ equity = Common stock of $7,200 + Paid-in capital in excess of par value of $9,100 + Retained earnings of $8,000 − Treasury stock of $5,000 = $19,300 63) D Stockholders’ equity = Common stock of $12,000 + Paid-in capital in excess of par value of $11,000 + Retained earnings of $12,000 − Treasury stock of $4,000 = $31,000 64) C Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders’ equity. 65) C Assets (Cash) decrease and stockholders’ equity decreases (by increasing Treasury Stock, a contra equity account) by $6,000 (or 200 shares × Cost of $30 per share). The cash outflow is reported in the financing activities section of the statement of cash flows. 66) A Assets (Cash) increase by $7,000 (200 × $35), Stockholders’ Equity (Treasury Stock) increases by $5,000 (200 × $25) and (Paid-In Capital in Excess of Cost from Treasury Stock) increases by $2,000. The cash inflow is reported in the Financing Activities section of the statement of cash flows. 67) D Version 1

Common reasons include (1) to have stock available to give employees pursuant to stock option plans, (2) to accumulate stock in preparation for a merger or business combination, (3) to reduce the number of shares outstanding in order to increase earnings per share, (4) to keep the price of the stock high when it appears to be falling, and (5) to avoid a hostile takeover. 68) A Common stock is reported at $4,000 (or 200 Shares issued × Par value of $20 per share). Paid-in capital in excess of par value–Common is reported at $6,000 [or 200 Shares issued × $30 (Original issue price of $50 per share − Par value of $20 per share)]. The Treasury Stock account is a contra equity account that is deducted from the other equity accounts in determining total stockholders’ equity. It is reported at $3,300 (or 75 Shares purchased × Purchase price of $44 per share). 69) C Treasury stock is a contra equity account. It is deducted from the other equity accounts in determining total stockholders’ equity. 70) D Outstanding stock (total issued stock minus treasury stock) is stock owned by investors outside the corporation. Outstanding shares = 66,000 Issued shares − 10,500 Treasury shares = 55,500 71) C Outstanding stock (total issued stock minus treasury stock) is stock owned by investors outside the corporation. Outstanding shares = 50,000 Issued shares − 10,000 Treasury shares = 40,000 72) D Version 1

The increase in liabilities (Dividends Payable) is accompanied by a decrease in stockholders’ equity (Retained Earnings). Since cash has not yet been paid to the stockholders, there is no effect on the statement of cash flows. 73) D Dividends declared = Par value of $50 per share × 6% × 1,500 Outstanding shares = $4,500 The declaration will increase liabilities (Dividends Payable) and decrease stockholders’ equity (Retained Earnings) by $4,500. Since cash has not yet been paid to the stockholders, there is no effect on the statement of cash flows. 74) B The payment will decrease assets (Cash) and liabilities (Dividends Payable). It is reported as a cash outflow in the financing activities section of the statement of cash flows. 75) A Price-Earnings Ratio = Market price per share ÷ Earnings per share The declaration of a cash dividend increases liabilities (dividends payable) and decreases stockholders’ equity (retained earnings). Because the liabilities and stockholders’ equity are not components of this ratio, the declaration of the dividend, in itself, has no effect on it. 76) B

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Preferred dividend = 1,900 Outstanding shares × Par value of $200 per share × 5.0% = $19,000 Dividends in arrears at end of Year 1 = Preferred dividend of $19,000 − Dividends paid in Year 1 of $10,500 = $8,500 Dividends in arrears at end of Year 2 = Preferred dividend of $19,000 + Dividend in arrears from Year 1 of $8,500 − Dividends paid in Year 2 of $16,500 = $11,000 Year 3 Dividends to common shareholders = Dividends paid in Year 3 of $30,500 − (Preferred dividend of $19,000 + Dividend in arrears from Year 2 of $11,000) = $500 77) C Preferred dividend = 1,000 Outstanding shares × Par value of $200 per share × 5% = $10,000 Dividends in arrears at end of Year 1 = Preferred dividend of $10,000 − Dividends paid in Year 1 of $6,000 = $4,000 Dividends in arrears at end of Year 2 = Preferred dividend of $10,000 + Dividend in arrears from Year 1 of $4,000 − Dividends paid in Year 2 of $12,000 = $2,000 Year 3 Dividends to common shareholders = Dividends paid in Year 3 of $20,000 − (Preferred dividend of $10,000 + Dividend in arrears from Year 2 of $2,000) = $8,000 78) D The payment of a previously declared cash dividend decreases assets (cash) and liabilities (dividends payable). 79) C

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In a 2-for-1 stock split, par value and approximate market value will be 1/2 of what they were prior to the split and number of shares will be two times what it was. Par value = Old par value of $6 × ½ = $3 Number of shares = Old number of shares of 8,000 × 2 = 16,000 Approximate market value = Old market value of $25 × ½ = $12.50 80) B Ending retained earnings = Beginning retained earnings + Net income − Dividends $196,900 = $148,900 + Net income − ($18,500 + $14,500) Net income = $196,900 − $148,900 + $33,000 = $81,000 Net income of $81,000 = Revenues (the unknown) − Expenses of $35,916 Revenues = $81,000 + $35,916 = $116,916 81) C Ending retained earnings = Beginning retained earnings + Net income − Dividends $231,012 = $208,054 + Net income − ($29,000 + $16,000) Net income = $231,012 − $208,054 + $45,000 = $67,958 Net income of $67,958 = Revenues (the unknown) − Expenses of $32,916 Revenues = $67,958 + $32,916 = $100,874 82) D

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Price-Earnings Ratio = Market price per share ÷ Earnings per share A common stock dividend increases the number of shares of stock outstanding. Because a greater number of shares represents the same ownership interest in the same amount of assets, the market value per share of a company’s stock normally declines as a result of a stock dividend. In addition, because a greater number of shares will be outstanding, the EPS will decline. Thus, the declines affect both the numerator and denominator. To determine how the declines affect the P/E ratio itself, additional information (i.e., the current market price and EPS, and the stock dividend percentage) would be required. 83) A A stock dividend is an equity exchange transaction. Stock dividends decrease retained earnings and increase common stock and paid-incapital in excess of par value. The income statement and statement of cash flows are not affected. 84) D A stock dividend is an equity exchange transaction. A stock dividend decreases retained earnings, increases common stock, and increases paid-in capital in excess of par value–common stock. There is no effect on total stockholders’ equity. 85) A A stock split has no effect on the dollar amounts of assets, liabilities, and stockholders’ equity. It only affects the number of shares of stock outstanding and the par value per share. A 2-for-1 stock split decreases the par value per share by one-half and replaces each existing share with two new shares. Because twice as many shares now represent the same ownership interest, the market value per share should be one-half as much as it was prior to the split. 86) B

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Number of shares issued = Outstanding shares of 45,000 × 5% = 2,250 Amount transferred = Number of shares issued × Market price of $26 per share = $58,500 87) A Number of shares issued = Outstanding shares of 55,000 × 5% = 2,750 Amount transferred = Number of shares issued × Market price of $22 per share = $60,500 88) C Number of shares issued in stock dividend = 40,000 Outstanding shares × 5% = 2,000 Number of shares outstanding after stock dividend = Shares outstanding before stock dividend of 40,000 + Shares issued in stock dividend of 2,000 = 42,000 89) A Number of shares issued in stock dividend = 55,000 Outstanding shares × 5% = 2,750 Number of shares outstanding after stock dividend = Shares outstanding before stock dividend of 55,000 + Shares issued in stock dividend of 2,750 = 57,750 90) D A stock split has no effect on the dollar amounts of assets, liabilities, and stockholders’ equity. It only affects the number of shares of stock outstanding and the par value per share. The balance of the common stock account before the stock split equals $12,000 (or 1,000 shares × Par value of $12 per share). The balance of the common stock account after the stock split also equals $12,000 (or 3,000 shares × $4 per share). 91) A

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A stock split has no effect on the dollar amounts of assets, liabilities, and stockholders’ equity. It only affects the number of shares of stock outstanding and the par value per share. The balance of the common stock account before the stock split equals $30,000 (or 5,000 shares × Par value of $6 per share). The balance of the common stock account after the stock split also equals $30,000 (or 10,000 shares × $3 per share). 92) D The appropriation shifts $36,000 from retained earnings to appropriated retained earnings. In other words, retained earnings decreases by $36,000 and appropriated retained earnings increases by $36,000. 93) B The company can pay a maximum dividend of $7,700,000, which is the amount of unrestricted retained earnings. 94) B The company can pay a maximum dividend of $600,000, which is the amount of unrestricted retained earnings. 95) C Number of shares issued = 20,000 Outstanding shares × Stock dividend of 7.5% = 1,500 Increase in Common stock = 1,500 Shares issued × Stated value of $10 per share = $15,000 Increase in Paid-in capital in excess of par value–common = 1,500 Shares issued × (Market value of $50 − Stated value of $10) = $60,000 Decrease in Retained earnings = 1,500 shares issued × Market value of $50 per share = $75,000 96) A

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Appropriating retained earnings has no impact on the financial statements, aside from shifting the $75,000 from retained earnings to appropriated retained earnings. Total stockholders’ equity does not change. 97) A Earnings per share = Net income ÷ Number of shares of common stock outstanding Earnings per share = $81,750 ÷ 109,000 shares = $0.75 Price-Earnings Ratio = Market price per share ÷ Earnings per share Price-Earnings Ratio = $45 ÷ $0.75 = 60 98) B Earnings per share = Net income ÷ Number of shares of common stock outstanding Earnings per share = $75,000 ÷ 100,000 shares = $0.75 Price-Earnings Ratio = Market price per share ÷ Earnings per share Price-Earnings Ratio = $18 ÷ $0.75 = 24 99) A The higher price-earnings ratio of Galax, Incorporated indicates that the investors are optimistic about the company’s future growth in revenues and profitability. 100) A Earnings per share = Net income ÷ Number of shares of common stock outstanding Earnings per share = $517,500 ÷ 575,000 shares = $.90 per share Price-Earnings Ratio = Market price per share ÷ Earnings per share Price-Earnings Ratio = $39 ÷ $.90 = 43.33 101) A

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Earnings per share = Net income ÷ Number of shares of common stock outstanding Earnings per share = $650,000 ÷ 500,000 shares = $1.30 per share Price-Earnings Ratio = Market price per share ÷ Earnings per share Price-Earnings Ratio = $22 ÷ $1.30 = 16.9 102) A After a public announcement like this, the market price of Burton’s stock is likely to increase immediately. While revenues are expected to increase by 20% over the next three years, this does not mean that cash flow from operations will increase by the same percentage. The announcement does not trigger any immediate recognition on the company’s financial statements. 103) D Companies with a history of paying dividends usually continue to pay dividends. Also, to pay dividends in the future, a company must have sufficient cash and retained earnings. 104) B Many investors will sell their stock if they fear that revenue and earnings growth in the future will not be as great as they have been in the past. (In other words, investors expect the stock price to fall when this happens.) Increases in a company’s stock price occur when investors believe the company’s earnings will grow. An increase in the market price of stock could be due to past or expected future performance of a company or due to general optimism about the economy in general. Increase in interest rates would not be a reason for the market price of the corporation to increase. 105) A Price-Earnings Ratio = Market price per share ÷ Earnings per share 106) B

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Creditors receive first priority in asset distribution during a business liquidation. Therefore, creditors would collect the $120,000 owed to them, leaving the shareholders with the remaining $80,000 ($70,000 common stock + $10,000 retained earnings). 107) C If a business ceases to operate, its remaining assets are sold and the sale proceeds are returned to the creditors and investors through a process called business liquidation. 108) A Negative retained earnings occurs when the company’s expenses have been greater than the provided resources, resulting in a loss of owners' equity. 109) A When expenses are greater than revenues there is a net loss. When revenues are greater than expenses there is net income.

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CHAPTER 12: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company issued 20,000 shares of common stock for $300,000 cash. Net Income Operating

Cash Flow Activities Investing

Financing

2) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company purchased land by issuing a note payable in the amount of $150,000. Net Income Operating

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Cash Flow Activities Investing

Financing

3) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. At the beginning of the current year, Howard Company paid cash to purchase equipment costing $80,000. There was $10,000 of depreciation expense recognized during the accounting period. (Show the combined effects of these two events.) Net Income Operating

Cash Flow Activities Investing

Financing

4) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company made a $25,000 cash payment on a term loan. The payment included a $23,000 reduction of principal as well as $2,000 of interest. (Show the combined effects of the events.) Net Income Operating

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Cash Flow Activities Investing

Financing

5) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company purchased $4,000 of supplies, paying $1,500 in cash and charging the remainder on account. $1,600 of the supplies were used during the accounting period. (Show the combined effects of the events.) Net Income Operating

Cash Flow Activities Investing

Financing

6) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company sold equipment with a book value of $20,000 for $17,000 cash. Net Income

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Cash Flow Activities

Operating

Investing

Financing

7) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company purchased land costing $25,000 by paying $8,000 cash and issuing a note payable for the remaining balance. Net Income Operating

Cash Flow Activities Investing

Financing

8) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. Howard Company declared and paid a $1.50 per share cash dividend on the 20,000 shares of its common stock.

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Net Income Operating

Cash Flow Activities Investing

Financing

9) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. On January 1 of the current year, Howard Company paid $10,000 to the Citizens Bank for accrued interest expense that had been accrued at the end of the previous year. Net Income Operating

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Cash Flow Activities Investing

Financing

10) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. On July 6, Year 1, Howard Company received an interest check relating to a note receivable. The interest revenue had not been previously accrued. Net Income Operating

Cash Flow Activities Investing

Financing

11) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. On September 10, Year 1, Howard Company received a check for $250 for dividends on Troxell Corporation stock that Howard holds as an investment. Show the effects of this transaction on Howard's income statement and statement of cash flows. Net Income Operating

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Cash Flow Activities Investing

Financing

12) Howard Company uses the direct method to prepare its operating activities section of the statement of cash flows. Indicate how each event affects net income and the three types of activities on the statement of cash flows. In the net income column, use the letter "I" to indicate increase, the letter "D" to indicate decrease, and the letters "NA" to indicate that the income statement is not affected. In the three cash flow columns, use the letter "I" to indicate cash inflow, the letter "D" to indicate cash outflow, and the letters "NA" to indicate that the cash flow statement is not affected. On December 31, Year 1, the Prepaid Insurance account decreased by $4,000 as a result of the recognition of insurance expense in an adjusting entry. Net Income Operating

Cash Flow Activities Investing

Financing

13) How does the direct method differ from the indirect method? How does the choice of methods impact the amount of net cash flow from operating activities?

14)

Give an example of a noncash financing and investing activity.

15) Which method of preparing the operating activities section of a cash flow statement is recommended by the Financial Accounting Standards Board?

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16) Which method do most companies use in preparing the operating activities section of the cash flow statement?

17)

What is the purpose of the statement of cash flows?

18) List the three categories of cash inflows and outflows shown on the statement of cash flows.

19) What is the major advantage of using the direct method of preparing the operating activities section of the statement of cash flows?

20) What is the major advantage of using the indirect method of preparing the operating activities section of the statement of cash flows?

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21)

How is depreciation expense reported on the statement of cash flows?

22) What are the two methods used to prepare the operating activities section of the statement of cash flows?

23) When the indirect method is used to prepare the operating activities section of the statement of cash flows, what is the starting point of that section?

24) When the indirect method is used to prepare the operating activities section of the statement of cash flows, are increases in current liabilities added or subtracted from net income to arrive at the net cash flow?

25) Can a company report net cash used in operating activities (that is, a negative cash flow amount) for the year even though it reports net income on its income statement? Explain.

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26) Describe how a noncash purchase of equipment would be reported in connection with the statement of cash flows.

27) How can the net cash flow from operating activities be greater than net income from operating activities?

28)

Why are financial analysts interested in the statement of cash flows?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 29) Indicate whether each of the following statements regarding the statement of cash flows (SCF) is true or false. 1.a) ________ Purchase of treasury stock would appear in the financing activities section of the SCF. 2.b) ________ Purchase of merchandise on account would appear in the operating activities section of the SCF. 3.c) ________ Payment of an account payable is an operating activity. 4.d) ________ Purchase of office supplies with cash would appear in the operating activities section of the SCF. 5.e) ________ Declarations of cash dividends would appear in the financing activities section of the SCF.

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30) Indicate whether each of the following statements regarding the statement of cash flows (SCF) is true or false. 1.a) ________ Purchase of merchandise inventory on account would appear in the operating activities section of the SCF. 2.b) ________ Sale of treasury stock would appear in the investing activities section of the SCF. 3.c) ________ Cash proceeds from the sale of a used truck would appear in the operating activities section of the SCF. 4.d) ________ Cash purchases of marketable securities would appear in the investing activities section of the SCF. 5.e) ________ Payment of salaries would appear in the operating activities section of the SCF.

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31) Marvel Company sold land that cost $440,000 for $470,000 cash. Indicate whether each of the following statements is true or false regarding Marvel's statement of cash flows (SCF). 1.a) ________ If Marvel uses the direct method, there would be a $30,000 cash inflow in the operating section of the SCF. 2.b) ________ If Marvel uses the indirect method to prepare the operating activities section of the statement of cash flows, the gain on the sale of the land would be added to net income in calculating the cash flows from operating activities. 3.c) ________ Marvel would report the event in the investing activities section of the SCF the same way whether it uses the direct method or the indirect method. 4.d) ________ Marvel would disclose the event as a noncash investing and financing activity. 5.e) ________ Marvel would report a $470,000 cash inflow in the investing section of the SCF.

32) Weymouth Company uses the indirect method to prepare the operating activities section of its statement of cash flows. Indicate whether each of the following statements is true or false. 1.a) ________ Depreciation expense would be subtracted from net income when determining the amount of cash flow from operating activities. 2.b) ________ Losses would be added to net income when determining the amount of cash flow from operating activities. 3.c) ________ Cash flow from investing activities would be reported the same as if the direct method were used. 4.d) ________ The amount of net cash flow from operating activities will be higher than it would be if the direct method were used. 5.e) ________ With the indirect method, a decrease in accounts receivable is added to net income in calculating the amount of cash flows from operating activities.

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33)

Indicate whether each of the following statements is true or false.

1.a) ________ It is possible for a growing business to have substantial earnings, but yet be short of cash. 2.b) ________ It is possible for a well-established business to report large operating losses, but have positive cash flow from operating activities. 3.c) ________ A merchandising firm adding new stores must report the additional inventory purchases as investing activities. 4.d) ________ When equipment is purchased to replace old equipment, the transaction is reported as an operating activity. 5.e) ________ FASB requires companies to disclose significant investing and financing activities even if these transactions do not affect cash.

34)

Consider each of the following activities.

Required: Identify whether each of the following activities will be reported in the operating activities, investing activities, or financing activities section of the statement of cash flows. Activity a) b)

Receipt of divendends from investments Issuance for common stock for cash

Repayment of loan principal

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Classification

Purchase of equipment of cash

Payment of cash divendend

Collection of accounts receivable

Proceed from sale of long term investment Payment of interest on loan

35) Baird Corporation had beginning Accounts Receivable of $254,000 and ending Accounts Receivable of $228,000. Assume total credit sales were $1,440,000. Required: 1.a) What amount of cash was collected from customers? 2.b) How would the information provided in this question be reported on the statement of cash flows using the: 3.1) Indirect method? 4.2) Direct method?

36) O'Hara Company uses the direct method to prepare the operating activities section of its statement of cash flows. The following information is available for Year 2. Inventory, January 1, Year 2 Inventory, December 31, Year 2 Cost of goods sold during Year 2

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$260,000 200,000 900,000

Accounts payable, January 1, Year 2 Accounts payable, December 31, Year 2

140,000 184,000

Required: 1.a) What amount of cash was paid for the purchase of merchandise? 2.b) Using only this information, prepare the operating activities section of the statement of cash flows.

37) At the beginning of Year 2, Griggs Company had a $64,000 of accounts receivable. During Year 2, Griggs earned revenue on account totaling $336,000. At the end of Year 2, the company had $44,000 of accounts receivable. Required: What was the amount of cash collected from accounts receivable during year 2?

38) Preston Corporation uses the indirect method to prepare the cash flow from operating activities section of the statement of cash flows. The company had the following beginning and ending balances for Year 2:

Equipment Accumulated depreciation

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January 1

December 31

$850,000 300,000

$900,000 280,000

During Year 2, Preston sold equipment for $60,000 that had originally been purchased for $140,000. The old equipment had accumulated depreciation of $120,000 at the time of sale. To replace the equipment, Preston purchased new equipment by making a $30,000 down payment and signing a two-year note for the balance due of $160,000. Required: 1.a) What was the cost of the new equipment purchased during the year? 2.b) What is the gain or loss on the sale of the old equipment? 3.c) How will the gain or loss be reported on the statement of cash flows? 4.d) How will the sale of the equipment be reported in the cash flow from investing activities section of the statement of cash flows? 5.e) How will the purchase of equipment be reported in the cash flow from investing activities section of the statement of cash flows? 6.f) How will the issuance of the two-year note be reported on the statement of cash flows?

39) Texas Corporation uses the indirect method to prepare the operating activities section of its statement of cash flows. The company's comparative balance sheet information was as follows: End of Year 2

End of Year 1

Cash Accounts receivable Inventory Prepaid insurance Property, plant & equipment Accumulated depreciation Total

$30,000 48,000 158,000 10,000 70,000 (14,000) $302,000

$28,000 50,000 156,000 8,000 60,000 (10,000) $292,000

Accounts payable Bonds payable Common stock Retained earnings

$14,000 90,000 140,000 58,000

$18,000 120,000 120,000 34,000

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Total

$302,000

$292,000

The company reported net income for Year 2 of $40,000. No property, plant & equipment was disposed of during the year. No additional bonds were issued during the year. Texas paid $16,000 in cash dividends during Year 2. Required: Prepare a statement of cash flows for Year 2.

40) The following data is supplied from the comparative balance sheets and income statement information from Moreno, Incorporated Net income for Year 2 was $40,000. No long-term assets were sold and no new notes were issued during Year 2. During Year 2, Moreno paid dividends of $24,000. Consider the information provided. End of Year 2

End of Year 1

Cash Accounts receivable Inventory Prepaid insurance Property, plant & equipment Accumulated depreciation Total

$ 88,000 48,000 56,000 32,000 88,000 (24,000) $288,000

$64,000 32,000 67,000 39,000 64,000 (19,000) $247,000

Accounts payable Salaries payable Long-term notes payable Common stock Retained earnings Total

$80,000 56,000 40,000 72,000 40,000 $288,000

$64,000 63,000 48,000 48,000 24,000 $247,000

Required: Prepare the operating activities section of Moreno's statement of cash flows using the indirect method.

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41) The following data is supplied from the comparative balance sheets and income statement information from Moreno, Incorporated Net income for Year 2 was $40,000. No long-term assets were sold and no new notes were issued during Year 2. During Year 2, Moreno paid dividends of $24,000. Consider the information provided. End of Year 2

End of Year 1

Cash Accounts receivable Inventory Prepaid insurance Property, plant & equipment Accumulated depreciation Total

$ 88,000 48,000 56,000 32,000 88,000 (24,000) $288,000

$64,000 32,000 67,000 39,000 64,000 (19,000) $247,000

Accounts payable Salaries payable Long-term notes payable Common stock Retained earnings Total

$80,000 56,000 40,000 72,000 40,000 $288,000

$64,000 63,000 48,000 48,000 24,000 $247,000

Required: Prepare the financing activities section of Moreno's statement of cash flows.

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42) Barry Company uses the indirect method to prepare the operating activities section of its statement of cash flows. Required: Indicate whether each of the following items would be added to net income, subtracted from net income, or not included in the operating activities section of the statement of cash flows. (Use the letter "A" for added to net income, use the letter "S" for subtracted from net income, or use the letter "N" for not listed in operating activities section.) Answer a) Decrease in prepaid insurance b) Increase in bonds payable c) Increase in common stock d) Increase in land e) Decrease in inventory f) Increase in unearned revenue g) Decrease in equipment h) Gain on sale of land i) Depreciation expenses j) Decrease in treasury stock k) Increase in interest payable l) Increase in prepaid rent m) Decrease in supplies n) Increase in long term notes payable o) Decrease in accounts payable

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43) Flores Corporation uses the indirect method to prepare the operating activities section of its statement of cash flows. The following is a partial list of the company's account balances: Title Land Accounts receivable Prepaid rent Prepaid insurance Equipment Accounts payable Utilities payable Cash Buildings Salaries payable Unearned revenue

End of Year 2 $ 65,900 10,000 1,400 2,800 14,500 1,400 800 7,200 112,000 2,200 900

End of Year 1 $ 2,400 10,400 2,050 900 12,000 1,800 500 8,000 94,000 2,900 800

Additional information: Net income for Year 2 was $36,900, depreciation expense was $26,700, and equipment with a book value of $20,000 was sold for $18,000 cash. Required: Prepare the operating activities section of the statement of cash flows for Year 2. (Note that a heading is not required.)

44) Garrity, Incorporated uses the perpetual inventory method. During the year, Garrity purchased $34,500 of inventory on account under the terms 2/10, net 30. After receipt of the merchandise, Garrity discovered some of the merchandise was defective and returned $6,000 of merchandise. Garrity River paid the total liability for the merchandise retained within the discount period. All merchandise was finally sold for $39,000 cash. Required: What is the net cash flow from operating activities resulting from the above transactions?

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45)

Manhattan Corporation provided the following partial list of account balances for Year 2: Account Title

Land Equipment Investment in marketable securities

Beginning Balance $ 48,000 36,800 200,000

Ending Balance $ 100,000 44,000 180,000

The following additional information is also available for Year 2: ● The company recognized a gain of $8,000 on sale of land that occurred when land that had cost $16,000 was sold for $24,000. ● The company recognized a loss of $10,000 on the sale of marketable securities. ● No additional marketable securities were purchased during the year. ● The company also sold equipment originally costing $6,000 with accumulated depreciation of $4,000 for $3,600. ● All purchases of land and equipment were made with cash. Required: Prepare the investing activities section of the statement of cash flows.

46) Clarion Corporation provided the provided the following partial list of account balances for Year 2: Account Title Mortgages payable Common stock

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Beginning Balance $ 100,000 78,000

Ending Balance $70,000 90,000

Paid-in capital in excess of par value Dividends payable Retained earnings

85,000 4,000 $ 290,000

190,000 2,500 370,000

Net income was $100,000 for Year 2. Required: Prepare the financing activities section of the statement of cash flows.

47) Burgess Company uses the direct method to prepare the operating activities section of its statement of cash flows. The company provided the following partial list of account balances for Year 2: Account Title Accounts receivable Inventory Prepaid insurance Interest receivable Accounts payable Salaries payable

Beginning Balance Ending Balance $ 40,000 $ 38,000 32,000 36,000 200 140 1,600 600 2,500 4,200 4,000 3,600

The company also provided the following information relating to Year 2: Sales (all on account) Interest income Cost of goods sold Salaries expense Insurance expense

$ 280,000 10,000 160,000 24,000 2,200

Required: Prepare the cash flows from operating activities section of the company's statement of cash flows.

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Answer Key Test name: Chap 12_2e_Problem Materials 1) (NA) (NA) (NA) (I) Issuing common stock for cash does not affect net income. The cash inflow is reported in the financing activities section of the statement of cash flows 2) (NA) (NA) (NA) (NA) Purchasing land by issuing a note does not affect net income. It is reported in the schedule of noncash investing and financing activities, but not on the statement of cash flows itself. 3) (D) (NA) (D) (NA) The purchase of equipment for cash is reported as a cash outflow in the investing activities section of the statement of cash flows. Depreciation expense decreases net income, but this noncash expense does not impact cash flows. 4) (D) (D) (NA) (D) A cash payment for interest expense decreases net income. It is reported as a cash outflow in the operating activities section of the statement of cash flows. The cash paid to reduce the principal on a term loan is reported as a cash outflow in the financing activities section of the statement of cash flows. 5) (D) (D) (NA) (NA) The $1,500 paid for the supplies purchase is a cash outflow in the operating activities section of the statement of cash flows. The $1,600 supplies expense for the supplies used reduces net income.

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6) (D) (NA) (I) (NA) Loss on sale = Proceeds of $17,000 − Book value of $20,000 = $3,000 The $17,000 cash received from the sale of equipment is reported as a cash inflow in the investing activities section of the statement of cash flows. The $3,000 loss on the sale reduces net income but does not affect cash flows for operating activities. 7) (NA) (NA) (D) (NA) The $8,000 paid for the land is reported as a cash outflow in the investing activities section of the statement of cash flows. The issuance of the note for $17,000 (or Purchase price of $25,000 − Cash paid of $8,000) is a noncash investing and financing activity, which is reported in the schedule of noncash investing and financing activities. 8) (NA) (NA) (NA) (D) Cash dividends are reported as a cash outflow in the financing activities section of the statement of cash flows. 9) (NA) (D) (NA) (NA) Cash paid for interest is a cash outflow reported in the operating activities section of the statement of cash flows. Because the interest had already been accrued (that is, it was expensed in the previous year), it does not affect net income in the current year. 10) (I) (I) (NA) (NA) Cash flows reported as operating activities include cash receipts from revenues, including interest revenue. The receipt of the interest check increases net income and is reported as a cash inflow in the operating activities section of the statement of cash flows.

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11) (I) (I) (NA) (NA) Cash flows reported as operating activities include cash receipts from revenues, including dividend revenue. The receipt of dividends on an investment increases net income and is reported as a cash inflow in the operating activities section of the statement of cash flows. 12) (D) (NA) (NA) (NA) Insurance expense decreases net income but does not affect cash flows. There was no cash payment to purchase insurance and thus there is no cash outflow reported in the operating activities section of the statement of cash flows. 13) The direct method shows the specific sources and uses of cash that are associated with operating activities. It does not show adjustments to net income. The amount of net cash flow from operating activities is the same whether it is presented using the indirect or the direct method. 14) Examples include but are not limited to the following: acquiring a long-term asset in exchange for common stock and acquiring land by issuing a mortgage note payable. 15) Direct method Because people typically find the direct method easier to understand, the Financial Accounting Standards Board (FASB) recommends it. 16) Indirect method Most companies use the indirect method because it is easier to prepare. 17) The statement of cash flows provides information about cash coming into and going out of a business during an accounting period. 18) Operating, investing, and financing

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19) The direct method shows the specific sources and uses of cash that are associated with operating activities. Because people typically find the direct method easier to understand, the Financial Accounting Standards Board (FASB) recommends it. 20) It is easier to prepare the operating activities section of the statement of cash flows using the indirect method. 21) Depreciation expense is not included on the statement of cash flows when using the direct method. Because noncash expenses are deducted in determining net income, they must be added to net income when computing net cash flow from operating activities using the indirect method. The calculation of accrual-based net income frequently includes noncash expenses such as depreciation expense. 22) The direct method and the indirect method. 23) The indirect method begins with the amount of net income as reported on the income statement. 24) Increases in current liabilities are added to net income to determine the cash flow from operating activities. 25) Yes. The timing of recognition of revenues and expenses does not correspond exactly with the receipt and payment of cash. Thus, it is possible to have a negative cash flow and a positive net income or viceversa. 26) Noncash investing and financing activities, such as a noncash purchase of equipment, are reported on the schedule of noncash investing and financing activities that accompanies the statement of cash flows.

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27) The accrual-based net income figure must be converted to a cashbasis equivalent to arrive at net cash flow from operating activities. Noncash expenses, such as depreciation and losses on sales of long-term assets, reduce net income but are added back to convert net income to net cash flow from operating activities. Most of the other differences between revenue and expense recognition and cash flows are related to changes in the balances of the noncash current assets and current liabilities. 28) Understanding the cash flows of a business is essential because cash is used to pay the bills. A company, especially one experiencing rapid growth, can be short of cash despite earning substantial net income. A business cannot survive without managing cash flow carefully. 29) a) T b) F c) T d) T e) F 1.a) This is true. The purchase of treasury stock is a financing activity. 2.b) This is false. The purchase of merchandise on account would not be reported on the statement of cash flows. 3.c) This is true. A payment on an account payable is an operating activity. 4.d) This is true. The purchase of office supplies with cash is an operating activity. 5.e) This is false. Cash flows reported as financing activities include cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. Declarations of dividends are not reported on the statement of cash flows.

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30) a) F b) F c) F d) T e) T 1.a) This is false. The purchase of merchandise inventory on account does not involve cash. 2.b) This is false. The sale of treasury stock is a financing activity. 3.c) This is false. Proceeds from the sale of a truck are recorded as an investing activity. 4.d) This is true. Cash flows reported as investing activities include cash payments (outflows) for purchasing property, plant, equipment, or marketable securities, as well as for making loans to borrowers. 5.e) This is true. Cash flows reported as operating activities include cash payments for expenses, including salaries expense. 31) a) F b) F c) T d) F e) T 1.a) This is false. The proceeds from the sale are not reported as a cash flow from operating activities. Cash flows reported as investing activities include cash receipts (inflows) from selling property, plant, and equipment. 2.b) This is false. Using the indirect method, the gain is subtracted from net income to arrive at cash provided by operating activities. 3.c) This is true. Under generally accepted accounting principles, the operating activities section of the statement of cash flows can be presented using either the direct or the indirect method. The investing activities section is not affected by the choice of direct or indirect method. 4.d) This is false. Because cash is received, this event is not an example of noncash investing and financing activities. 5.e) This is true. The cash received is a cash inflow from investing activities.

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32) a) F b) T c) T d) F e) T 1.a) This is false. Depreciation expense is a noncash expense. Because noncash expenses are deducted in determining net income, they must be added to net income when computing net cash flow from operating activities using the indirect method. 2.b) This is true. Because losses are deducted in determining net income, they must be added to net income when computing net cash flow from operating activities using the indirect method. 3.c) This is true. The direct and indirect methods only differ in their presentation of operating activities. 4.d) This is false. Net cash flow is the same whether the direct or the indirect method is used. 5.e) This is true. A decrease in a noncash current asset, such as accounts receivable, is added to net income. 33) a) T b) T c) F d) F e) T 1.a) This is true. A company, especially one experiencing rapid growth, can be short of cash in spite of earning substantial net income. 2.b) This is true. This could result when accrual-based revenues and expenses are converted to their cash flow equivalents. 3.c) This is false. Cash purchases of inventory are operating activities. 4.d) This is false. Cash flows reported as investing activities include cash payments (outflows) from purchasing property, plant, equipment. 5.e) This is true. Noncash investing and financing activities are disclosed in a schedule. 34) Activity

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Classification

a) b) c) d) e) f) g) h)

Receipt of divendends from investments Issuance for common stock for cash Repayment of loan principal Purchase of equipment of cash Payment of cash divendend Collection of accounts receivable Proceed from sale of long term investment Payment of interest on loan

Operating Financing Financing Investing Financing Operating Investing Operating

35) 1.a) $1,466,000 Decrease in accounts receivable = Beginning balance of accounts receivable of $254,000 − Ending balance of accounts receivable of $228,000 = $26,000 Cash collected from customers = Sales of $1,440,000 + Decrease in accounts receivable of $26,000 = $1,466,000 1.b) 2.(1) The $26,000 decrease in accounts receivable would be added to net income in the operating activities section. 3.(2) A cash inflow from customers of $1,466,000 would be reported as a cash inflow from operating activities. 36) 1.a) $836,000 Inventory sold Less: Decrease in inventory Total merchandise purchased Less: Increase in accounts payable Total cash paid for merchandise

$900,000 (60,000) 80,000 (44,000) $796,000

1.b) Cash flow from operating activities Cash payment for inventory

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$796,000

37) $356,000 Ending balance of accounts receivable of $44,000 = Beginning balance of accounts receivable of $64,000 + Sales on account of $336,000 − Cash collected from customers (the unknown) Cash collected from customers = $44,000 + $336,000 − $44,000 = $356,000 38) 1.a) $190,000 Ending equipment account balance of $900,000 = Beginning equipment account balance of $850,000 + Cost of new equipment purchased (the unknown) − Cost of new equipment sold of $140,000 Cost of new equipment purchased = $900,000 − $850,000 + $140,000 = $190,000 1.b) Gain of $40,000 Book value of equipment sold = Cost of $140,000 − Accumulated depreciation of $120,000 = $20,000 Gain on sale = Selling price of $60,000 − Book value of $20,000 = $40,000 1.c) The gain of $40,000 will be subtracted from net income to compute cash flow from operating activities. 2.d) The $60,000 proceeds from the sale will be reported as a cash inflow in the investing activities section. 3.e) The $30,000 down payment for new equipment will be reported as a cash outflow in the investing activities section. 4.f) The issuance of the two-year note in the amount of $160,000 will be reported in the schedule of noncash investing and financing activities. 39) Texas Corporation

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Statement of Cash Flow For the Year Ended December 31, Year 2 Cash Flows from Operating Activities Net income

$40,000

Adjustments to reconcile net income to net cash flow from operating activities: Depreciation expense

$4,000

Decrease in accounts receivable

2,000

Increase in inventory

(2,000)

Increase in prepaid insurance

(2,000)

Decrease in accounts payable Cash inflows from operating activities

(4,000)

(2,000) 38,000

Cash Flows from Investing Activities Cash outflow to purchase property, plant & equipment Cash Flows from Financing Activities Cash inflow from issuing common stock

(10,000)

20,000

Cash outflow for payment of bonds payable

(30,000)

Cash outflow for payment of dividends

(16,000)

Net cash outflow for financing activities Net increase in cash

2,000

Beginning cash balance

28,000

Ending cash balance

$30,000

40) Cash Flows from Operating Activities Net income

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$40,000

Adjustments to reconcile net income to net cash flow from operating activities: Depreciation expense Increase in accounts receivable

$5,000 (16,000)

Decrease in inventory

11,000

Decrease in prepaid insurance

7,000

Increase in accounts payable

16,000

Decrease in salaries payable Cash inflows from operating activities

(7,000)

16,000 56,000

41) Cash Flows from Financing Activities Cash inflow from issuing common stock Cash outflow for payment of long-term notes payable Cash outflow for payment of dividends Net cash outflow for financing activities

$24,000 (8,000) (24,000) $(8,000)

42) Answer a) Decrease in prepaid insurance b) Increase in bonds payable c) Increase in common stock d) Increase in land e) Decrease in inventory f) Increase in unearned revenue g) Decrease in equipment h) Gain on sale of land i) Depreciation expenses j) Decrease in treasury stock k) Increase in interest payable l) Increase in prepaid rent m) Decrease in supplies n) Increase in long term notes payable o) Decrease in accounts payable

A N N N A A N S A N A S A N S

43) Version 1

Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flow from operating activities: Depreciation expense

$ 36,900

$ 26,700

Decrease in accounts receivable

400

Decrease in prepaid rent

650

Increase in prepaid insurance

(1,900)

Decrease in accounts payable

(400)

Increase in utilities payable

300

Decrease in salaries payable

(700)

Increase in unearned revenue

100

Loss on sale of equipment Cash inflows from operating activities

2,000

27,150 $ 64,050

44) $11,070 Inventory purchased on account Less: Returns Less: Discount Payment for inventory Inflow from sale of inventory Outflow for purchase of inventory Net cash flow

$ 34,500 (6,000) (570) $ 27,930 $ 39,000 (27,930) $ 11,070

45) Cash Flows from Investing Activities Cash inflows from sale of marketable securities Cash inflows from sale of land Cash inflows from sale of equipment Cash outflow for purchase of land Cash outflow for purchase of equipment Net cash outflow for investing activities

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$ 10,000 24,000 3,600 (68,000) (13,200) $ (43,600)

Cash inflow from sale of marketable securities = Cost of securities of $20,000 − Loss on sale of securities of $10,000 = $10,000 Beginning balance in land

$ 48,000

Increase due to purchase of land Decrease due to sale of land

? (16,000)

Ending balance in land

$ 100,000

Beginning balance in equipment

$ 36,800

Increase due to purchase of equipment Decrease due to sale of equipment

? (6,000)

Ending balance in equipment

$ 44,000

Beginning balance in marketable securities

$ 200,000

Increase due to purchase of marketable securities Decrease due to sale of marketable securities Ending balance in marketable securities

= 68,000

= 13,200

− ?

= (20,000)

$ 180,000

46) Cash Flows from Financing Activities Cash inflow from issue of common stock Cash outflow for repayment of mortgage Cash outflow for payment of dividends Net cash inflow from financing activities

$ 117,000 (30,000) (21,500) $ 65,500

Beginning balance in retained earnings

$ 290,000

Net income Dividends declared Ending balance in retained earnings Beginning balance in dividends payable

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100,000 ? $ 370,000

= (20,000)

$ 4,000

Dividends declared

20,000

Dividends paid Ending balance in dividends payable

? $ 2,500

= (21,500)

47) Burgess Company Cash Flows from Operating Activities For the Year Ended December 31, Year 2 Cash receipts from: Sales Interest

$ 282,000 11,000

Total cash inflows

$ 293,000

Cash payments for: Inventory purchases

$ (162,300)

Salaries

(24,400)

Insurance

(2,140)

Total cash outflows

(188,840)

Net cash flow from operating activities

$ 104,160

Beginning balance in accounts receivable

$ 40,000

Sales on account

280,000

Cash collected from customers Ending balance in accounts receivable

? $ 38,000

Beginning balance in interest receivable

$ 1,600

Interest income

10,000

Cash received from interest Ending balance in interest receivable

? $ 600

Beginning balance in inventory

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= (282,000)

= (11,000)

$ 32,000

Purchases of inventory Cost of goods sold

? (160,000)

Ending balance in inventory

$ 36,000

Beginning balance in accounts payable

$ 2,500

Purchases of inventory

164,000

Payments to creditors Cost of goods sold

? (160,000)

Ending balance in accounts payable

$ 36,000

Beginning balance in salaries payable

$ 4,000

Salaries expense

24,000

Cash paid for salaries Ending balance in salaries payable

? $ 3,600

Beginning balance in prepaid insurance Payments for insurance Insurance expense Ending balance in prepaid insurance

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= 164,000

= (24,400)

$ 200 ? (2,200)

= 2,140

$ 140

CHAPTER 12 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) On the statement of cash flows, cash receipts from interest and dividends are classified as investing activities. ⊚ true ⊚ false

2) If a company sells equipment at a loss, the loss from selling the equipment is reported in the investing activities section of the statement of cash flows. ⊚ true ⊚ false

3) Investing activities on the statement of cash flows always involve long-term assets, including marketable securities. ⊚ true ⊚ false

4) A cash payment to purchase treasury stock is reported on the statement of cash flows as a financing activity. ⊚ true ⊚ false

5) Companies report significant noncash investing and financing activities on a schedule that accompanies the statement of cash flows. ⊚ true ⊚ false

6) The three main sections of the statement of cash flows are, in order, operating activities, investing activities, and financing activities. ⊚ true ⊚ false

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7) The final or bottom line on the statement of cash flows is the net increase or decrease in cash for the period. ⊚ true ⊚ false

8) The amount of revenue a company recognizes on the income statement normally differs from the amount of cash collected from customers. ⊚ true ⊚ false

9) Goodloe Corporation's credit sales for Year 1 were $500,000, and the balance in its accounts receivable increased by $26,000 during the year. In Year 1, Goodloe collected $526,000 in cash from its customers. ⊚ true ⊚ false

10) Mayes Corporation reported utilities expense of $18,200 on its income statement for Year 1. For the year, the beginning balance in Utilities Payable was $2,500 and the ending balance was $1,500. The amount of cash that Mayes paid for utilities in Year 1 was $19,200. ⊚ true ⊚ false

11) Jones Company requires prepayment from all customers. Jones Company reported revenue of $258,000 on its Year 1 income statement. The balance in its Unearned Revenue account was $12,000 at the start of Year 1 and $4,000 at the end of the year. Based on this information alone, the amount of cash that Jones collected from customers for Year 1 was $250,000. ⊚ true ⊚ false

12) The direct method of preparing the operating activities section of the statement of cash flows is preferred by the Financial Accounting Standards Board. ⊚ true ⊚ false

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13) The indirect method for preparing the operating activities section of the statement of cash flows begins with the amount of sales revenue reported on the income statement. ⊚ true ⊚ false

14) In preparing the statement of cash flows by the indirect method, increases in noncash current assets are subtracted from net income. ⊚ true ⊚ false

15) In preparing the operating activities section of the statement of cash flows by the indirect method, decreases in noncash current liabilities are added to net income. ⊚ true ⊚ false

16) In preparing the operating activities section of the statement of cash flows by the indirect method, gains are added to net income. ⊚ true ⊚ false

17) A company experiencing rapid growth can be short of cash despite earning substantial net income. ⊚ true ⊚ false

18)

Rapid growth of a company can cause it to be short of cash. ⊚ true ⊚ false

19) TheFASB requires that companies report cash flow per share in their audited financial statements.

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⊚ ⊚

true false

20) Cash flow from operating activities can be more stable from year to year than the amount of operating income. ⊚ true ⊚ false

21) The investing activities section of the statement of cash flows distinguishes between acquisitions of long-term assets that expand operating capacity and those that replace old, wornout assets. ⊚ true ⊚ false

22) The direct method of preparing the operating activities section of the statement of cash flows shows increases and decreases in noncash current assets and current liabilities to arrive at cash flows from operating activities. ⊚ true ⊚ false

23) When the direct method is used to prepare the operating activities section of the statement of cash flows, cash inflows from customers and cash outflows for depreciation are among the categories of cash flows likely to be reported. ⊚ true ⊚ false

24) The amount of increase in accounts receivable is added to credit sales to calculate the amount of cash inflow from customers when using the direct method to prepare the operating activities section of the statement of cash flows. ⊚ true ⊚ false

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 25) How are interest expense and interest paid reported? A) Interest expense is reported as an operating item on the income statement and interest paid is reported as an investing activity on the statement of cash flows. B) Interest paid is reported as an operating activity on the statement of cash flows and interest expense is reported as a nonoperating expense on the income statement. C) Interest expense is reported as an operating expense on the income statement and interest paid is reported as a financing activity on the statement of cash flows. D) Interest paid is reported as a financing activity on the statement of cash flows and interest expense is reported as an operating item on the income statement.

26) How are cash receipts from interest on a note receivable classified on a statement of cash flows prepared using the direct method? A) Operating activity B) Investing activity C) Financing activity D) Noncash financing and investing activity

27)

How is the cash paid to purchase land reported in the statement of cash flows? A) Cash outflow from financing activities B) Schedule of noncash investing and financing activities C) Cash outflow from investing activities D) Cash inflow from operating activities

28) Valdez Company sold land that had cost $48,000 for $60,000 cash.Which of the following statements is true about this transaction?

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A) The $12,000 gain would be subtracted from net income in the operating activities section using the direct method. B) $48,000 would appear as a cash inflow from investing activities and $12,000 would be added in the operating activities section using the indirect method. C) $60,000 would appear as a cash inflow from investing activities. D) The $12,000 gain would be subtracted from net income in the operating activities section prepared using the indirect method and $60,000 would be reported as a cash inflow from investing activities.

29) On August 1, Year 1, Jackson Company issued a one-year $48,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end.

What is the cash flow from financing activities that will be reported during the year ending December 31, Year 1? A) $0 B) $48,000 inflow C) $49,800 inflow D) ($52,320) outflow

30) On August 1, Year 1, Jackson Company issued a one-year $80,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end. What is the cash flow from financing activities that will be reported during the year ending December 31, Year 1? A) $0 B) $80,000 inflow C) $83,000 inflow D) ($87,200) outflow

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31) On August 1, Year 1, Jackson Company issued a one-year $72,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end. What is the amount of interest expense and the cash outflow for interest during the year ending December 31, Year 1? (Do not round your intermediate calculations.) Interest Cash Outflow Expense $ 2,700 $ 2,700 $ 2,700 $ 0 $ 6,480 $ 0 $ 6,480 $ 6,480

A B C D

A) Option A B) Option B C) Option C D) Option D

32) On August 1, Year 1, Jackson Company issued a one-year $80,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end. What is the amount of interest expense and the cash outflow for interest during the year ending December 31, Year 1? Interest Expense $ 7,200 $ 7,200 $ 3,000 $ 3,000

A. B. C. D.

Cash Outflow $ 7,200 $ 0 $ 0 $ 3,000

A) Option A B) Option B C) Option C D) Option D

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33) On August 1, Year 1, Jackson Company issued a one-year $52,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end. What is the amount of interest expense and the total cash outflow related to the note during the year ending December 31, Year 2? (Do not round your intermediate calculations.) Interest Expense A B C D

$ 2,730 $ 4,680 $ 4,680 $ 1,950

Cash Outflow $ 56,680 $ 2,730 $ 52,000 $ 4,680

A) Option A B) Option B C) Option C D) Option D

34) On August 1, Year 1, Jackson Company issued a one-year $80,000 face value interestbearing note with a stated interest rate of 9% to Galaxy Bank. Jackson accrues interest expense on December 31, Year 1, its calendar year-end. What is the amount of interest expense and the total cash outflow related to the note during the year ending December 31, Year 2? Interest Expense $ 3,000 $ 7,200 $ 7,200 $ 4,200

A. B. C. D.

Cash Outflow $ 7,200 $ 80,000 $ 4,200 $ 87,200

A) Option A B) Option B C) Option C D) Option D

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35) During Year 1, El Paso Company had the following changes in account balances: ● The Accumulated Depreciation account had a beginning balance of $80,000 and an ending balance of $112,000. The increase was due to depreciation expense. ● The Long-Term Notes Payable account had a beginning balance of $128,000 and an ending balance of $66,000. The decrease was due to repayment of debt. ● The Equipment Account had a beginning balance of $110,000 and an ending balance of $299,000. The increase was due to the purchase of other operational assets. ● The Long-Term Investments Account (Marketable Securities) had a beginning balance of $79,200 and an ending balance of $55,000. The decrease was due to the sale of investments at cost. ● The Dividends Payable account had a beginning balance of $52,800 and an ending balance of $44,000. There were $88,000 of dividends declared during the period. ● The Interest Payable account had a beginning balance of $9,900 and an ending balance of $5,500. The difference was due to the payment of interest. What is the net cash flow from financing activities? A) $96,800 inflow B) $62,000 inflow C) $62,000 outflow D) $158,800 outflow

36) During Year 1, El Paso Company had the following changes in account balances: ● The Accumulated Depreciation account had a beginning balance of $25,000 and an ending balance of $35,000. The increase was due to depreciation expense. ● The Long-Term Notes Payable account had a beginning balance of $40,000 and an ending balance of $15,000. The decrease was due to repayment of debt. ● The Equipment Account had a beginning balance of $25,000 and an ending balance of $92,500. The increase was due to the purchase of other operational assets. ● The Long-Term Investments Account (Marketable Securities) had a beginning balance of $18,000 and an ending balance of $12,500. The decrease was due to the sale of investments at cost. ● The Dividends Payable account had a beginning balance of $12,000 and an ending balance of $10,000. There were $20,000 of dividends declared during the period. ● The Interest Payable account had a beginning balance of $2,250 and an ending balance of $1,250. The difference was due to the payment of interest. What is the net cash flow from financing activities?

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A) $22,000 inflow B) $25,000 inflow C) $25,000 outflow D) $47,000 outflow

37) During Year 1, El Paso Company had the following changes in account balances: ● The Accumulated Depreciation account had a beginning balance of $70,000 and an ending balance of $98,000. The increase was due to depreciation expense. ● The Long-Term Notes Payable account had a beginning balance of $112,000 and an ending balance of $54,000. The decrease was due to repayment of debt. ● The Equipment Account had a beginning balance of $90,000 and an ending balance of $261,000. The increase was due to the purchase of other operational assets. ● The Long-Term Investments Account (Marketable Securities) had a beginning balance of $64,800 and an ending balance of $45,000. The decrease was due to the sale of investments at cost. ● The Dividends Payable account had a beginning balance of $43,200 and an ending balance of $36,000. There were $72,000 of dividends declared during the period. ● The Interest Payable account had a beginning balance of $8,100 and an ending balance of $4,500. The difference was due to the payment of interest. What is the net cash flow from investing activities? A) $151,200 outflow B) $151,200 inflow C) $179,200 inflow D) $179,200 outflow

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38) During Year 1, El Paso Company had the following changes in account balances: ● The Accumulated Depreciation account had a beginning balance of $25,000 and an ending balance of $35,000. The increase was due to depreciation expense. ● The Long-Term Notes Payable account had a beginning balance of $40,000 and an ending balance of $15,000. The decrease was due to repayment of debt. ● The Equipment Account had a beginning balance of $25,000 and an ending balance of $92,500. The increase was due to the purchase of other operational assets. ● The Long-Term Investments Account (Marketable Securities) had a beginning balance of $18,000 and an ending balance of $12,500. The decrease was due to the sale of investments at cost. ● The Dividends Payable account had a beginning balance of $12,000 and an ending balance of $10,000. There were $20,000 of dividends declared during the period. ● The Interest Payable account had a beginning balance of $2,250 and an ending balance of $1,250. The difference was due to the payment of interest. What is the net cash flow from investing activities? A) $62,000 outflow B) $62,000 inflow C) $67,500 outflow D) $73,000 outflow

39) Assuming a transaction increases interest receivable and interest revenue, what effect does it have on the amount of cash generated by operating activities? A) Decreases it B) Increases it C) Has no effect D) Cannot be determined from the information given

40) How would the issuance of a mortgage note in exchange for a building be reported on the statement of cash flows? A) Financing activity B) Investing activity C) Operating activity D) Noncash financing and investing activity

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41)

Which of the following would not be a cash flow from financing activities? A) Borrowing on a long-term note payable B) Repayment of principal on bonds payable C) Payment of interest on bonds payable D) Payment of a cash dividend

42)

Which of the following items appear on the statement of cash flows?

A) Beginning cash balance B) Ending cash balance C) An explanation of the activities that caused the change between the beginning and ending balances in the cash account D) All of the choices are items that appear on the statement of cash flows

43)

Which of the following is not a section of the statement of cash flows? A) Operating activities B) Purchasing activities C) Financing activities D) Investing activities

44) When using the indirect method, which of the following items should be added to the amount of net income when determining the amount of net cash flow from operating activities? A) The amount of an increase in the balance of a Land account B) The amount of a decrease in the balance of a Prepaid Rent account C) The amount of an increase in the balance of the Accounts Receivable account D) The amount of a decrease in the balance of the Other Operating Expenses Payable account

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45) Shamoo Incorporated presents its statement of cash flows using the indirect method. The following accounts and corresponding balances were drawn from the company’s year-end balance sheets: Account Title Accounts receivable Accounts payable

Year 2 $ 23,000 15,000

Year 1 $ 19,000 9,000

The Year 2 income statement showed net income of $50,000. Based on this information, the amount of the cash flow from operating activities shown on the Year 2 statement of cash flows is A) $46,000. B) $48,000. C) $50,000. D) $52,000.

46) The Club, Incorporated (TCI) presents its statement of cash flows using the indirect method. For the current year the Company reported net income of $120,000. All sales are on account and the balance in the Accounts Receivable account increased by $7,000. The balance in the unearned revenue account decreased by $6,000. Also, the company reported depreciation expense of $15,000 and a gain on the sale of equipment of $8,000. Based on this information alone, the amount of the cash flow from operating activities shown on statement of cash flows is A) $114,000 B) $126,000 C) $128,000 D) $130,000

47)

What effect does depreciation expense have on net income and cash flows?

A. B. C. D.

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Net Income

Cash Flows

Decrease Decrease Decrease Increase

Increase None Decrease Increase

A) Option A B) Option B C) Option C D) Option D

48) On January 1, Year 1, Chisolm Company purchased equipment for $36,000 cash. On December 31, Year 1, depreciation of $9,000 was recorded. Which of the following correctly shows the combined effect of these two events on the income statement and statement of cash flows? Chisolm uses the direct method. Net Income A. B. C. D.

(45,000) (9,000) (9,000) (9,000)

Operating (45,000) NA (9,000) 9,000

Cash Flows Investing NA (36,000) (27,000) (27,000)

Financing NA NA NA NA

A) Option A B) Option B C) Option C D) Option D

49) On January 1, Year 1, Mayer Corporation signed a contract to perform $25,000 worth of services for Phips Company over the next three years. Which of the following indicates the effects of this event on the Year 1 income statement and statement of cash flows of Mayer Corporation? Net Income A. B. C. D.

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NA 25,000 25,000 NA

Operating NA NA 25,000 NA

Cash Flows Investing NA 25,000 NA NA

Financing 25,000 NA NA NA

A) Option A B) Option B C) Option C D) Option D

50) On September 1, Year 1, Laredo Company purchased equipment making a down payment of $15,500 cash and signing a one-year note payable on the $22,500 balance. The note carried an interest rate of 6%, and all interest was to be paid on the maturity date. Which of the following correctly shows the combined effect of the purchase as well as the accrual of interest on December 31, Year 1? Net Income A. B. C. D.

(450) NA (450) (450)

Operating NA (450) NA (450)

Cash Flows Investing (15,500) NA (15,500) (15,500)

Financing NA 22,500 22,500 NA

A) Option A B) Option B C) Option C D) Option D

51) Which of the following items would be classified as a cash flow from investing activities? 1.1) Issue common stock for cash 2.2) Payment on principal of note payable 3.3) Payment of dividends 4.4) Sale of equipment for cash

A) 1 and 4 B) 4 only C) 3 only D) 1, 2, 3, and 4

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52) What is the name given to the sum of the subtotals of the three sections (operating activities, investing activities, and financing activities) of the statement of cash flows? A) Net income for the period B) Net change in cash C) The ending cash balance D) The amount of cash inflow for the period

53)

Which of the following transactions affects cash flows? A) Accrual of interest receivable B) Issuance of a stock dividend C) Recognition of depreciation expense D) Payment of dividends declared in a previous year

54) Which of the following is the correct sequence of the three sections that are presented on the statement of cash flows? A) Operating, Investing, Financing B) Investing, Operating, Financing C) Operating, Financing, Investing D) Financing, Investing, Operating

55) During Year 1, Mallard Company earned $165,000 of sales revenue on account and accrued $122,500 of operating expenses. The company also earned $26,400 of service revenue that had previously been recorded as unearned revenue. In addition, a $2,200 stock dividend was issued to the stockholders. What can be said about cash flows considering these transactions? A) Cash outflows from financing activities are $2,200. B) Cash inflows from operating activities are $68,900. C) Cash inflows from operating activities are $42,500. D) There are no cash inflows or outflows as a result of these activities.

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56) The financial statements of Gregg Company reported wages expense of $372,000 during Year 2, wages payable of $52,800 at the beginning of Year 2, and wages payable of $72,600 at the end of Year 2. What amount of cash was paid for wages during Year 2? A) $424,800 B) $372,000 C) $319,200 D) $352,200

57) The financial statements of Gregg Company reported wages expense of $160,000 during Year 2, wages payable of $16,000 at the beginning of Year 2, and wages payable of $22,000 at the end of Year 2. What amount of cash was paid for wages during Year 2? A) $176,000 B) $160,000 C) $154,000 D) $144,000

58) Phillips Company reported total credit sales of $236,600 for Year 2. Its accounts receivable totaled $37,100 and $53,600 at the beginning and end of the year, respectively. What was the cash collected from customers during Year 2? A) $273,700 B) $253,100 C) $236,600 D) $220,100

59) PhillipsCompany reported total credit sales of $460,000 for Year 2. Its accounts receivable totaled $70,000 and $100,000 at the beginning and end of the year, respectively. What was the cash collected from customers during Year 2? A) $530,000 B) $460,000 C) $490,000 D) $430,000

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60) Ervin Company began the accounting period with $55,500 in accounts receivable. The ending balance in accounts receivable was $20,600. If the credit sales during the period were $100,000, what is the amount of cash received from customers? A) $55,500 B) $100,000 C) $134,900 D) $176,100

61) Ervin Company began the accounting period with $64,000 in accounts receivable. The ending balance in accounts receivable was $40,000. If the credit sales during the period were $588,000, what is the amount of cash received from customers? A) $564,000 B) $612,000 C) $24,000 D) $548,000

62)

Which of the following transactions is a use of cash? A) Short-term borrowing of cash B) Acquisition of land by issuing a short-term note payable C) Issuance of a stock dividend D) Purchase of treasury stock

63) Erie Company reports the following comparative balance sheets and income statement information for the current year. All revenues are from credit sales. Comparative Balance Sheets Beginning of Year

End of Year

$ 101,000 45,000

$ 61,000 29,000

Assets Cash Accounts receivable

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Prepaid insurance Inventory Property, plant & equipment Total Assets

45,000 21,000 53,000

53,000 37,000 61,000

$ 265,000

$ 241,000

$ 61,000 29,000 37,000 33,000 105,000

$ 45,000 53,000 45,000 33,000 65,000

$ 265,000

$ 241,000

Liabilities and Stockholder’s Equity Accounts payable Salaries payable Long-term notes payable Common stock Retained earnings Total Liabilities and Stockholders’ Equity Income Statement Revenue Cost of goods sold Gross margin Operating expenses

$ 345,000 (173,000) 172,000 (93,000)

Net income

$ 79,000

What was the cash received from customers during the year? A) $300,000 B) $316,000 C) $345,000 D) $361,000

64) Erie Company reports the following comparative balance sheets and income statement information for the current year. All revenues are from credit sales. Comparative Balance Sheets Beginning of Year

End of Year

$ 88,000 32,000 32,000 8,000

$ 48,000 16,000 40,000 24,000

Assets Cash Accounts receivable Prepaid insurance Inventory

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Property, plant & equipment Total Assets

40,000

48,000

$ 200,000

$ 176,000

$ 48,000 16,000 24,000 20,000 92,000

$ 32,000 40,000 32,000 20,000 52,000

$ 200,000

$ 176,000

$ 280,000 (160,000) 120,000

Operating expenses

(80,000)

Net income

$ 40,000

What was the cash received from customers during the year? A) $296,000 B) $264,000 C) $280,000 D) $248,000

65) Erie Company reports the following comparative balance sheets and income statement information for the current year. Comparative Balance Sheets Beginning of Year

End of Year

Assets Cash Accounts receivable Prepaid insurance Inventory Property, plant & equipment Total Assets

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$ 89,000 33,000 33,000 9,000 41,000

$ 49,000 17,000 41,000 25,000 49,000

$ 205,000

$ 181,000

Liabilities and Stockholder’s Equity Accounts payable Salaries payable Long-term notes payable Common stock Retained earnings Total Liabilities and Stockholders’ Equity

$ 49,000 17,000 25,000 21,000 93,000

$ 33,000 41,000 33,000 21,000 53,000

$ 205,000

$ 181,000

Income Statement Revenue Cost of goods sold Gross margin Operating expenses

$ 285,000 (161,000) 124,000 (81,000)

Net income

$ 43,000

Assuming accounts payable is used for inventory purchases only, what was the amount of cash paid for inventory purchases during the year? A) $161,000 B) $33,000 C) $193,000 D) $177,000

66) Erie Company reports the following comparative balance sheets and income statement information for the current year. Comparative Balance Sheets Beginning of Year

End of Year

Assets Cash Accounts receivable Prepaid insurance Inventory Property, plant & equipment Total Assets

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$ 88,000 32,000 32,000 8,000 40,000

$ 48,000 16,000 40,000 24,000 48,000

$ 200,000

$ 176,000

Liabilities and Stockholder’s Equity Accounts payable Salaries payable Long-term notes payable Common stock Retained earnings Total Liabilities and Stockholders’ Equity

$ 48,000 16,000 24,000 20,000 92,000

$ 32,000 40,000 32,000 20,000 52,000

$ 200,000

$ 176,000

Income Statement Revenue Cost of goods sold Gross margin Operating expenses Net income

$ 280,000 (160,000) 120,000 (80,000) $ 40,000

Assuming accounts payable is used for inventory purchases only, what was the amount of cash paid for inventory purchases during the year? A) $32,000 B) $176,000 C) $192,000 D) $160,000

67) The following beginning and ending balances were drawn from the records of Allen Company. Beginning Equipment Accumulated depreciation

$ 900,000 $ 410,000

Ending $ 650,000 $ 400,000

If Allen Company sold equipment that had an original cost of $550,000 and accumulated depreciation of $250,000 for $175,000, how much did Allen pay for new equipment?

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A) $150,000 B) $800,000 C) $300,000 D) $75,000

68) The following beginning and ending balances were drawn from the records of Allen Company. Beginning Equipment Accumulated depreciation

$ 350,000 175,000

Ending $ 275,000 100,000

If Allen Company sold equipment that had an original cost of $175,000 and accumulated depreciation of $75,000 for $62,500, how much did Allen pay for new equipment? A) $12,500 B) $25,000 C) $100,000 D) $250,000

69) A review of Pueblo Company’s balance sheet revealed a beginning balance in its Land account of $150,000. The ending balance in the account was $325,000. All transactions associated with the purchase or sale of land were cash transactions. Based on this information alone, Pueblo would show a A) $175,000 cash outflow in the financing activities section of its statement of cash flows. B) $325,000 cash outflow in the financing activities section of its statement of cash flows. C) $325,000 cash outflow in the investing activities section of its statement of cash flows. D) $175,000 cash outflow in the investing activities section of its statement of cash flows.

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70) When using the indirect method to complete the cash flows from operating activities section of the statement of cash flows, what is the proper disposition of a loss on disposal of equipment? A) Disregard the loss because it relates to an investing activity. B) Disregard the loss because it relates to a financing activity. C) Add the loss to net income. D) Subtract the loss from net income.

71) When using the indirect method to complete the cash flows from operating activities section of the statement of cash flows, what is the proper disposition of depreciation expense? A) Subtract depreciationexpense from net income. B) Add depreciationexpense to net income. C) Disregard depreciationexpense because it relates to an investing activity. D) Disregard depreciationexpense because it is a noncash expense.

72) Which method of reporting cash flows from operating activities is used by most businesses in preparing the statement of cash flows? A) Accrual method B) Direct method C) Indirect method D) Computational method

73) When using the indirect method to prepare the operating activities section of the statement of cash flows, how is an increase in noncash current assets handled? A) It is subtracted from net income in the cash flows from operating activities section. B) It is subtracted from current liabilities in the cash flows from financing activities section. C) It is added to net income in the cash flows from operating activities section. D) It is added to equipment purchases in the cash flows from investing activities section.

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74) When using the indirect method to prepare the operating activities section of the statement of cash flows, how is a decrease in current liabilities handled? A) It is subtracted from net income in the cash flows from operating activities section. B) It is subtracted from current assets in the cash flows from financing activities section. C) It is added to net income in the cash flows from operating activities section. D) It is added to inventory purchases in the cash flows from investing activities section.

75) On January 1, Year 1, Colgate Corporation decided to switch from the direct method to the indirect method of preparing the statement of cash flows. Assuming a positive net income figure but a decrease in the cash balance, what can be said about the change in method of preparing the statement? A) The direct method will yield a larger amount for cash flows from operating activities. B) The only difference will be in the cash flows from financing activities section. C) The indirect method will yield a larger amount for cash flows from operating activities. D) There will be no difference in the totals on the statement of cash flows.

76) Which of the following is a correct statement of one of the rules for converting net income to the cash flow from operating activities using the indirect method? A) All noncash expenses and losses are subtracted from net income. B) Increases in current liabilities are added to net income. C) Increases in current assets are added to net income. D) Decreases in current assets are subtracted from net income.

77) Which of the following is an incorrect statement of one of the rules for converting net income to the cash flow from operating activities using the indirect method? A) Increases in current assets are subtracted from net income. B) Decreases in current assets are added to net income. C) Gains are added to net income. D) Increases in current liabilities are added to net income.

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78) Which of the following statements best explains the correct handling of depreciation on the statement of cash flows when using the indirect method? A) Depreciation expense is a noncash expense that is added to net income to derive cash flows from operating activities. B) Depreciationexpense is subtracted in the cash flows from investing activities section because it reduces the book value of the corresponding plant asset. C) Depreciationexpense is subtracted from net income because it causes a loss when the related plant asset is sold. D) Depreciationexpense adds to the company's Cash account to help pay for new equipment.

79) Which section of the statement of cash flows is prepared using either the direct or indirect method? A) Operating activities B) Investing activities C) Financing activities D) All of these answer choices are correct

80) On January 1, Year 2, the balance of Jacobs Corporation's Accounts Receivable was $27,000. Sales on account for Year 2 amounted to $174,000 and the ending balance of Accounts Receivable was $42,500. What is the amount of cash collected from customers? A) $131,500 B) $158,500 C) $189,500 D) $201,000

81) On January 1, Year 2, the balance of Jacobs Corporation's Accounts Receivable was $40,000. Sales on account for Year 2 amounted to $320,000 and the ending balance of Accounts Receivable was $64,000. What is the amount of cash collected from customers?

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A) $296,000 B) $256,000 C) $344,000 D) $360,000

82) Hilliard Company, a small consulting firm, charges all of its operating expenses on Accounts Payable. On January 1, Year 2, Hilliard's Accounts Payable balance was $13,500 and, during Year 2, an additional $111,000 of operating expenses were charged on account. On December 31, Year 2, the Accounts Payable balance was $38,200. What is the amount of cash paid for expenses during Year 2? A) $72,800 B) $135,700 C) $124,500 D) $86,300 E) $72,800

83) Hilliard Company, a small consulting firm, charges all of its operating expenses on Accounts Payable. On January 1, Year 2, Hilliard's Accounts Payable balance was $24,000 and, during Year 2, an additional $216,000 of operating expenses were charged on account. On December 31, Year 2, the Accounts Payable balance was $72,000. What is the amount of cash paid for expenses during Year 2? A) $264,000 B) $240,000 C) $168,000 D) $64,000

84) If cash from operating activities was $29,000, cash used for investing activities was ($49,500) and the net change in cash was $56,100, what was cash from/used for financing activities?

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A) ($105,600) B) $29,000 C) $56,100 D) $76,600

85) If cash from operating activities was $48,000, cash used for investing activities was ($88,000) and the net change in cash was $96,000, what was cash from/used for financing activities? A) ($144,000) B) $48,000 C) $136,000 D) $96,000

86)

Which of the following cash transactions is not classified as an operating activity? A) Cash paid for interest. B) Cash paid for dividends. C) Cash received from dividends. D) None of these answer choices would be shown under operating activities.

87) Under the indirect method, which of the following items would be added to net income to determine the cash flow from operating activities? A) Gain on the sale of equipment B) Depreciation expense C) Accrued interest receivable D) Decrease in the balance of accounts payable

88) The following income statement was drawn from the annual report of Newtown Company: Cash revenue

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$ 64,400

Depreciation expense Accrued interest expense Cash operating expenses Operating income Gain on sale of equipment

(22,200) (8,000) (26,600) 7,600 1,800

Net income

$ 9,400

What is the net cash flow from operating activities? A) $37,800 B) $30,200 C) $28,400 D) $39,600

89) The following income statement was drawn from the annual report of Newtown Company: Cash revenue Depreciation expense Accrued interest expense Cash operating expenses Operating income Gain on sale of equipment

$ 30,000 (10,000) (3,000) (12,000) 5,000 600

Net Income

$ 5,600

What is the net cash flow from operating activities? A) $18,000 B) $18,600 C) $13,000 D) $14,400

90) Which of the following describes the only difference between the direct and indirect methods of preparing the statement of cash flows?

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A) The manner in which cash flows from operating activities is presented. B) The manner in which cash flows from investing activities is presented. C) The manner in which cash flows from financing activities is presented. D) Whether a schedule of noncash items needs to be presented.

91) Chisholm Associates uses the indirect method to prepare the operating activities section of the statement of cash flows. The following accounts and balances were drawn from the company's accounting records:

Accounts receivable Prepaid insurance Accounts payable Unearned revenue

Beginning Balance $ 30,600 5,200 24,600 7,000

Ending Balance $ 40,750 1,750 26,550 4,550

Net income for the period was $47,500. What is the net cash flows from operating activities? A) $40,300 B) $45,550 C) $45,200 D) $53,400

92) Chisholm Associates uses the indirect method to prepare the operating activities section of the statement of cash flows. The following accounts and balances were drawn from the company's accounting records:

Accounts receivable Prepaid insurance Accounts payable Unearned revenue

Beginning Balance $ 60,000 9,200 48,000 12,800

Ending Balance $ 80,000 2,000 51,600 7,600

Net income for the period was $80,000. What is the net cash flows from operating activities?

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A) $70,400 B) $65,600 C) $76,000 D) $94,400

93)

The following information is for Cleveland Company:

Accounts receivable Prepaid rent Long term investments Dividends payable Salaries payable Long term notes payable

Beginning of Year $ 194,000 25,100 176,500 66,400 180,600 380,600

End of Year $ 136,000 53,000 150,000 51,800 172,000 354,200

Additional data for the current year: 1.(1) Sales on account for the period were $219,000. 2.(2) Operating expenses for the period were $124,000. Based on this limited information, what was the net cash inflow from operating activities? A) $36,500 B) $116,500 C) $58,000 D) $95,000

94)

The following information is for Cleveland Company:

Accounts receivable Prepaid rent Long term investments Dividends payable Salaries payable

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Beginning of Year $ 84,000 8,000 80,000 24,000 82,000

End of Year $ 60,000 20,000 70,000 20,000 76,000

Long term notes payable

180,000

170,000

Additional data for the current year: 1.(1) Sales on account for the period were $80,000. 2.(2) Operating expenses for the period were $52,000. Based on this limited information, what was the net cash inflow from operating activities? A) $18,000 B) $22,000 C) $28,000 D) $34,000

95) Baird Company reported depreciation expense of $21,800 and net income of $36,600 on its Year 2 income statement. During Year 2, the company's accounts receivable balance decreased by $9,400. Based on this information alone, what was the amount of cash flow from operating activities? A) $27,200 B) $36,600 C) $67,800 D) $58,400

96) Baird Company reported depreciation expense of $10,000 and net income of $16,000 on its Year 2 income statement. During Year 2, the company's accounts receivable balance decreased by $4,000. Based on this information alone, what was the amount of cash flow from operating activities? A) $12,000 B) $16,000 C) $32,000 D) $30,000

97) Warren Corporation's balance sheet reports equipment that originally cost $73,000. The accumulated depreciation for the equipment is $27,600. Warren sells the equipment for $39,600. What would the effect be on its income statement and statement of cash flows?

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A. B. C. D.

Income Statement

Cash Flows

Gain: $ 39,600 Gain: $ 5,800 Loss: $ 5,800 Loss: $ 5,800

Investing + $ 39,600 Operating − $ 5,800 Operating − $ 39,600 Investing + $ 39,600

A) Option A B) Option B C) Option C D) Option D

98) Warren Corporation's balance sheet reports equipment that originally cost $65,000. The accumulated depreciation for the equipment is $25,000. Warren sells the equipment for $37,000. What would the effect be on its income statement and statement of cash flows?

A. B. C. D.

Income Statement

Cash Flows

Gain: $ 37,000 Gain: $ 3,000 Loss: $ 3,000 Loss: $ 3,000

Investing + $ 37,000 Operating − $ 3,000 Operating − $ 3,000 Investing + $ 37,000

A) Option A B) Option B C) Option C D) Option D

99) For the year ended December 31, Year 1, Fields Company made cash payments of $63,300 for dividends, paid interest of $32,100, paid $41,300 cash to suppliers, and purchased equipment for $79,300 cash. What is the net cash used by investing activities for Year 1? A) $79,300 B) $95,400 C) $133,400 D) $216,000

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100) For the year ended December 31, Year 1, Fields Company made cash payments of $50,000 for dividends, paid interest of $20,500, paid $30,000 cash to suppliers, and purchased equipment for $64,000 cash. What is the net cash used by investing activities for Year 1? A) $114,000 B) $64,000 C) $20,500 D) $134,500

101) Belvedere Corporation had a balance in its Equipment account on January 1, Year 2 of $334,000. During the year, equipment originally costing $89,500 and having Accumulated Depreciation of $22,500 was sold for $69,000. The ending balance of the Equipment Account was $291,500. How much did the company spend to purchase additional equipment during Year 2? A) $22,500 B) $47,000 C) $89,500 D) $91,500

102) Belvedere Corporation had a balance in its Equipment account on January 1, Year 2 of $320,000. During the year, equipment originally costing $85,000 and having Accumulated Depreciation of $20,000 was sold for $67,000. The ending balance of the Equipment Account was $275,000. How much did the company spend to purchase additional equipment during Year 2? A) $40,000 B) $25,000 C) $90,000 D) $92,000

103) Grace Company sold equipment for $40,000 cash. The equipment has cost $70,000 and had accumulated depreciation of $44,000 at the time of the sale. Based on this information alone, which of the following statements is true?

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A) Cash flow from investing activities would be less if the sale of equipment is reported on the statement of cash flows under the direct method than if it is reported under the indirect method. B) Cash flow from investing activities would be greater if the sale of equipment is reported on the statement of cash flows under the direct method than if it is reported under the indirect method. C) Cash flow from investing activities would be the same regardless of whether the sale of equipment is reported on the statement of cash flows under the direct method or the indirect method. D) The answer cannot be determined because the amount of the salvage value is unknown.

104) Which of the following would not be presented in the financing activities section of the statement of cash flows? A) Purchased a new office building by issuing a note payable B) Purchased treasury stock C) Repayment of long-term bonds payable D) Issuing of preferred stock

105) Which of the following transactions would be disclosed on a schedule of noncash investing and financing activities? A) A building acquired by issuing a mortgage note B) Recording depreciation expense C) The issuance of bonds for cash D) All of these answer choices are correct

106)

Which of the following would not be reported in the body of the statement of cash flows? A) The payment of a cash dividend B) The issuance of preferred stock for cash C) The purchase and retirement of treasury stock D) A 2-for-1 stock split

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107) Statler Corporation has beginning and ending accounts payable balances of $420 and $830, respectively. Inventory had beginning and ending balances of $720 and $530, respectively. If cost of goods sold was $3,000, how much cash was spent to purchase inventory? A) $2,170 B) $2,580 C) $2,810 D) $2,400

108) Statler Corporation has beginning and ending accounts payable balances of $400 and $800, respectively. Inventory had beginning and ending balances of $700 and $600, respectively. If cost of goods sold was $2,800, how much cash was spent to purchase inventory? A) $2,100 B) $2,500 C) $2,700 D) $2,300

109) Which of the following cash flows would be included in the operating activities section of the statement of cash flows if the direct method is used? A) Cash received from a bond issue B) Cash paid to purchase equipment C) Cash receipts from dividends D) Cash gains and losses from the sale of operational assets

110) For the year ended December 31, Year 1, Carsem Company had cash collections from customers of $220,000, cash paid to employees of $32,000, cash paid to suppliers of $100,000, cash used to retire long-term bonds of $32,000, and cash payments for dividends of $20,000. Based on this information, what is the net cash provided from operating activities?

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A) $68,000 B) $88,000 C) $188,000 D) $120,000

111) Anton Company reported a beginning balance of $13,200 and an ending balance of $14,400 in its Unearned Revenue account for the current year. During the year, $36,000 of revenue (previously unearned) was recognized. Considering only this information, how much cash was received in advance from customers during the year? A) $36,000 B) $37,200 C) $36,800 D) $27,600

112) Oglethorpe Corporation reported a beginning balance of $12,400 in its Prepaid Insurance account. During the year, Oglethorpe paid a total of $42,000 to purchase insurance, and the Prepaid Insurance account had an ending balance of $13,100. What was the amount of insurance expense for the year? A) $42,000 B) $42,300 C) $42,700 D) $41,300

113) LePage Corporation reported a beginning balance of $2,200 in its Prepaid Insurance account. During the year, a total of $17,000 was recognized as Insurance Expense and the Prepaid Insurance account had an ending balance of $1,800. How much cash did LePage pay for insurance during the year? A) $16,600 B) $17,400 C) $17,000 D) $18,800

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114) Mercury Company rents out a portion of its office space to another company. At the beginning of the year, the balance in the Unearned Rent Revenue account was $3,400. During the year, Mercury recognized $16,600 of rent revenue. If the ending balance of Unearned Rent Revenue is $2,600, how much cash was received from the tenant for rent during the year? A) $14,000 B) $16,600 C) $17,400 D) $15,800

115) Bristol Corporation reported a beginning balance of $6,200 in accounts receivable. During the year, sales on account totaled $49,600. If the ending balance of accounts receivable amounts to $25,000, what was the amount of cash received from customers? A) $24,600 B) $25,000 C) $30,800 D) $68,400

116) Pittsburgh Company pays cash for all inventory purchases. The company had a beginning inventory of $18,500 and an ending inventory of $16,900. Their cost of goods sold amounted to $75,000. Based on this information, what was the amount of cash paid for inventory purchases? A) $76,600 B) $73,400 C) $75,000 D) $81,800

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Answer Key Test name: Chap 12_2e_Test Bank_MCQs_TF 1) FALSE Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue. 2) FALSE The cash received from the sale, not the loss, is reported in the investing activities section of the statement of cash flows. 3) TRUE Cash flows reported as investing activities include cash receipts (inflows) from selling property, plant, equipment, or marketable securities, as well as collections from credit instruments such as notes or mortgages receivable. Cash flows reported as investing activities include cash payments (outflows) for purchasing property, plant, equipment, or marketable securities, as well as for making loans to borrowers. 4) TRUE Cash flows reported as financing activities include cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. 5) TRUE Noncash investing and financing activities, such as the purchase of property by issuing a mortgage note, are reported in the schedule of noncash investing and financing activities. 6) TRUE The statement of cash flows reports operating, investing, and financing activities, in that order. 7) FALSE The last line of the statement of cash flows reports the ending cash balance. Version 1

8) TRUE Many aspects of accrual accounting, such as recognizing revenues and expenses on account, can cause differences between the amount of net income reported on a company’s income statement and the amount of net cash flow it reports from operating activities. 9) FALSE The increase in accounts receivable indicates that the company collected $26,000 less from customers than it recorded in credit sales. Therefore, collections would have been $474,000 (or $500,000 − $26,000). 10) TRUE Ending balance of utilities payable of $1,500 = Beginning balance of utilities payable of $2,500 + Increase due to utilities expense of $18,200 − Decrease due to payment of utilities payable (the unknown) Outflow for payment of utilities = $2,500 + $18,200 − $1,500 = $19,200 11) TRUE Ending balance of unearned revenue of $4,000 = Beginning balance of unearned revenue of $12,000 + Increase due to cash collected in advance (the unknown) − Decrease due to services provided to customers of $258,000 Cash collected in advance from customers = $4,000 − $12,000 + $258,000 = $250,000 12) TRUE TheFASB continues to advocate the direct method. 13) FALSE The indirect method starts with net income. 14) TRUE Decreases in noncash current assets are added to and increases in noncash current assets are subtracted from net income to determine net cash flow from operating activities. Version 1

15) FALSE Increases in noncash current liabilities are added to and decreases in noncash current liabilities are subtracted from net income to determine net cash flow from operating activities. 16) FALSE Noncash expenses and losses are added to and gains are subtracted from net income to determine net cash flow from operating activities. 17) TRUE A company, especially one experiencing rapid growth, can be short of cash despite earning substantial net income. 18) TRUE A company, especially one experiencing rapid growth, can be short of cash despite earning substantial net income. 19) FALSE TheFASB prohibits companies from disclosing cash flow per share in audited financial statements. The requirement for a per share amount is to report earnings per share on an income statement. 20) FALSE Cash flow from operating activities can be more stable than operating income. 21) FALSE There is no differentiation on the statement between types of long-term asset purchases. 22) FALSE The indirect method of preparing the operating activities section of the statement of cash flows shows increases and decreases in noncash current assets and current liabilities to arrive at cash flows from operating activities. The direct method shows actual cash inflows and outflows from operating activities. 23) FALSE Version 1

Depreciation expense is a noncash expense. 24) FALSE Increases in accounts receivable are deducted from credit sales to determine cash collections from customers. 25) B Even though interest expense is reported as a nonoperating expense after operating income on the income statement, interest paid is reported as an operating activity on the statement of cash flows. 26) A Cash flows reported as operating activities include cash receipts from revenues, including interest revenue. 27) C Cash paid for the purpose of any long-term asset, such as land, is reported as an investing activity. 28) D Gain on sale = Proceeds of $60,000 − Book value of $48,000 = $12,000 Because the gain increased net income, but did not provide cash from operating activities, it is subtracted from net income to arrive at cash flow from operating activities using the indirect method. Cash flows reported as investing activities include cash receipts (inflows) from selling land. 29) B Cash flows reported as financing activities include cash receipts (inflows) from borrowing money. 30) B Cash flows reported as financing activities include cash receipts (inflows) from borrowing money. 31) B

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Year 1 Interest expense = $72,000 × 9% × 5/12 months = $2,700 At December 31, Year 1, the accrual of interest expense does not affect cash flows. At maturity (in Year 2), the payment of interest will be reported as a cash outflow from operating activities. 32) C Year 1 Interest expense = $80,000 × 9% × 5/12 months = $3,000 At December 31, Year 1, the accrual of interest expense does not affect cash flows. At maturity (in Year 2), the payment of interest will be reported as a cash outflow from operating activities. 33) A Year 2 Interest expense = $52,000 × 9% × 7/12 months = $2,730 Year 2 Payment of interest = $52,000 × 9% × 12/12 months = $4,680 Year 2 Cash outflows = Interest paid of $4,680 (operating activities) and Principal repayment of $52,000 (financing activities) = $56,680 34) D Year 2 Interest expense = $80,000 × 9% × 7/12 months = $4,200 Year 2 Payment of interest = $80,000 × 9% × 12/12 months = $7,200 Year 2 Cash outflows = Interest paid of $7,200 (operating activities) and Principal repayment of $80,000 (financing activities) = $87,200 35) D

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Cash flows reported as financing activities include cash receipts (inflows) from borrowing money and issuing stock and cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. Ending balance of notes payable of $66,000 = Beginning balance of notes payable of $128,000 + Increase due to issuing notes payable of $0 − Decrease due to payment of notes payable (the unknown) Outflow for repayment of long-term notes payable = $128,000 − $66,000 = $62,000 Ending balance in dividends payable of $44,000 = Beginning balance in dividends payable of $52,800 + Increase due to declaring dividends of $88,000 − Decrease due to payment of dividends (the unknown) Outflow for payment of dividends = $52,800 + $88,000 − $44,000 = $96,800 Net cash outflow from financing activities = $62,000 (outflow) + $96,800 (outflow) = $158,800 36) D

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Cash flows reported as financing activities include cash receipts (inflows) from borrowing money and issuing stock and cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. Ending balance of notes payable of $15,000 = Beginning balance of notes payable of $40,000 + Increase due to issuing notes payable of $0 − Decrease due to payment of notes payable (the unknown) Outflow for repayment of long-term notes payable = $40,000 − $15,000 = $25,000 Ending balance in dividends payable of $10,000 = Beginning balance in dividends payable of $12,000 + Increase due to declaring dividends of $20,000 − Decrease due to payment of dividends (the unknown) Outflow for payment of dividends = $12,000 + $20,000 − $10,000 = $22,000 Net cash outflow from financing activities = $25,000 (outflow) + $22,000 (outflow) = $47,000 37) A

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Cash flows reported as investing activities include cash receipts (inflows) from selling property, plant, equipment, or marketable securities, as well as collections from credit instruments such as notes or mortgages receivable and cash payments (outflows) for purchasing property, plant, equipment, or marketable securities, as well as for making loans to borrowers. Ending balance of equipment of $261,000 = Beginning balance of equipment of $90,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $0 Outflow for purchase of equipment = $261,000 − $90,000 = $171,000 Ending balance of long-term investments of $45,000 = Beginning balance of long-term investments of $64,800 + Increase due to purchase of long-term investments of $0 − Decrease due to cost of long-term investments (the unknown) Decrease due to cost of long-term investments sold = $64,800 − $45,000 = $19,800 The long-term investments were sold at cost, thus $19,800 is the inflow. Net cash outflow from investing activities = $171,000 (outflow) − $19,800 (inflow) = $151,200 38) A

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Cash flows reported as investing activities include cash receipts (inflows) from selling property, plant, equipment, or marketable securities, as well as collections from credit instruments such as notes or mortgages receivable and cash payments (outflows) for purchasing property, plant, equipment, or marketable securities, as well as for making loans to borrowers. Ending balance of equipment of $92,500 = Beginning balance of equipment of $25,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $0 Outflow for purchase of equipment = $92,500 − $25,000 = $67,500 Ending balance of long-term investments of $12,500 = Beginning balance of long-term investments of $18,000 + Increase due to purchase of long-term investments of $0 − Decrease due to cost of long-term investments (the unknown) Decrease due to cost of long-term investments sold = $18,000 − $12,500 = $5,500 The long-term investments were sold at cost, thus $5,500 is the inflow. Net cash outflow from investing activities = $67,500 (outflow) − $5,500 (inflow) = $62,000 39) C While cash flows reported as operating activities include cash receipts from revenues, including interest, the accrual of interest revenue does not impact cash. 40) D This transaction is a noncash investing and financing activity, which is reported in the schedule of noncash investing and financing activities. 41) C

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Cash flows reported as financing activities include cash receipts (inflows) from borrowing money and issuing stock and cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. Cash flows reported as operating activities include cash payments for expenses, including interest expense. 42) D The statement of cash flows displays the activities (operating, investing, and financing) that caused the cash balance to change during the accounting period. The beginning cash balance is then added to the amount of the change in the cash balance with the result being the ending cash balance. 43) B Companies do engage in purchasing activities that affect cash flows. However, the associated cash flows are shown as components of the broader classification scheme used for the statement of cash flows. For example, cash outflow for the purchase of inventory would go in the operating activities section or the cash paid to purchase equipment would be shown in the financing activities section. There is no specific section titled "purchasing activities" used in the statement of cash flows. 44) B There are several rules for converting net income to cash flow from operations. One of these rules is that a decrease in the balance of any noncash current asset account must be added back to the amount of net income to arrive at the cash flow from operations. Since prepaid rent is a noncash current asset account, the decrease in the balance of this account must be added to the amount of net income to determine the cash flow from operating activities. 45) D

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Two conversion rules apply to this exercise: (1) an increase in the balance of any noncash current asset account must be subtracted from the amount of net income to arrive at the cash flow from operations, (2) an increase in the balance of any current liability account must be added back to the amount of net income to arrive at the cash flow from operations. Applying these rules to the information provided in this exercise results in a cash flow from operations of $52,000 ($50,000 Net income − $4,000 increase in accounts receivable + $6,000 increase in accounts payable). 46) A Four conversion rules apply to this exercise: (1) an increase in the balance of any noncash current asset account must be subtracted from the amount of net income to arrive at the cash flow from operations, (2) a decrease in the balance of any current liability account must be subtracted from the amount of net income to arrive at the cash flow from operations, (3) noncash expenses must be added back to the amount of net income to arrive at the cash flow from operations, and (4) gains must be subtracted from the amount of net income to arrive at the cash flow from operations. Applying these rules to the information provided in this exercise results in a cash flow from operations of $114,000 ($120,000 Net income − $7,000 increase in accounts receivable − $6,000 decrease in unearned revenue + $15,000 depreciation expense − $8,000 gain on sale of equipment). 47) B Depreciation expense decreases net income, but it is a noncash expense. 48) B

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The purchase of equipment for $36,000 cash is reported as a cash outflow in the investing activities section of the statement of cash flows. Depreciation expense of $9,000 decreases net income, but this noncash expense does not impact cash flows. 49) D Simply signing a contract does not affect the income statement or the statement of cash flows. It is not recorded in Mayer's financial statements. 50) A Interest expense = $22,500 × 6% × 4/12 = $450 Interest expense of $450 decreases net income, but the accrual of interest expense is not reported on the statement of cash flows because no interest is paid in Year 1. The $15,500 cash paid as a down payment on the equipment is reported as a cash outflow in the investing activities section of the statement of cash flows. The issuance of the note for $22,500 is a noncash investing and financing activity, which is reported in the schedule of noncash investing and financing activities. 51) B Cash flows reported as investing activities include cash receipts (inflows) from selling property, plant, equipment (item 4), or marketable securities, as well as collections from credit instruments such as notes or mortgages receivable. Cash flows reported as investing activities also include cash payments (outflows) for purchasing property, plant, equipment, or marketable securities, as well as for making loans to borrowers. The other items listed (2, 3, and 4) are cash flows reported as financing activities. 52) B The total of operating, investing, and financing activities is equal to the net change in cash. It is then added to the beginning cash balance to arrive at the ending cash balance for the period. Version 1

53) D Cash flows reported as financing activities include cash payments (outflows) to pay dividends. The other choices do not affect cash, and therefore do not affect cash flows. 54) A The statement of cash flows reports operating, investing, and financing activities, in that order. 55) D Because none of the events described affect cash, none of them affect cash flows. 56) D Year 2: Ending balance of wages payable of $72,600 = Beginning balance of wages payable of $52,800 + Increase due to wages expense of $372,000 − Decrease due to payment of wages payable (the unknown) Outflow for payment of wages = $52,800 + $372,000 − $72,600 = $352,200 57) C Year 2: Ending balance of wages payable of $22,000 = Beginning balance of wages payable of $16,000 + Increase due to wages expense of $160,000 − Decrease due to payment of wages payable (the unknown) Outflow for payment of wages = $16,000 + $160,000 − $22,000 = $154,000 58) D

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Ending balance of accounts receivable of $53,600 = Beginning balance of accounts receivable of $37,100 + Increase due to credit sales of $236,600 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $37,100 + $236,600 − $53,600 = $220,100 59) D Ending balance of accounts receivable of $100,000 = Beginning balance of accounts receivable of $70,000 + Increase due to credit sales of $460,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $70,000 + $460,000 − $100,000 = $430,000 60) C Ending balance of accounts receivable of $20,600 = Beginning balance of accounts receivable of $55,500 + Increase due to credit sales of $100,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $55,500 + $100,000 − $20,600 = $134,900 61) B Ending balance of accounts receivable of $40,000 = Beginning balance of accounts receivable of $64,000 + Increase due to credit sales of $588,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $64,000 + $588,000 − $40,000 = $612,000 62) D

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Cash flows reported as financing activities include cash payments (outflows) to purchase treasury stock. The short-term borrowing of cash is a source of cash. The acquisition of land by issuing a short-term note and the issuance of a stock dividend are noncash investing and financing activities. 63) D Ending balance of accounts receivable of $29,000 = Beginning balance of accounts receivable of $45,000 + Increase due to credit sales of $345,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $45,000 + $345,000 − $29,000 = $361,000 64) A Ending balance of accounts receivable of $16,000 = Beginning balance of accounts receivable of $32,000 + Increase due to credit sales of $280,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $32,000 + $280,000 − $16,000 = $296,000 65) C

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Ending balance of inventory of $25,000 = Beginning balance of inventory of $9,000 + Increase due to inventory purchased on account (the unknown) − Decrease due to cost of goods sold of $161,000 Inventory purchased on account = $25,000 − $9,000 + $161,000 = $177,000 Ending balance of accounts payable of $33,000 = Beginning balance of accounts payable of $49,000 + Increase due to inventory purchased on account of $177,000 − Decrease due to cash paid for inventory (the unknown) Cash paid for inventory = $49,000 + $177,000 − $33,000 = $193,000 66) C Ending balance of inventory of $24,000 = Beginning balance of inventory of $8,000 + Increase due to inventory purchased on account (the unknown) − Decrease due to cost of goods sold of $160,000 Inventory purchased on account = $24,000 − $8,000 + $160,000 = $176,000 Ending balance of accounts payable of $32,000 = Beginning balance of accounts payable of $48,000 + Increase due to inventory purchased on account of $176,000 − Decrease due to cash paid for inventory (the unknown) Cash paid for inventory = $48,000 + $176,000 − $32,000 = $192,000 67) C Ending balance of equipment of $650,000 = Beginning balance of equipment of $900,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $550,000 Outflow for purchase of equipment = $650,000 − $900,000 + $550,000 = $300,000 Version 1

68) C Ending balance of equipment of $275,000 = Beginning balance of equipment of $350,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $175,000 Outflow for purchase of equipment = $275,000 − $350,000 + $175,000 = $100,000 69) D Cash outflow for the purchase of land: Beginning balance in the land account Cash payment to purchase land Ending balance in the land account

$ 150,000 ? = $ 175,000 $ 325,000

The purchase of long-term assets such as land are defined as investing activities. 70) C Because losses decrease net income, but do not use cash for operating activities, losses are added back to net income to arrive at net cash flows from operating activities. 71) B Because depreciation expense reduces net income, but is a noncash expense, it is added back to net income to arrive at net cash flows from operating activities. 72) C Because the indirect method is easier, most companies use this method. 73) A Decreases in noncash current assets are added to and increases in noncash current assets are subtracted from net income to determine net cash flow from operating activities. 74) A Version 1

Increases in noncash current liabilities are added to and decreases in noncash current liabilities are subtracted from net income to determine net cash flow from operating activities. 75) D The amount of net cash flow from operating activities is the same whether it is presented using the indirect or the direct method. 76) B Increases in noncash current liabilities are added to and decreases in noncash current liabilities are subtracted from net income to determine net cash flow from operating activities. Decreases in noncash current assets are added to and increases in noncash current assets are subtracted from net income to determine net cash flow from operating activities. Noncash expenses and losses are added to and gains are subtracted from net income to determine net cash flow from operating activities. 77) C Because they are included in net income, gains are subtracted from net income to determine net cash flow from operating activities. 78) A Because depreciation expense reduces net income, but is a noncash expense, it is added to net income to arrive at cash flows from operating activities. 79) A Under generally accepted accounting principles, the operating activities section of the statement of cash flows can be presented using either the direct or the indirect method. 80) B

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Ending balance of accounts receivable of $42,500 = Beginning balance of accounts receivable of $27,000 + Increase due to credit sales of $174,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $27,000 + $174,000 − $42,500 = $158,500 81) A Ending balance of accounts receivable of $64,000 = Beginning balance of accounts receivable of $40,000 + Increase due to credit sales of $320,000 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $40,000 + $320,000 − $64,000 = $296,000 82) D Ending balance of accounts payable of $38,200 = Beginning balance of accounts payable of $13,500 + Increase due to expenses charged on account of $111,000 − Decrease due to cash paid for expenses (the unknown) Cash paid for expenses = $13,500 + $111,000 − $38,200 = $86,300 83) C Ending balance of accounts payable of $72,000 = Beginning balance of accounts payable of $24,000 + Increase due to expenses charged on account of $216,000 − Decrease due to cash paid for expenses (the unknown) Cash paid for expenses = $24,000 + $216,000 − $72,000 = $168,000 84) D

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Net change in cash of $56,100 = Cash flow from operating activities of $29,000 − Cash used in investing activities of $49,500 + Cash flow from financing activities (the unknown) Cash flow from financing activities = $56,100 − $29,000 + $49,500 = $76,600 85) C Net change in cash of $96,000 = Cash flow from operating activities of $48,000 − Cash used in investing activities of $88,000 + Cash flow from financing activities (the unknown) Cash flow from financing activities = $96,000 − $48,000 + $88,000 = $136,000 86) B Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue and cash payments for expenses, including interest expense. Cash paid for dividends is reported as a cash outflow in the financing activities section of the statement of cash flows. 87) B Because depreciation expense reduces net income, but is a noncash expense, it is added to net income. 88) A Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue and cash payments for expenses, including interest expense. Net cash flow from operating activities = Cash revenue of $64,400 − Cash operating expenses of $26,600 = $37,800 89) A

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Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue and cash payments for expenses, including interest expense. Net cash flow from operating activities = Cash revenue of $30,000 − Cash operating expenses of $12,000 = $18,000 90) A Under generally accepted accounting principles, the operating activities section of the statement of cash flows can be presented using either the direct or the indirect method. 91) A Net cash flow from operating activities = Net income of $47,500 − Increase in accounts receivable of $10,150 (or $40,750 − $30,600) + Decrease in prepaid insurance of $3,450 (or $5,200 − $1,750) + Increase in accounts payable of $1,950 (or $26,550 − $24,600) − Decrease in unearned revenue of $2,450 (or $7,000 − $4,550) = $40,300 92) B Net cash flow from operating activities = Net income of $80,000 − Increase in accounts receivable of $20,000 (or $80,000 − $60,000) + Decrease in prepaid insurance of $7,200 (or $9,200 − $2,000) + Increase in accounts payable of $3,600 (or $51,600 − $48,000) − Decrease in unearned revenue of $5,200 (or $12,800 − $7,600) = $65,600 93) B Net income = Sales of $219,000 − Operating expenses of $124,000 = $95,000 Net cash flow from operating activities = Net income of $95,000 + Decrease in accounts receivable of $58,000 − Increase in prepaid rent of $27,900 − Decrease in salaries payable of $8,600 = $116,500 94) D

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Net income = Sales of $80,000 − Operating expenses of $52,000 = $28,000 Net cash flow from operating activities = Net income of $28,000 + Decrease in accounts receivable of $24,000 − Increase in prepaid rent of $12,000 − Decrease in salaries payable of $6,000 = $34,000 95) C Net cash flow from operating activities = Net income of $36,600 + Depreciation expense of $21,800 + Decrease in accounts receivable of $9,400 = $67,800 96) D Net cash flow from operating activities = Net income of $16,000 + Depreciation expense of $10,000 + Decrease in accounts receivable of $4,000 = $30,000 97) D Loss = Proceeds of $39,600 − Book value of ($73,000 − $27,600) = $5,800 Cash flows reported as investing activities include cash receipts (the inflow of $39,600) from selling equipment. 98) D Loss = Proceeds of $37,000 − Book value of ($65,000 − $25,000) = $3,000 Cash flows reported as investing activities include cash receipts (the inflow of $37,000) from selling equipment. 99) A The $79,300 paid to purchase equipment is reported as a cash outflow in the investing activities section. Cash payments for dividends are reported as outflows in the financing activities section. Cash paid for interest and cash paid to suppliers are reported as cash outflows in the operating activities section.

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100) B The $64,000 paid to purchase equipment is reported as a cash outflow in the investing activities section. Cash payments for dividends are reported as outflows in the financing activities section. Cash paid for interest and cash paid to suppliers are reported as cash outflows in the operating activities section. 101) B Ending balance of equipment of $291,500 = Beginning balance of equipment of $334,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $89,500 Outflow for purchase of equipment = $291,500 − $334,000 + $89,500 = $47,000 102) A Ending balance of equipment of $275,000 = Beginning balance of equipment of $320,000 + Increase due to purchase of equipment (the unknown) − Decrease due to cost of equipment sold of $85,000 Outflow for purchase of equipment = $275,000 − $320,000 + $85,000 = $40,000 103) C Under generally accepted accounting principles, the operating activities section of the statement of cash flows can be presented using either the direct or the indirect method. The investing activities section of the statement of cash flows is not affected by the choice of direct or indirect method. 104) A

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Cash flows reported as financing activities include cash receipts (inflows) from borrowing money and issuing stock and cash payments (outflows) to repay debt, purchase treasury stock, and pay dividends. Purchasing a building by issuing a note payable would be reported as a noncash investing and financing activity in the schedule of noncash investing and financing activities. 105) A Because the building was acquired by issuing a mortgage note payable, the company did not use cash for the purchase. This type of transaction is reported in the noncash investing and financing activities section of the statement of cash flows. 106) D Stock splits do not involve cash and are not be reported in the body of the statement of cash flows. Instead, they would be reported on the schedule of noncash investing and financing activities. 107) D Ending balance of inventory of $530 = Beginning balance of inventory of $720 + Increase due to inventory purchased on account (the unknown) − Decrease due to cost of goods sold of $3,000 Inventory purchased on account = $530 − $720 + $3,000 = $2,810 Ending balance of accounts payable of $830 = Beginning balance of accounts payable of $420 + Increase due to inventory purchased on account of $2,810 − Decrease due to cash paid for inventory (the unknown) Cash paid for inventory = $420 + $2,810 − $830 = $2,400 108) D

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Ending balance of inventory of $600 = Beginning balance of inventory of $700 + Increase due to inventory purchased on account (the unknown) − Decrease due to cost of goods sold of $2,800 Inventory purchased on account = $600 − $700 + $2,800 = $2,700 Ending balance of accounts payable of $800 = Beginning balance of accounts payable of $400 + Increase due to inventory purchased on account of $2,700 − Decrease due to cash paid for inventory (the unknown) Cash paid for inventory = $400 + $2,700 − $800 = $2,300 109) C Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue and cash payments for expenses, including interest expense. 110) B Cash flows reported as operating activities include cash receipts from revenues, including interest and dividend revenue and cash payments for expenses, including interest expense. Net cash flow from operating activities = Cash collected from customers of $220,000 − Cash paid to employees of $32,000 − Cash paid to suppliers of $100,000 = $88,000 111) B Ending balance of unearned revenue of $14,400 = Beginning balance of unearned revenue of $13,200 + Increase due to cash collected in advance of (the unknown) − Decrease due to services provided to customers of $36,000 Cash collected in advance from customers = $14,400 − $13,200 + $36,000 = $37,200 112) D

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Ending balance of prepaid insurance of $13,100 = Beginning balance of prepaid insurance of $12,400 + Increase due to premiums paid in advance of $42,000 − Decrease due to insurance expense (the unknown) Insurance expense = $12,400 + $42,000 − $13,100 = $41,300 113) A Ending balance of prepaid insurance of $1,800 = Beginning balance of prepaid insurance of $2,200 + Increase due to premiums paid in advance (the unknown) − Decrease due to insurance expense of $17,000 Premiums paid in advance = $1,800 − $2,200 + $17,000 = $16,600 114) D Ending balance of unearned revenue of $2,600 = Beginning balance of unearned revenue of $3,400 + Increase due to cash collected in advance (the unknown) − Decrease due to rent revenue earned of $16,600 Cash collected in advance = $2,600 − $3,400 + $16,600 = $15,800 115) C Ending balance of accounts receivable of $25,000 = Beginning balance of accounts receivable of $6,200 + Increase due to sales on account of $49,600 − Decrease due to cash collected from customers (the unknown) Cash collected from customers = $6,200 + $49,600 − $25,000 = $30,800 116) B Ending balance of inventory of $16,900 = Beginning balance of inventory of $18,500 + Increase due to inventory purchases for cash (the unknown) − Decrease due to cost of goods sold of $75,000 Inventory purchases for cash = $16,900 − $18,500 + $75,000 = $73,400

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CHAPTER 13: PROBLEM MATERIAL SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 1) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = D Not Affected = NA A transaction recorded as a debit to Cash and a credit to Common Stock. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

2) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA A transaction recorded as a debit to Accounts Receivable and a credit to a revenue account. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

3) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA A transaction recorded as a debit to Cash and a credit to Accounts Receivable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

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Statement of Cash Flows

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Statement of Cash Flows

7) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA A transaction recorded as a debit to Accounts Payable and a credit to Cash. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

8) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA A transaction recorded as a debit to Land and a credit to Cash. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

9) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Rent Expense and a credit to Prepaid Rent. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

10) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Unearned Revenue and a credit to Service Revenue. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

12) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Supplies Expense and a credit to Supplies. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

13) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA A transaction recorded as a debit to Furniture and a credit to Cash. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

14) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Depreciation Expense and a credit to Accumulated Depreciation. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

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Statement of Cash Flows

15) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Uncollectible Accounts Expense and a credit to Allowance for Doubtful Accounts. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

Statement of Cash Flows

16) Indicate how each event affects the financial statements. Use the following letters to record your answer in the box shown below. If an event increases one account and decreases another account equally within the same element, record I/D. If an event has no impact on the element, record NA. You do not need to enter amounts. Increase = I Decrease = DNot Affected = NA An adjusting entry recorded as a debit to Interest Expense and a credit to Interest Payable. Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income

17)

Statement of Cash Flows

What effect do debits have on asset accounts? On liability accounts?

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18)

What effect do credits have on asset accounts? On stockholders' equity accounts?

19) What are the meanings of the terms "debit" and "credit" and what are the effects of each on the various types of accounts?

20)

Are liability accounts increased by debits or credits?

21)

Cornelius Company purchased supplies on account. What account is credited?

22)

What is a trial balance? Why do accountants regularly prepare trial balances?

23)

Which accounts are categorized as temporary?

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24) Which types of accounts are closed out to the Retained Earnings account at the end of an accounting period?

ESSAY. Write your answer in the space provided or on a separate sheet of paper. 25) Indicate whether each of the following statements concerning the rules for debits and credits is true or false. 1.a) ________ The settlement of an account payable requires a credit to a liability account. 2.b) ________ The payment of a cash expense requires a debit to cash and a credit to the related expense account. 3.c) ________ Debits are entered on the left and credits are entered on the right in a Taccount. 4.d) ________ A credit entry decreases an asset account. 5.e) ________ Increases in revenues are recorded with debits to the revenue accounts.

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26)

Indicate whether each of the following statements is true or false.

1.a) ________ A debit may increase a liability. 2.b) ________ Closing a revenue account includes a debit to retained earnings. 3.c) ________ A debit may decrease stockholders' equity. 4.d) ________ A credit may decrease an asset. 5.e) ________ Debits to the Cash account are reported as cash outflows on the statement of cash flows.

27)

Indicate whether each of the following statements is true or false.

1.a) ________ Every journal entry includes at least one debit and one credit. 2.b) ________ The double-entry accounting format always records two separate events simultaneously. 3.c) ________ The double-entry system requires that total debits equal total credits. 4.d) ________ When an asset decreases in a double-entry system, a stockholders' equity account may also decrease. 5.e) ________ The double entry system ensures the accuracy of a company's accounting records.

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28)

Indicate whether each of the following statements is true or false.

1.a) ________ An asset source transaction may involve a debit to an asset and a credit to a stockholders' equity account. 2.b) ________ An asset use transaction may involve a debit to an asset account and a credit to a liability. 3.c) ________ A credit to the Common Stock account would be included in an asset use transaction. 4.d) ________ The payment of rent in advance involves a debit to Prepaid Rent and a credit to Cash. 5.e) ________ Recognition of Rent Expense (when a cash payment had previously been made in advance) involves a debit to Rent Expense and a credit to Prepaid Rent.

29)

Indicate whether each of the following statements is true or false.

1.a) ________ The entry to record the purchase of supplies involves a debit to Supplies Expense and a credit to Cash. 2.b) ________ The entry to record the amount of supplies used involves a debit to Supplies Expense and a credit to Supplies. 3.c) ________ An asset use transaction may involve a debit to an asset and a credit to a liability. 4.d) ________ An asset exchange transaction may involve a debit to an asset and a credit to a liability. 5.e) ________ A claims exchange transaction may involve a debit to a liability and a credit to revenue.

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30)

Indicate whether each of the following statements is true or false.

1.a) ________ A debit entry to Cash is never accompanied by a credit entry to a revenue account. 2.b) ________ The adjustment for accrued salary expenses would include a debit to Salaries Expense and a credit to Salaries Payable. 3.c) ________ Adjusting entries will always include either a debit to an expense account or a credit to a revenue account. 4.d) ________ The closing entry for an expense account involves a debit to retained earnings and a credit to the expense account. 5.e) ________ The closing entry for a revenue account involves a debit to the revenue account and a credit to Retained Earnings.

31)

Assume that a company recorded the following journal entry:

Account Title Salaries Expense

Debit 2,500

Cash

Credit

2,500

Indicate whether each of the following statements is true or false with regards to the impact of this journal entry. 1.a) _____ Cash decreases 2.b) _____ Total assets decrease 3.c) _____ Liabilities decrease 4.d) _____ Cash flows from operating activities increase 5.e) _____ Net income decreases

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32)

Assume that a company recorded the following journal entry,

Account Title Wages Expense

Debit 4,200

Wages Payable

Credit

4,200

Indicate whether each of the following statements is true or false with regards to the impact of this journal entry. 1.a) _____ Total claims stay the same 2.b) _____ Total assets stay the same 3.c) _____ Total liabilities decrease 4.d) _____ Cash flows from operating activities increases 5.e) _____ Stockholders' equity stays the same

33)

Assume that a company recorded the following journal entry, Account Title

Dividends Cash

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Debit 500

Credit

500

Indicate whether each of the following statements is true or false with regards to the impact of this journal entry. 1.a) _____ Net income decreases 2.b) _____ Total assets decrease 3.c) _____ Total liabilities stay the same 4.d) _____ Cash flows from investing activities decrease 5.e) _____ Stockholders' equity decreases

34)

Indicate whether each of the following statements is true or false

1.a) ________ The general ledger is often called the book of original entry. 2.b) ________ Transactions are first recorded in the journal and then transferred to the ledger. 3.c) ________ The process of making entries into a journal is called posting. 4.d) ________ The general ledger is an example of a source document. 5.e) ________ The list of a business's ledger accounts, and their account numbers is called a chart of accounts.

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35)

Consider each of the following accounting events:

1.1) Debited cash and credited common stock. 2.2) Debited accounts receivable and credited service revenue. 3.3) Debited office supplies and credited accounts payable. 4.4) Debited prepaid rent and credited cash. 5.5) Debited cash and credited accounts receivable. 6.6) Debited accounts payable and credited cash. 7.7) Debited dividends and credited cash. 8.8) Debited rent expense and credited prepaid rent. Required: For each of the events listed above, use the table shown below to: 1.a) Identify the transaction giving rise to that event as asset source (AS), asset use (AU), asset exchange (AX), or claims exchange (CX) transaction. 2.b) Show the effect of each transaction on the components of the accounting equation. Use "+" to signify an increase, "−" to signify a decrease, and "NA" to signify that a given element is not affected by the transaction. If one account increases and another account decreases within the same element, record “+/−” (i.e. an asset exchange transaction). Note that "Not Affected" means that the event does not affect that element of the financial statements.

Event

Type of Event

Assets

Liabilities

Common Stock

Retained Earings

(1) (2) (3) (4) (5) (6) (7) (8)

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36)

Consider the following list of transactions:

1.1) Provide services to customers on account 2.2) Purchase land by paying cash. 3.3) Purchase a fire insurance policy that will provide coverage for a two-year period 4.4) Acquire cash by issuing common stock. 5.5) Recognize expense for the amount of supplies that had been used during the period 6.6) Receive payment from a customer for services that will be provided over the next six months Required: 1.a) In the table below, indicate the accounts that would be debited and credited for each of the transactions listed above.

Transaction 1

Account to be debited

Account to be credited

2 3 4 5 6

1.b) Indicate how each transaction affects the financial statements using a "+" to signify an increase, "−" to signify a decrease, or "NA" to signify not affected under each component in the horizontal financial statements model shown below. In the last column, use the letters "OA" for operating activities, "IA" for investing activities, and "FA" for financing activities, or "NA" if the statement of cash flows is not affected. Event Assets = Liabilities + Stockholder's Revenue − Expnese = Net Statement Equity Income of Cash

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Flows 1

−

37)

Consider each of the following unrelated transactions:

1.a) Issued common stock for cash 2.b) Provided services for cash 3.c) Purchased supplies on account 4.d) Paid for the supplies purchased above 5.e) Paid cash dividends to stockholders Required: Using the table below, indicate the account that will be debited and the account that will be credited to record each of the transactions. Event a)

Accout Debited

Account Credited

b) c) d) e)

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38)

Matt's Computer Service entered into the following transactions during Year 1:

1.1) Issued stock to investors for $45,000 cash 2.2) Purchased land for $36,000 cash 3.3) Performed services on account for $51,000 4.4) Collected $33,600 from customers on account 5.5) Paid $19,500 cash for operating expenses Required: 1.a) Draw T-accounts and post the above transactions to the appropriate T-accounts. 2.b) Prepare a balance sheet for Matt's Computer Service for December 31, Year 1.

39)

Natalie Preston had the following transactions for Preston Business Services for Year 1:

1.1) Provided services on account for $30,000. 2.2) Purchased $7,500 of supplies on account. 3.3) At the end of the year, an adjusting entry was prepared for the supplies that had been used. The amount of supplies still on hand was $750. Required: 1.a) Fill in the three components of the accounting equation. Then, show the effect of each of these three events on the accounting equation by entering the dollar amounts in the appropriate columns. (Put parentheses around amounts that decrease a component of the accounting equation.) Accounting Equation = +

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1) 2) 3)

2. 3.b) Draw a T-account for each of the accounts that are affected by these transactions and record each of the transactions in the T-accounts. 4.c) Determine the amount of total assets at the end of Year 1. 5.d) Determine the amount of net income for Year 1.

40) Consider the following situations that require adjustments for Anaheim Company at December 31, Year 1: 1.1) Owed salary expenses totaling $10,500 that will be paid during January of Year 2 2.2) The supplies account has a balance of $2,400 and a physical count of the supplies revealed that $660 of unused supplies were available for future use 3.3) On October 1, Year 1, the company had collected an advance payment from a customer for $96,000 for services to be rendered equally over the six-month period beginning on that date. Required: Record the adjusting entry required for each of the situations described above.

Event Number 1)

General Journal Account Title

Debit

Credit

2) 3)

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41) The Grayson Clinic provides dental care services. During Year 1, the clinic entered into the following transactions: 1.1) On October 1, collected $9,000 in advance of services being provided. The services are to be performed equally over the next 12 months. 2.2) On April 1, purchased insurance costing $36,000. The insurance policy would cover the next 12 months. Required: 1.a) Draw T-accounts and record each of the adjustments required in those T-accounts. 2.b) Analyze how the year end adjusting entries affect the financial statements using the horizontal financial model below. (Put parentheses around amounts that decrease a financial statement element.)

Cash

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Assets Prepaid Insurance

Liabilities Unearned Revenue

Stockholder's Equity Common Stock Retained Earings

42)

Phelps Company entered into the following transactions during Year 1:

1.1) Provided services to customers for cash, $70,000 2.2) Purchased land by paying cash, $32,000 3.3) Paid rent in advance for 6 months, $24,000 4.4) Acquired cash of $50,000 by issuing common stock 5.5) Purchased supplies on account, $5,400 6.6) Receive payment of $6,000 from a customer for services that will be provided over the next six months. Required: 1.a) Prepare journal entries for each of the preceding transactions.

Event Number 1.

Account Title

Debit

Credit

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1.b) Show how each transaction affects the financial statements by inserting the related dollar amounts. Precede each amount with a plus sign ("+") if the transaction increases, a minus sign ("−") if the transaction decreases, or "NA" if the transaction does not affect a given element of the financial statements. In the last column, use the letters "OA" for operating activities, "IA" for investing activities, and "FA" for financing activities, or "NA" if the statement of cash flows is not affected. Event Assets = Liability + Stockholder's Revenue − Expenses = Net Statement Equity Income of Cash Flows 1. = + − = 2.

−

43)

Levitt Company prepared the following adjusted trial balance at the end of its fiscal year: Debit

Cash

Credit

$ 24,300

Account Receivable

12,000

Prepaid Rent

2,000

Land

49,000

Account Payable

$ 2,000

Common Stock

24,000

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Retained Earings

13,000

Sales Revenue

72,000

Rent Expense

16,200

Repair Expense

1,500

Utilities Expense

6,000

Totals

$ 111,000

$ 111,00

Required: 1.a) Draw T-accounts for all of the accounts that will be affected by the closing entries and insert the existing account balance in each of those accounts. 2.b) Enter the closing entries in the T-accounts. 3.c) Prepare a post-closing trial balance.

44) The following is a list of all of the account balances for the Jepson Corporation immediately prior to closing the books on December 31, Year 1: Cash Accounts receivable Suppiles Accounts payable Common stock Retained earnings Dividend Service revenue Rent expense Salaries expense Utilities expense Supplies expense

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12,000 78,000 6,000 12,000 60,000 20,400 24,000 144,000 36,000 60,000 12,000 8,400

Required: Prepare an adjusted trial balance dated December 31, Year 1.

45) The following is a list of adjusted account balances for Giddeon Company as of December 31, Year 1: Accounts payable Accounts receivable Cash Common Stock Insurance expense Land Maintenance expense Prepaid rent Rent expense Retained earnings Salaries expense Service revenue Unearned revenue Utilities expense

14,800 32,500 21,500 37,500 6,200 30,000 3,750 3,050 12,600 25,500 72,000 103,500 4,500 4,200

Required: 1.a) Prepare an adjusted trial balance. 2.b) Prepare an income statement and balance sheet using those adjusted account balances.

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46) The following is a list of adjusted account balances for Shenandoah Company as of December 31, Year 1: Accounts payable Accounts receivable Cash Common Stock Insurance expense Land Supplies Supplies expense Rent expense Retained earnings Salaries expense Service revenue Utilities expense

195,000 369,300 118,500 270,000 9,600 217,500 25,800 23,250 57,000 54,000 588,000 912,000 22,050

Required: 1.a) Prepare an adjusted trial balance. 2.b) Prepare the closing entries as of December 31, Year 1 in journal entry format. 3.c) Prepare an income statement. 4.d) Determine the balance in retained earnings after the closing entries had been posted.

47)

The following adjusted trial balance is for Wayne Company as of December 31, Year 1: Wayne Company Adjusted Trial Balance December 31, Year 1 Debit

Cash Accounts receivable

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Credit

$ 16,350 37,050

Supplies Land

1,650 120,000

Accounts payable

$ 27,000

Common stock

60,000

Retained earnings

35,400

Dividends

7,500

Consulting revenue

292,500

Salaries expense

180,000

Supplies expense

5,850

Insurance expense

10,500

Rent expense

36,000

Totals

$ 414,900

Required: Using this information: 1.a) Record the closing entries in journal entry format. 2.b) Prepare an income statement 3.c) Prepare a balance sheet 4.

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48) Stuart Corporation entered into the following transactions during the year ending December 31, Year 1: 1.1) Performed services for $26,000 cash 2.2) Purchased $800 of supplies on account 3.3) Purchased land for $95,000 cash 4.4) Paid salary expense of $16,500 5.5) Paid for $600 of the supplies purchased in event (2) 6.6) Collected $15,000 in advance for services to be provided over the next 12 months 7.7) Recognized $10,000 of revenue on the contract from event (6) 8.8) Owed $5,500 of salaries expenses to employees for work done during December, Year 1, that will be paid during January, Year 2. Required: Prepare the journal entries for these transactions and adjustments using the general journal format.

49) At December 31, Year 1, the records of Jefferson Corporation included the following adjusted account balances. (Note: This is an incomplete listing of the company's adjusted account balances.) Common stock Accounts payable Equipment Supplies Consulting revenue Supplies expense Dividends Utilities expense Cash Salaries expense Accounts receivable Rent expense

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$ 10,000 2,000 18,000 1,000 24,000 1,400 4,000 2,000 2,000 10,000 4,000 6,000

Required: 1.a) Prepare the necessary closing entries in general journal format. Account Titles

Debit

Credit

2. 3.b) Assuming the balance of retained earnings prior to closing was $6,400, determine the post-closing balance of this account.

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50) For each of the following journal entries, describe the event or adjustment that would have prompted the entry. The first has been completed for you as an example. Event Number 1)

Account Title Slaries expense

Debit

Credit

1,200

Salary payable

1,200

Accured $1,200 of salaries expense. 2)

Supplies

600

Accounts payable 3)

Cash

600 16,000

Unearned revenue 4)

Land

16,000 40,000

Cash 5)

Accounts receivable

40,000 655

Service revenue 6)

Unearned revenue

655 1,250

Service revenue 7)

Insurance expense Prepaid insurance

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1,250 360 360

Answer Key Test name: Chap 13_2e_Problem Materials 1) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I NA NA NA

Statement of Cash Flows I

In this transaction, the company acquired cash from the issue of common stock. This event increases both assets and stockholders' equity. Debits increase asset accounts, such as cash, and credits increase stockholders' equity accounts, such as common stock. The income statement is not affected. There is a cash inflow under financing activities on the cash flow statement. 2) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I NA I I NA I

Statement of Cash Flows NA

Recognizing revenue earned on account increases both assets and stockholders' equity. Accounts receivable is debited because the transaction increases assets. Revenue is credited because the transaction increases stockholders' equity (retained earnings). On the income statement, revenue increases which increases net income. There is no effect on the statement of cash flows because it is not a cash transaction (i.e. revenue was earned on account). 3)

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Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I/D NA NA NA NA NA

Statement of Cash Flows I

Collecting an account receivable increases one asset account and decreases another asset account. Debits increase asset accounts, such as cash, and credits decrease asset accounts, such accounts receivable. The income statement is not affected. There is a cash inflow from operating activities on the statement of cash flows. 4) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows I

Accepting the cash in advance creates an obligation for the company. The obligation is to provide future services to a customer. The company recognizes a liability called unearned revenue. Recording the event increases both assets and liabilities. Debits increase asset accounts, such as cash, and credits increase liability accounts, such as unearned revenue. There is no effect on the income statement because the revenue has not been earned at this point in time. There is a cash inflow from operating activities on the statement of cash flows. 5) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA NA NA

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Statement of Cash Flows D

Recognizing cash dividends decreases both assets and stockholders' equity. Because credits decrease assets, the decrease in assets (Cash) is recorded with a credit, and because debits decrease stockholders' equity (Dividends), the decrease in stockholders' equity is recorded with a debit. There is no effect on the income statement because paying a dividend is not an expense. There is a cash outflow from financing activities on the statement of cash flows. 6) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I I NA NA NA NA

Statement of Cash Flows NA

Purchasing supplies on account increases both assets and liabilities. Debits increase asset accounts, such as office supplies, and credits increase liability accounts, such as accounts payable. The income statement and statement of cash flows are not affected. 7) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D D NA NA NA NA

Statement of Cash Flows D

Paying cash to reduce liabilities decreases both assets and liabilities. Because credits decrease assets, the decrease in assets (Cash) is recorded with a credit, and because debits decrease liabilities, the decrease in liabilities (Accounts Payable) is recorded with a debit. There is no effect on the income statement. There is a cash outflow from operating activities on the statement of cash flows. 8) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net

Version 1

Statement of Cash 33

I/D

Equity NA

Income NA

Flows D

Purchasing land with cash increases one asset account and decreases another asset account. Because credits decrease assets, the decrease in assets (Cash) is recorded with a credit, and because debits increase assets, the increase in assets (Land) is recorded with a debit. The income statement is not affected. There is a cash outflow under investing activities on the statement of cash flows. 9) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

Making an adjusting entry to recognize rent expense decreases both assets and stockholders' equity. Because credits decrease assets, the decrease in assets (Prepaid Rent) is recorded with a credit and because debits decrease stockholders' equity, the decrease in stockholders' equity (Rent Expense) is recorded with a debit. On the income statement, expenses increase which decreases net income. There is no effect on the statement of cash flows. 10) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA D I I NA I

Version 1

Statement of Cash Flows NA

In the past, the company received payment for services that it had not provided which created the liability account, Unearned Revenue. Now the company has provided the services, which means it has earned the revenue and settled the obligation. Making an adjustment to recognize revenue (that was previously unearned) decreases liabilities and increases stockholders' equity. Because debits decrease liabilities, the decrease in liabilities (Unearned Revenue) is recorded with a debit, and because credits increase stockholders' equity, the increase to stockholders' equity (Service Revenue) is recorded with a credit. On the income statement, revenue increases which increases net income. There is no effect on the statement of cash flows. 11) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

An adjusting entry to recognize accrued salaries expense increases liabilities and decreases stockholders' equity. Because credits increase liabilities, the increase in liabilities (Salaries Payable) is recorded with a credit, and because debits decrease stockholders' equity the decrease in stockholders' equity (Salaries Expense) is recorded with a debit. On the income statement, expenses increase which decreases net income. There is no effect on the statement of cash flows. 12) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Version 1

Statement of Cash Flows NA

An adjustment to recognize the amount of supplies used during the period (supplies expense) decreases both assets and stockholders' equity. Because credits decrease assets, the decrease in assets (Supplies) is recorded with a credit and because debits decrease stockholders' equity, the decrease in stockholders' equity (Supplies Expense) is recorded with a debit. On the income statement, expenses increase which decreases net income. There is no effect on the statement of cash flows. 13) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income I/D NA NA NA NA NA

Statement of Cash Flows D

Paying cash to purchase furniture is an asset exchange transaction. One asset, Cash, decreases and another asset, Furniture, increases; total assets remain unchanged. Because credits decrease assets, the decrease to assets (Cash) is recorded with a credit and because debits increase assets, the increase to assets (Furniture) is recorded with a debit. There is no effect on the income statement. On the statement of cash flows, there is a cash outflow from investing activities. 14) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

This expense is an asset use event. Both assets and stockholders' equity decrease. Depreciation expense is debited and decreases stockholders' equity. Expenses are increased on the income statement which decreases net income. There is no effect on the statement of cash flows because depreciation is a non-cash expense. Accumulated depreciation (contra asset account) is credited, which decreases total assets. Version 1

15) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income D NA D NA I D

Statement of Cash Flows NA

This expense recognition is an asset use event. Both assets and stockholders' equity decrease. Because credits decrease assets, there is a credit to a contra-asset account (Allowance for Doubtful Accounts) and because debits decrease stockholders' equity, there is a debit to Uncollectible Accounts Expense. Expenses are increased on the income statement which reduces net income. The statement of cash flows is not affected. 16) Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenue − Expense = Net Equity Income NA I D NA I D

Statement of Cash Flows NA

Recognizing accrued interest expense increases liabilities and decreases stockholders' equity. Because credits increase liabilities, the increase in liabilities (Interest Payable) is recorded with a credit, and because debits decrease stockholders' equity, the decrease in stockholders' equity (Interest Expense) is recorded with a debit. Expenses are increased on the income statement which decreases net income. The statement of cash flows is not affected. 17) Debits increase asset accounts. Debits decrease liability accounts. Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders' equity accounts; credits increase liability and stockholders' equity accounts.

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18) Credits decrease asset accounts. Credits increase stockholders' equity accounts. Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders' equity accounts; credits increase liability and stockholders' equity accounts. 19) "Debit" means the left side of an account and refers to increases in asset, expense, and dividend accounts and decreases in revenue, liability, and stockholders' equity accounts. "Credit" means the right side of the account and refers to increases in revenues, liabilities, and stockholders' equity accounts and decreases in asset, expense, and dividend accounts. 20) Credits Debits decrease liability and stockholders' equity accounts; credits increase liability and stockholders' equity accounts. 21) Accounts Payable Accounts Payable, a liability account, is increased with a credit. Supplies, an asset account, is increased with a debit. 22) A trial balance is an internal accounting schedule that ensures that debits and credits are equal. Debit balances are listed in one column, and credit balances are listed in an adjacent column. The columns are totaled and the totals are compared. If the debit total does not equal the credit total, the accountant knows to search for an error. Equal debits and credits in a trial balance provide evidence rather than proof of accuracy. Even if the totals are equal, however, there may be errors in the accounting records. 23) Revenue, expense and dividend accounts are referred to as temporary accounts because information is held in these accounts temporarily. The balance in temporary accounts is closed at the end of the period (i.e. transferred to retained earnings) making these accounts have a zero balance at the beginning of each period. Version 1

24) Revenues, expenses, and dividends are temporary accounts and are closed at the end of the accounting period. These accounts are called temporary accounts. Note that dividends are not reported on either the income statement or the balance sheet. 25) a) F b) F c) T d) T e) F 1.a) This is false. Settling (or paying) accounts payable decreases this liability account. Decreases to liability accounts are recorded with debits rather than credits. 2.b) This is false. Payment of a cash expense decreases assets and stockholders' equity. Because credits decrease assets, the decrease in assets (Cash) is recorded with a credit; because debits decrease stockholders' equity, the decrease in stockholders' equity (Expense) is recorded with a debit. 3.c) This is true. Debits are always entered on the left, and credits on the right. 4.d) This is true. Credit entries decrease asset accounts. 5.e) This is false. Increases to revenues increase stockholders' equity and should be recorded with credits (rather than debits).

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26) a) F b) F c) T d) T e) F 1.a) This is false. A liability account is increased with a credit (rather than a debit). 2.b) This is false. When closing a revenue account, the credit balance in the revenue account is moved to the retained earnings account by debiting the revenue account to close it. The corresponding credit to retained earnings increases the balance in that account. 3.c) This is true. Debits decrease stockholders' equity. 4.d) This is true. Assets are decreased with credits. 5.e) This is false. Debits to the Cash account increase cash and would be reported as cash inflows on the statement of cash flows. 27) a)T b) F c) T d) T e) F 1.a) This is true. In a double-entry system, every journal entry includes at least one debit and one credit entry. 2.b) This is false. The double-entry format records each event separately although there are at least two components in each event. 3.c) This is true. Every journal entry must include equal debits and credits. 4.d) This is true. Thus, a decrease to an asset account may also include a decrease to a stockholders' equity account. For example, paying cash for salaries decreases assets (cash) with a credit and increases expenses (salaries expense). The debit to salaries expense actually decreases stockholders' equity (retained earnings). 5.e) This is false. Erroneous entries may still be entered into the accounting records, such as the following: the failure to record transactions; misclassifications, such as debiting the wrong account; or, incorrectly recording the amount of a transaction.

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28) a) T b)F c) F d) T e) T 1.a) This is true. An asset source transaction increases an asset, which would be recorded as a debit. This may be accompanied by an increase to stockholders' equity, which would be recorded with a credit. Examples include providing services for cash or on account. 2.b) This is false. An asset use transaction decreases an asset, which would be recorded as a credit (rather than a debit). This may be accompanied by a debit to a liability, which would decrease the liability. An example includes paying cash to settle accounts payable. 3.c) This is false. A credit to the Common Stock account would increase it. For example, the issuance of common stock for cash is an asset source transaction (rather than an asset use transaction) that increases Cash and increases Common Stock. 4.d) This is true. The payment of rent in advance is an asset exchange transaction that increases prepaid rent with a debit and decreases cash with a credit. 5.e) This is true. Recognition of rent expense, when payment had been made in advance, includes a debit to rent expense and a credit to prepaid rent. Both assets and stockholders' equity decrease.

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29) a) F b)T c) F d)F e) T 1.a) This is false. The entry to record the purchase of supplies involves a debit to supplies (to increase that asset account) and a credit to cash (to decrease that asset account). 2.b) This is true. Expenses are recorded with debits because expenses decrease stockholders' equity. Decreases to assets are recorded with credits. The entry to record the use of supplies involves a debit to supplies expense and a credit to supplies. 3.c) This is false. An asset use transaction involves a decrease to assets, which is recorded with a credit. 4.d) This is false. A debit to an asset account and a credit to a liability would describe an asset source transaction (rather than an asset exchange transaction). 5.e) This is true. A claims exchange transaction may involve a debit to a liability (decreasing it) and a credit to revenue stockholders' equity (increasing it). This entry would be made when recognizing revenue that had been collected in advance (and deferred).

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30) a) F b)T c) T d) T e) T 1.a) This is false. A company may provide services for cash, which would be recorded with a debit to cash and a credit to revenue. 2.b) This is true. Accruing salaries involves recording salaries expense (a debit) and increasing the liability salaries payable (a credit). 3.c) This is true. All adjusting entries increase expenses (debit) or increase revenue (credit). 4.d) This is true. The closing entry for an expense decreases both the expense and the retained earnings account and involves a debit to retained earnings and a credit to the expense. 5.e) This is true. The closing entry for revenue decreases the revenue account and increases the retained earnings account and involves a debit to the revenue account and a credit to retained earnings. 31) a) T b)T c) F d)F e) T 1.a) This is true. A credit to cash decreases that asset account. 2.b) This is true. A credit to cash decreases total assets. 3.c) This is false. There are no liabilities in this transaction. 4.d) This is false. Cash decreases, so it would be reported as a cash outflow, not inflow. 5.e) This is true. Salaries expense increases, which would cause net income to decrease.

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32) a) T b)T c) F d)F e) F 1.a) This is true. This is a claims exchange transaction that increases liabilities and decreases stockholders' equity (retained earnings). The increase to expenses decreases net income. Thus, total claims remain the same. 2.b) This is true. There are no assets in this transaction. 3.c) This is false. The credit to salaries payable increases that liability account, which increases total liabilities. 4.d) This is false. There is no effect on cash flows. 5.e) This is false. The debit to wages expense decreases stockholders' equity. 33) a)F b)T c)T d)F e) T 1.a) This is false. Dividends do not affect net income. 2.b) This is true. The credit to Cash decreases that asset account, which increases total assets. 3.c) This is true. There are no liabilities in this transaction. 4.d) This is false. Paying dividends will be recorded as a cash outflow from financing activities (rather than investing activities). 5.e) This is true. Paying a dividend decreases stockholders' equity (retained earnings).

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34) a)F b)T c)F d)F e) T 1.a) This is false. Transactions are recorded in journals before they are entered into ledger accounts. Journals are therefore books of original entry. 2.b) This is true. Transactions are first recorded in the journal and transferred to the ledger. 3.c) This is false. After transactions are initially recorded in a journal, the dollar amounts of each debit and credit are copied into the ledger accounts through a process called posting. 4.d) This is false. To simplify recordkeeping, businesses rely on source documents, such as cash register tapes, invoices, timecards, check registers, and deposit tickets. Data from source documents are initially recorded in journals and then they are entered into ledger accounts in the general ledger. 5.e) This is true. The chart of accounts is a list of all ledger accounts and their account numbers. 35) a) and b) Event (1) (2) (3) (4) (5) (6) (7) (8)

Type of Event AS AS AS AX AX AU AU AU

Assets

Liabilities

Common Stock

+ + + +− +− − − −

NA NA + NA NA − NA NA

+ NA NA NA NA NA NA NA

Retained Earings NA + NA NA NA NA − −

36) a) Transaction 1 2 3

Version 1

Account to be debited Account Receivable Land Prepaid Insurance

Account to be credited Revenue Cash Cash

4 5 6

Cash Office Supplies Expense Cash

Common Stock Office Supplies Unearned Revenue

b) Event Assets = Liabilities + Stockholder's Revenue − Expense = Net Statement Equity Income of Cash Flows 1 + = NA + + + − NA = + NA 2 + − or = NA + NA NA − NA = NA −IA NA 3 + − or = NA + NA NA − NA = NA −OA NA 4 + = NA + + NA − NA = NA +FA 5 − = NA + − NA − + = − NA 6 + = + + NA NA − NA = NA +OA

37) Event a) b) c) d) e)

Accout Debited Cash Cash Supplies Accounts payable Dividens

Account Credited Common stock Service revenue Accounts payable Cash Cash

38) a)

Debit 1) 4)

Debit

Cash Credit 45,000 33,600 23,100

36,000 2) 19,500 5)

Common Stock Credit 45,000 1)

Version 1

Debit 2)

Land Credit 36,000

Debit

Service Revenue Credit

51,000

Debit 3)

Accounts Receivable Credit 51,000 17,400

Debit 5)

33,600 4)

Operating Expense Credit 19,500

b) Matt's Computer Service Balance Sheet AS of December 31, Year 1 Assests Cash

$ 23,100

Account receivable

17,400

Land

36,400

Version 1

Total assets

$ 76,500

Stockholder's equity Common stock

45,000

Retained earnings

31,500

Total stockholder's equity

$ 76,500

Ending Retained Earnings = Beginning RE + Net Income − Dividends Since it is Year 1, beginning retained earnings is zero. The company did not pay dividends during Year 1; therefore dividends is equal to zero. Net income = Service revenue of $51,000 − $19,500 operating expenses = $31,500 Ending Retained Earnings is calculated as follows: Beginning RE of $0 + Net Income of $31,500− Dividends of $0 = $31,500 39) a) Assests 1)

30,000

7,500

(6,750)

Labilities

Equity 30,000

7,500 (6,750)

Debit 1.

Accounts Receivable Credit 30,000 30,000

Version 1

Accounts Payable Credit

Debit

7,500 2.

Revenue Credit

Debit

30,000

Supplies Credit

Debit 2.

7,500 750

6,750

Supplies Expense Credit

Debit 3.

6,750

c) $30,750 Total assets: = $30,000 + $750 = $30,750 d) $23,250 Net income = $30,000 − $6,750 = $23,250 40) Event 1)

Account Title Salaries Expense

Debit 10,500

Salaries Payable 2)

Supplies Expense

10,500 1,740

Supplies 3)

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Unearned Revenue

Credit

1,740 48,000

Service Revenue

48,000

Supplies Expense = $2,400 − $660 = $1,740 Service Revenue = $96,000 × (3/6) = $48,000 41) a) Unearned Revenue Credit

Debit

2,250 Revenue Credit

Debit

2,250 Prepaid Insurance Credit

Debit

27,000 Insurance Expense Credit

Debit

27,000

b) Assets Adjustment Cash

= Prepaid Insurance

1) 2)

Liabilities Unearned Revenue (2,250)

Stockholder's Equity Common Retained Stock Earings 2,250

(27000)

Revenue = $9,000 × (3/12) = $2,250 Insurance Expense = $36,000 × (9/12) = $27,000 42) a) Event Number 1.

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Account Title Cash

Debit

Credit

70,000

Service revenue 2.

70,000

Land

32,000

Cash 3.

32,000

Prepaid rent

24,000

Cash 4.

24,000

Cash

50,000

Common stock 5.

50,000

Supplies

5,400

Account payable 6.

5,400

Cash

6,000

Unearned revenue

6,000

Assets = Liabilit + Stockholder' Revenu − Expense = Net Statemen y s Equity e s Income t of Cash Flows +70,00 NA +70,000 +70,00 NA +70,00 +70,000 0 0 0 OA +32,00 NA NA NA NA NA −32,000 0 IA −32,00 0 +24,00 NA NA NA NA NA −24,000 0 OA −24,00 0 +50,00 NA +50,000 NA NA NA +50,000 0 FA +5,400 +5,400 NA NA NA NA NA

+6,000

Even t

1. 2.

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+6,000

+6,000 OA

43) a) and b)

Debit

Sales Revenue Credit 72,000 72,000

Debit

Utilities Expense Credit 6,000 6,000

Debit

Retained Earnings Credit 13,000 16,200

72,000

1,500 6,000 61,300

Debit

balance

Rent Expense Credit 16,200 16,200

Debit

Repairs Expense Credit 1,500 1,500

c) Debit

Version 1

Credit

Cash

$ 24,300

Account Receivable

12,000

Prepaid Rent

2,000

Land

49,000

Account Payable

$ 2,000

Common Stock

24,000

Retained Earnings

61,300

Totals

$ 87,300

Jepson Corporation Adjusted Trial Balance December 31, Year 1 Debit

Credit

44)

Cash

$ 12,000

Accounts receivable

78,000

Supplies

6,000

Accounts payable

$ 12,000

Common stock

60,000

Retained earnings

20,400

Dividends

24,000

Service revenue

144,000

Rent expense

36,000

Salaries expense

60,000

Utilities expense

12,000

Supplies expense

8,400

Version 1

Totals

$ 236,400

45) a) Giddeon Company Adjusted Trial Balance December 31, Year 1 Debit Cash

Credit

$ 21,500

Accounts receivable

32,500

Prepaid rent

3,050

Land

30,000

Accounts payable

$ 14,800

Unearned revenue

4,500

Common stock

37,500

Retained earnings

25,500

Service revenue

103,500

Salaries expense

72,000

Insurance expense

6,200

Maintenance expense

3,750

Rent expense

12,600

Utilities expense

4,200

Totals

$ 185,800

b) Giddeon Company Income Statement For the Year Ended December 31, Year 1 Service revenue

$ 103,500

Less expenses:

Version 1

Salaries expense

$ 72,000

Insurance expense

6,200

Maintenance expense

3,750

Rent expense

12,600

Utilities expense Net Income

4,200

98,750 $ 4,750

Giddeon Company Balance Sheet As of December 31, Year 1 Assets Cash

$ 21,500

Accounts receivable

32,500

Prepaid rent

3,050

Land

30,000

Total assets

$ 87,050

Liabilities Accounts payable

$ 14,800

Unearned revenue

4,500

Total liabilities

$19,300

Stockholders' Equity Common stock

37,500

Retained earnings

30,250

Total stockholders' equity Total liabilities and stockholders' equity

67,750 $ 87,050

46) a) Shenandoah Company

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Adjusted Trial Balance December 31, Year 1 Debit Cash

Credit

$ 118,500

Accounts receivable

369,300

Supplies

25,800

Land

217,500

Accounts payable

$ 195,000

Common stock

270,000

Retained earnings

54,000

Service revenue

912,000

Salaries expense

588,000

Supplies expense

23,250

Insurance expense

9,600

Rent expense

57,000

Utilities expense

22,050

Totals

$ 1,431,000

b) Account Titles Service Revenue

Debit 912,000

Retained Earnings Retained Earnings

Credit

912,000 699,900

Salaries Expense

588,000

Supplies Expense

23,250

Insurance Expense

9,600

Version 1

Rent Expense

57,000

Utilities Expense

22,050

Alternative solution: Account Titles Service Revenue

Debit 912,000

Credit

Salaries Expense

588,000

Supplies Expense

23,250

Insurance Expense

9,600

Rent Expense

57,000

Utilities Expense

22,050

Retained Earnings

212,100

c) Shenandoah Company Income Statement For the Year Ended December 31, Year 1 Service revenue

$ 912,000

Less expenses: Salaries expense

$ 588,000

Office supplies expense

23,250

Insurance expense

9,600

Rent expense

57,000

Utilities expense Net Income

22,050

699,900 $ 212,100

d) $266,100 Balance in retained earnings = $54,000 + $212,100 = $266,100

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47) a) Account Titles Consulting Revenue

Debit 292,500

Retained Earnings Retained Earnings

Credit

292,500 239,850

Salaries Expense

180,000

Supplies Expense

5,850

Insurance Expense

10,500

Rent Expense

36,000

Dividends

7,500

Alternative solution: Account Titles Consulting Revenue

Debit 292,500

Credit

Salaries Expense

180,000

Supplies Expense

5,850

Insurance Expense

10,500

Rent Expense

36,000

Dividends

7,500

Retained Earnings

52,650

b) Wayne Company Income Statement For the Year Ended December 31, Year 1 Consulting revenue

$ 292,500

Less expenses:

Version 1

Salaries expense

$ 180,000

Office supplies expense

5,850

Insurance expense

10,500

Rent expense Net Income

36,000

232,350 $ 60,150

c) Wayne Company Balance Sheet As of December 31, Year 1 Assets Cash

$ 16,350

Accounts receivable

37,050

Office supplies

1,650

Land

120,000

Total assets

$ 175,050

Liabilities Accounts payable

$ 27,000

Stockholders' Equity Common stock

$ 60,000

Retained earnings

88,050

Total stockholders' equity

148,050

Total liabilities and stockholders' equity

$ 175,050

48) Event Number

Version 1

Account Title

Debit

Credit

Cash

26,000

Service revenue 2)

Supplies

26,000 800

Account payable 3)

Land

800 95,000

Cash 4)

Salary expense

95,000 16,500

Cash 5)

Accounts payable

16,500 600

Cash 6)

Cash

600 15,000

Unearned revenue 7)

Unearned revenue

15,000 10,000

Service revenue 8)

Salary expense

10,000 5,500

Salaries payable

5,500

49) a) Account Titles Consulting revenue

Debit 24,000

Retained earnings Retained earnings

Credit

24,000 23,400

Supplies expense

1,400

Utilities expense

2,000

Salaries expense

10,000

Version 1

Rent expense

6,000

Dividendns

4,000

b) $7,000 Post-closing retained earnings balance = Pre-close balance of $6,400 + Revenues of $24,000 − Expenses of $19,400 (or $1,400 + $2,000 + $10,000 + $6,000) − Dividends of $4,000 = $7,000 50) Event Number 1)

Account Title Slaries expense

Debit

Credit

1,200

Salary payable

1,200

Accured $1,200 of salaries expense. 2)

Supplies

600

Accounts payable

600

Purchased $600 of supplies on account. 3)

Cash

16,000

Unearned revenue

16,000

Received $16,000 for services to be provided in the future. 4)

Land

40,000

Cash

40,000

Purchased $40,000 of land for cash. 5)

Accounts receivable

655

Service revenue

655

Provided $655 of service revenue on account. 6)

Version 1

Unearned revenue

1,250

Service revenue

1,250

Performed $1,250 of service from cash received in advance. 7)

Insurance expense

360

Prepaid insurance

360

Recongnized $360 of prepaid insurance expense.

Version 1

CHAPTER 13 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The year for which companies prepare their financial statements is their fiscal year. ⊚ true ⊚ false

2) Generally accepted accounting principles require that a business's fiscal year must end on December 31. ⊚ true ⊚ false

The T-account format is also called the chart of accounts. ⊚ true ⊚ false

4) Source documents provide information that serves as the basis for entries into the accounting system. Examples of source documents include invoices and deposit tickets. ⊚ true ⊚ false

A company's general ledger provides a chronological record of its business transactions. ⊚ true ⊚ false

The general journal is a list of a business's accounts and their account numbers. ⊚ true ⊚ false

The Dividends account normally has a credit balance. ⊚ true ⊚ false

Version 1

A liability account normally has a credit balance. ⊚ true ⊚ false

The balance in Retained Earnings is decreased by debiting the account. ⊚ true ⊚ false

10)

The left side of a T-account is the debit side. ⊚ true ⊚ false

11)

Debits decrease asset accounts. ⊚ true ⊚ false

12)

An increase to a liability account is recorded with a debit entry. ⊚ true ⊚ false

13) Double entry accounting requires that every entry must include at least one debit and at least one credit. ⊚ true ⊚ false

14)

To record the purchase of supplies on account, an accountant would credit Supplies. ⊚ true ⊚ false

15) When a company receives cash in advance from a customer, it should debit Cash and credit Accounts Receivable. ⊚ true ⊚ false Version 1

16) To record an asset source transaction, an asset account would be debited and a liability or stockholders’ equityaccount credited. ⊚ true ⊚ false

17) The type of transaction that would be represented by a debit to one asset and a credit to another asset is an asset source transaction. ⊚ true ⊚ false

18) The three primary asset use transactions are incurring expenses, accruing liabilities, and paying dividends. ⊚ true ⊚ false

19) The entry to record revenue earned on account includes a debit to accounts receivable and a credit to revenue. ⊚ true ⊚ false

20) Many companies choose to end their fiscal years during a part of the year when they expect low activity. ⊚ true ⊚ false

21) At the end of its fiscal year, a company must adjust its accounting records for unrecorded accruals and deferrals before it can prepare financial statements. ⊚ true ⊚ false

22) Closing entries move all current year data for revenues, expenses, and dividends into the retained earnings account. Version 1

⊚ ⊚

23)

true false

A business's chart of accounts is prepared to verify the equality of debits and credits. ⊚ true ⊚ false

24) A company's adjusted trial balance provides the information needed to prepare the balance sheet and income statement. ⊚ true ⊚ false

25) A trial balance can only be prepared at the end of the fiscal year, as part of the adjusting and closing processes. ⊚ true ⊚ false

26)

A trial balance can be in balance, even if there are errors in the accounting system. ⊚ true ⊚ false

27) Journals are sometimes called books of original entry because transactions are recorded in journals before amounts are entered into the ledger. ⊚ true ⊚ false

28)

All of a company’s temporary accounts appear on the income statement. ⊚ true ⊚ false

29) Posting is the process of determining the balance in an account by subtracting debits and credits.

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⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 30) Which of the following accounts normally has a debit balance? A) Prepaid Insurance B) Unearned Service Revenue C) Accounts Payable D) Common Stock

31) Account Number (1) (2) (3) (4) (5) (6) (7) (8)

Account Title Cash Service Revenue Accounts Receivable Salaries Expense Dividends Common Stock Salaries Payable Retained Earnings

Which of the following is a true statement? (Note: A statement may be true even if it does not identify all accounts that appear on that particular financial statement.) A) Account numbers 2, 4, and 5 will appear on the income statement. B) Account numbers 1, 3, and 8 will appear on the balance sheet. C) Account numbers 2, 5, and 8 will appear on the statement of cash flows. D) Account numbers 4, 5, and 6 will appear on the statement of changes in stockholders' equity.

32) Account Number

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Account Title

(1) (2) (3) (4) (5) (6) (7) (8)

Cash Service Revenue Accounts Receivable Salaries Expense Dividends Common Stock Salaries Payable Retained Earnings

Which of the following is a true statement? (Note: A statement may be true even if it does not identify all accounts that have debit balances on that particular financial statement). A) Account numbers 1, 3, and 5 normally have debit balances. B) Account numbers 2, 4, and 5 normally have debit balances. C) Account numbers 2, 5, and 8 normally have debit balances. D) Account numbers 4, 5, and 6 normally have debit balances.

33)

What is the term used to describe the left side of a T-account? A) Equity Side B) Debit Side C) Credit Side D) Claims Side

34)

What is the term used to describe the right side of a T-account? A) Credit Side B) Claims Side C) Debit Side D) Equity Side

35) What is the term that is used to describe the difference between the total debit and credit amounts in a T-account?

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A) Net Income B) Trial Balance C) Equality D) Account Balance

36)

Which of the following statements about debits is false? A) Debits increase assets. B) Debits decrease stockholders’ equity. C) Debits decrease liabilities. D) Debits increase liabilities.

37) Warren Company began the accounting period with a $54,000 debit balance in its accounts receivable account. During the accounting period, the company recorded revenue on account amounting to $120,000. The accounts receivable account at the end of the accounting period contained a $27,000 debit balance. Based on this information, what isthe amount of cash collected from customers during the period? A) $39,000 B) $135,000 C) $99,000 D) $147,000

38) Warren Company began the accounting period with a $32,000 debit balance in its accounts receivable account. During the accounting period, the company recorded revenue on account amounting to $88,000. The accounts receivable account at the end of the accounting period contained a $16,000 debit balance. Based on this information, what is the amount of cash collected from customers during the period? A) $104,000 B) $40,000 C) $72,000 D) $84,000

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39) Benson Company purchased land and paid the full purchase price in cash. Which of the following would be included in the journal entry necessary to record this event? A) A debit to Land and a debit to Cash B) A debit to Cash and a credit to Land C) A credit to Land and a credit to Cash D) A debit to Land and a credit to Cash

40)

Which of the following statements regarding credit entries is true? A) Credits decrease liability accounts. B) Credits increase asset accounts. C) Credits increase the common stock account. D) Credits increase asset and common stock accounts and decrease liability accounts.

41)

Which of the following elements is increased with a debit? A) Stockholders’ Equity B) Liabilities C) Assets D) None of these choices are increased with a debit

42)

Which of the following is decreased with a credit? A) Assets B) Liabilities C) Stockholders’ Equity D) Net Income

43)

If you debit an expense account, what impact does that have on stockholders’ equity?

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A) Decreases stockholders’ equity B) Increases stockholders’ equity C) There is no effect on stockholders’ equity D) Decreases net income but has no effect on stockholders’ equity

44) The Baker Company purchased $1,000 of supplies on account. How would this event be reflected in T-accounts? A) On the right side of the Supplies T-account B) On the left side of the Supplies T-account C) On the left side of the Accounts Payable T-account D) On the right side of the Cash T-account

45)

A transaction has been recorded in the T-accounts of Gibbs Company as follows:

Cash Debit

Credit 1,500

Unearned Revenue Debit Credit 1,500

Which of the following could be an explanation for this transaction? A) Cash has been paid out to a company that will provide future services to Gibbs Company. B) Gibbs has completed services for which they had earlier received cash in advance. C) Gibbs has provided services to a customer on account. D) Gibbs has received cash for services to be provided in the future.

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46)

A transaction has been recorded in the T-accounts of Horowitz Corporation as follows:

Cash Debit

Credit 25,000 Common Stock

Debit

Credit 25,000

Which of the following reflects how this event affects the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue - Expense = Net Flows Equity Income A. + + N/A N/A N/A N/A +FA B.

N/A

+FA

−

N/A

−

N/A

−

+OA

−

N/A

−

−IA

A) Option A B) Option B C) Option C D) Option D

47)

A transaction has been recorded in the T-accounts of Powell Corporation as follows:

Rent Expense Debit

Credit 1,000 Prepaid Rent

Debit

Credit 1,000

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Which of the following reflects how this event affects the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + N/A N/A N/A N/A +FA B.

−

N/A

−

N/A

−

N/A

+OA

−

N/A

−

−OA

A) Option A B) Option B C) Option C D) Option D

48)

A transaction has been recorded in the T-accounts of Vernon Company as follows:

Land Debit

Credit 10,000 Cash

Debit

Credit 10,000

Which of the following reflects how this event affects the company's financial statements? Balance Sheet Assets = Liability + Stock Equity A. + + n/a B.

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n/a

Income Statement Statement of Cash Flows Revenue − Expenses = Net Income n/a n/a n/a +FA n/a

n/a

−FA

n/a

−IA

+/−

n/a

−IA

A) Option A B) Option B C) Option C D) Option D

49) The Wagner Company acquired $500,000 cash from the issue of common stock. How would this transaction be recorded in the company’s T-accounts? A) Cash 500,000

Common Stock 500,000

B) Common Stock 500,000

Cash 500,000

C) Common Stock 500,000

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Retained Earnings 500,000

D) Retained Earnings 500,000

Common Stock 500,000

50) Fitzpatrick Company had $500 of accrued salary expenses that will be paid during the following accounting period. How would the related adjusting entry be recorded in the company’s T-accounts? A) Salaries Expense 500

Cash 500

B) Cash 500

Salaries Expense 500

C) Version 1

Salaries Expense 500

Salaries Payable 500

D) Salaries Payable 500

Salaries Expense 500

51) Bijan Corporation earned $4,000 of revenue that had been deferred. How would the related adjusting entry be recorded in the company’s T-accounts? A) Cash 4,000

Unearned Revenue 4,000

B) Cash 4,000

Revenue 4,000

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C) Revenue 4,000

Unearned Revenue 4,000

D) Unearned Revenue 4,000

Revenue 4,000

52)

A transaction has been recorded in the T-accounts of Simpson Company as follows:

Cash Debit

Credit 850

Notes Payable Debit Credit 850

Which of the following could be an explanation for this transaction?

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A) The company borrowed $850. B) The company loaned $850 to another company. C) The company repaid a $850 debt. D) Simpson acquired $850 cash from the issue of common stock.

53)

A transaction has been recorded in the T-accounts of Hough Company as follows:

Cash Debit

Credit 500

Notes Payable Debit Credit 500

Which of the following reflects how this event affects the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + N/A N/A + − +FA B.

N/A

+OA

N/A

+OA

N/A

+FA

A) Option A B) Option B C) Option C D) Option D

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54) On August 1, Year 1, Benjamin and Associates collected $18,000 in advance for legal services to be rendered for one year. Which of the following entries reflect the end-of-the-year adjustment to reflect revenue earned? A)

Cash

7,500

Revenue

7,500

Accounts Receivable

6,000

Revenue

6,000

Cash

18,000

Unearned Revenue

10,500

Revenue

7,500

Unearned Revenue Revenue

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7,500 7,500

55) The employees of Able Company have worked the last two weeks of Year 1, but the employees' salaries have not been paid or recorded as of December 31, Year 1. The adjusting entry that Able should make to accrue these unpaid salaries on December 31, Year 1 is: A) debit to Salaries Expense and credit to Cash. B) debit to Salaries Expense and credit to Salaries Payable. C) debit to Salaries Payable and credit to Salaries Expense. D) no entry is required until the employee is paid next period.

56) On October 1, Year 1, Senegal Company paid $1,200 in advance for rent of office space for one year and recorded a journal entry debiting Prepaid Rent and crediting Cash for $1,200. On December 31, Year 1, the required adjusting entry was recorded. What are the adjusted account balances at December 31, Year 1? A) Prepaid Rent, $300; Rent Expense, $900 B) Prepaid Rent, $1,200; Rent Expense, $0 C) Prepaid Rent, $0; Rent Expense, $1,200 D) Prepaid Rent, $900; Rent Expense, $300

57) During a company's first yearof operations, the asset account, Office Supplies, was debited for $3,500 for the purchases of supplies. At year-end, a physical count of the supplies on hand revealed that $1,425 of unused supplies were available for future use. How will the related adjusting entry affect the company’s financial statements? A) Expenses will increase, and assets will decrease by $2,075. B) Assets and expenses will both increase by $1,425. C) Expenses and assetswill both increase by $2,075. D) The related adjusting entry has no effect on net income or the accounting equation.

58) During a company's first year of operations, the asset account, Office Supplies, was debited for $2,300 for the purchases of supplies. At year-end, a physical count of the supplies on hand revealed that $825 of unused supplies were available for future use. How will the related adjusting entry affect the company’s financial statements? Version 1

A) Expenses will increase, and assets will decrease by $1,475. B) Assets and expenses will both increase by $825. C) Expenses and assets will both increase by $1,475. D) The related adjusting entry has no effect on net income or the accounting equation.

59)

Why are adjusting entries recorded at the end of the accounting period?

A) The Cash account must be adjusted for the effects of the daily transactions with customers and creditors. B) The company’s accounts must be adjusted to ensure that debits are equal to credits prior to preparing the trial balance. C) Unrecorded accruals and deferrals must be recognized before the financial statements can be prepared. D) The data from the temporary accounts (revenues, expenses, and dividends) must be moved into the retained earnings account.

60) On November 1, Year 1, Shumate Company paid $1,200 in advance for an insurance policy that covered the company for six months. Which of the following will be included in the adjustment required on December 31, Year 1? A) A debit to Prepaid Insurance for $400 B) A credit to Prepaid Insurance for $400 C) A debit to Insurance Expense for $1,200 D) A credit to Insurance Expense for $1,200

61)

The closing entry for the Dividends account would involve which of the following? A) A credit to Retained Earnings B) A credit to Dividends C) A credit to Common Stock D) A credit to Cash

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62) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash Dividends Land Accounts payable Retained earnings

$4,300 2,300 3,500 1,950 6,200

Accounts receivable Common stock Revenue Expense

$3,700 4,200 3,500 2,350

What is the amount of total assets that will be reported on the balance sheet as of December 31, Year 1? A) $13,800 B) $11,500 C) $7,800 D) $15,000

63) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash Dividends Land Accounts payable Retained earnings

$4,000 2,000 3,200 1,800 5,900

Accounts receivable Common stock Revenue Expense

$3,400 3,900 3,200 2,200

What is the amount of total assets that will be reported on the balance sheet as of December 31, Year 1? A) $12,600 B) $13,800 C) $7,200 D) $10,600

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64) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash Dividends Land Accounts payable Retained earnings

$4,100 2,100 3,300 1,850 6,000

Accounts receivable Common stock Revenue Expense

$3,500 4,000 3,300 2,250

What is the amount of net income that will be reported on the Year 1 income statement? A) $1,050 B) $2,250 C) $3,300 D) $250

65) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash Dividends Land Accounts payable Retained earnings

$4,000 2,000 3,200 1,800 5,900

Accounts receivable Common stock Revenue Expense

$3,400 3,900 3,200 2,200

What is the amount of net income that will be reported on the Year 1 income statement? A) $2,200 B) $3,200 C) $1,000 D) $200

66) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash

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$5,800

Accounts receivable

$5,200

Dividends Land Accounts payable Retained earnings

3,800 5,000 2,700 7,700

Common stock Revenue Expense

5,700 5,000 3,100

The amount of Carolina’s retained earnings on December 31, Year 1 was: A) $7,700 B) $10,800 C) $5,700 D) $5,800

67) The following pre-closing accounts and balances were drawn from the records of Carolina Company on December 31, Year 1: Cash Dividends Land Accounts payable Retained earnings

$4,000 2,000 3,200 1,800 5,900

Accounts receivable Common stock Revenue Expense

$3,400 3,900 3,200 2,200

The amount of Carolina’s retained earnings on December 31, Year 1 was: A) $5,900 B) $7,200 C) $3,900 D) $4,900

68)

Which one of the following would not be included in a closing entry? A) A credit to Rent Expense B) A debit to Unearned Revenue C) A debit to Service Revenue D) A credit to Dividends

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69) The trial balance of Barger Company at the end of the accounting period, immediately prior to recording closing entries, showed the following: Debit Cash

28,000

Land

54,000

Credit

Notes Payable

31,400

Common Stock

21,000

Retained Earnings

9,200

Service Revenue

67,000

Expenses

44,400

Dividends

2,200

Total

$ 128,600

What will the balance of the retained earnings accountbe after the closing entries are recorded? A) $31,800 B) $22,600 C) $20,400 D) $29,600

70) The trial balance of Barger Company at the end of the accounting period, immediately prior to recording closing entries, showed the following: Debit Cash

16,000

Land

30,000

Credit

Notes Payable

19,400

Common Stock

9,000

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Retained Earnings

14,000

Service Revenue

43,000

Expenses

38,400

Dividends

1,000

Total

$85,400

What will the balance of the retained earnings account be after the closing entries are recorded? A) $17,600 B) $4,600 C) $18,600 D) $3,600

71)

Which of the following statements is true?

A) Adjusting entries are recorded after the closing entries have been recorded. B) Equal totals in a trial balance guarantees that no errors were made in the recording process. C) Debits are equal to credits only after closing entries have been recorded. D) The balance in the retained earnings account in the trial balance will equal the retained earnings balance on the balance sheet only after closing entries have been posted to the general ledger.

72) Which of the following journal entries would be required to close a salaries expense account? A)

Salaries Expense Retained Earnings

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XXX XXX

Retained Earnings

XXX

Salaries Expense

XXX

Salaries Expense

XXX

Cash

XXX

Salaries Payable Retained Earnings

73)

XXX XXX

The journal entry to close the revenue account would include which of the following? A) A debit to both the revenue and the retained earnings account B) A credit to both the revenue and the retained earnings account C) A debit to the revenue account and a credit to the retained earnings account D) A credit to the revenue account and a debit to the retained earnings account

74)

Which of the following statements is true?

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A) Closing the revenue account increases retained earnings. B) Closing expense accounts decreases retained earnings. C) Closing the dividend account decreases retained earnings. D) All of the statements are true.

75)

Which of the following statements is true regarding the trial balance?

A) Incorrectly recording a cash sale as a sale on account would not cause the trial balance to be out of balance. B) The income statement is prepared using the post-closing trial balance. C) A balance of debits and credits ensures that all transactions have been recorded correctly. D) Trial balances are only prepared at the end of an accounting period.

76) Valley Packaging Company’s adjusted trial balance showed a zero balance in retained earnings. Which of the following is the most likely explanation for this? A) Valley reported zero net income in the current year. B) Valley’s trial balance will be out of balance until closing entries are recorded. C) The current year was Valley’s first year in business. D) An error must have been made in preparing Valley’s trial balance.

77) The following account balances were taken from the adjusted trial balance of Kendall Company: Revenues Operating Expenses Dividends Retained Earnings

$27,500 16,700 6,200 18,700

What is the Retained Earnings account balance that will be included on the post-closing trial balance?

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A) $29,500. B) $4,600. C) $23,300. D) $10,800.

78) The following account balances were taken from the adjusted trial balance of Kendall Company: Revenues Operating Expenses Dividends Retained Earnings

$22,400 15,000 4,500 17,000

What is the Retained Earnings account balance that will be included on the post-closing trial balance? A) $19,900 B) $7,400 C) $2,900 D) $24,400

79)

What effect will the following closing entry have on the retained earnings account?

Account Title Service Revenue

Debit 21,600

Credit

Interest Expense

1,450

Operating Expenses

16,900

Retained Earnings

3,250

A) Retained earnings will remain unchanged. B) Retained earnings will decrease by $3,250. C) Retained earnings will increase by $3,250. D) Retained earnings will be transferred to the income statement.

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80)

What effect will the following closing entry have on the retained earnings account?

Account Title Service Revenue

Debit 18,800

Interest Expense

Credit

750

Operating Expenses

15,500

Retained Earnings

2,550

A) Retained earnings will remain unchanged. B) Retained earnings will decrease by $2,550. C) Retained earnings will increase by $2,550. D) Retained earnings will be transferred to the income statement.

81) .

The following adjusted trial balance was drawn from the records of the Dakota Company Adjusted Trial Balance

Account Title Cash Equipment

Debit 400

Credit

1,000

Accounts Payable

400

Common Stock

300

Retained Earnings

200

Service Revenue

1,100

Operating Expenses

500

Dividends

100

Totals

2,000

Based on the information in the adjusted trial balance

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A) the total of the debit column in the post-closing trial balance will be $1,400. B) the total of the credit column in the post-closing trial balance will be $2,000. C) the total of the debit column in the post-closing trial balance will be $2,000. D) the total of the credit column in the post-closing trial balance will be $1,500.

82)

Which of the following is a (are) permanent account(s)? A) The Retained Earnings account B) All income statement accounts C) The Dividend account D) All balance sheet accounts and the Dividends account

83) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,090 cash from the issue of common stock. 2.2) Borrowed $560 from a bank. 3.3) Earned $930 of revenues. 4.4) Paid expenses of $390. 5.5) Paid a $120 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $465 of common stock. 2.2) Repaid $360 of its debt to the bank. 3.3) Earned revenues of $890. 4.4) Incurred expenses of $500. 5.5) Paid dividends of $240. What was the balance of Packard's Retained Earnings account before closing in Year 1?

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A) $540 B) $0 C) $630 D) $870

84) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. What was the balance of Packard's Retained Earnings account before closing in Year 1? A) $400 B) $0 C) $350 D) $450

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85) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $1,040 cash from the issue of common stock. 2.2) Borrowed $510 from a bank. 3.3) Earned $830 of revenues. 4.4) Paid expenses of $340. 5.5) Paid a $95 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $415 of common stock. 2.2) Repaid $310 of its debt to the bank. 3.3) Earned revenues of $840. 4.4) Incurred expenses of $450. 5.5) Paid dividends of $190. What is the after-closing amount of retained earnings that will be reported on Packard’s balance sheet at the end of Year 2? (Assume that closing entries have been made). A) $210 B) $595 C) $1,115 D) $785

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86) Packard Company engaged in the following transactions during Year 1, its first year of operations: (Assume all transactions are cash transactions.) 1.1) Acquired $950 cash from the issue of common stock. 2.2) Borrowed $420 from a bank. 3.3) Earned $650 of revenues. 4.4) Paid expenses of $250. 5.5) Paid a $50 dividend. During Year 2, Packard engaged in the following transactions: (Assume all transactions are cash transactions.) 1.1) Issued an additional $325 of common stock. 2.2) Repaid $220 of its debt to the bank. 3.3) Earned revenues of $750. 4.4) Incurred expenses of $360. 5.5) Paid dividends of $100. What is the after-closing amount of retained earnings that will be reported on Packard’s balance sheet at the end of Year 2?(Assume that closing entries have been made). A) $640 B) $800 C) $290 D) $740

87) Nelson Company began operations on December 1, Year 1. The following transactions and adjustments were recorded in December and posted to the company’s ledger accounts: 1.1) Acquired $3,800 cash from the issue of common stock to its stockholders. 2.2) Provided services on account for $3,300. 3.3) Paid $1,900 cash for land. 4.4) Owed $1,400 of salaries expenses to employees for work done in December that will be paid during January. 5.5) Purchased $500 of supplies on account to be used in January. 6.6) Collected $1,700 from customers. What is the total of the debit account balances that will be reported on the company's adjusted trial balance at December 31, Year 1?

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A) $9,000 B) $6,900 C) $3,500 D) $5,200

88) Nelson Company began operations on December 1, Year 1. The following transactions and adjustments were recorded in December and posted to the company’s ledger accounts: 1.1) Acquired $9,000 cash from the issue of common stock to its stockholders. 2.2) Provided services on account for $7,500. 3.3) Paid $4,500 cash for land. 4.4) Owed $3,000 of salaries expenses to employees for work done in December that will be paid during January. 5.5) Purchased $900 of supplies on account to be used in January. 6.6) Collected $3,900 from customers. What is the total of the debit account balances that will be reported on the company's adjusted trial balance at December 31, Year 1? A) $12,000 B) $20,400 C) $6,900 D) $28,800

89) How would the trial balance column totals be affected if a $600 credit to Service Revenue was erroneously posted as a $600 debit to Salaries Expense? A) The credit column of the trial balance would be $600 more than the debit column. B) The debit column of the trial balance would be $1,200 more than the credit column. C) The credit column of the trial balance would be $1,200 more than the debit column. D) The debit column of the trial balance would be $600 more than the credit column.

90)

The following is a trial balance of Barnhart Company as December 31, Year 1:

Account Title:

Version 1

Debit

Credit

Cash

14,200

Accounts Receivable

4,100

Accounts Payable

3,650

Common Stock

8,300

Retained Earnings

4,670

Service Revenue

9,150

Operating Expenses Dividends Totals

6,800 670 25,770

25,770

What is the total amount of assets that will be reported on the balance sheet prepared as of December 31, Year 1? A) $27,450. B) $14,200. C) $18,300. D) $25,770.

91)

The following is a trial balance of Barnhart Company as December 31, Year 1:

Account Title: Cash

Debit 12,500

Accounts Receivable

3,250

Credit

Accounts Payable

2,800

Common Stock

6,600

Retained Earnings

4,500

Service Revenue

7,450

OperatingExpenses

Version 1

5,100

Dividends

500

Totals

21,350

What is the total amount of assets that will be reported on the balance sheet prepared as of December 31, Year 1? A) $21,350 B) $12,500 C) $15,750 D) $23,200

92) The following is a random list of the adjusted account balances of Wyoming Company as of the end of the current accounting period: Cash Accounts Payable Land Operating Expenses

18,900 5,600 25,900 13,300

Accounts Receivable Service Revenue Retained Earnings Common Stock

6,600 19,100 18,100 21,900

What is the total of the credit account balances that will be shown on the adjusted trial balance? A) $63,700 B) $65,700 C) $64,700 D) $45,600

93) The following is a random list of the adjusted account balances of Wyoming Company as of the end of the current accounting period:

Cash Accounts Payable Land Operating Expenses

34,000 7,400 48,000 22,800

Accounts Receivable Service Revenue Retained Earnings Common Stock

9,400 34,400 32,400 40,000

What is the total of the credit account balances that will be shown on the adjusted trial balance?

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A) $112,200 B) $114,200 C) $116,200 D) $79,800

94) Which of the following errors would cause the debit side of a trial balance to be larger than the credit side? A) Revenue earned on account was recorded with a debit to Cash and a credit to Revenue. B) Purchase of supplies on account was recorded with a credit to Supplies and a debit to Accounts Payable. C) Land purchased with cash was recorded with a debit to the Land account and a credit to Accounts Payable. D) None of these answer choices would cause the debit side of the trial balance to be larger than the credit side.

95)

Which of the following statements is true regarding a trial balance that balances?

A) All transactions have been properly recorded. B) There are no missing transactions. C) This equality can only be achieved after closing entries have been recorded and posted to the ledger accounts. D) The equality of debits and credits has been proven.

96)

Explain how the following general journal entry affects the accounting equation.

Account Title Accounts Receivable Service Revenue

Version 1

Debit 500

Credit

500

A) Both assets and stockholders’ equity increase. B) Both liabilities and assets increase. C) Assets increase and stockholders’ equity decreases. D) Liabilities increase and stockholders’ equity decreases.

97)

The following transaction has been recorded in the general journal entry:

Account Title Accounts Payable

Debit 1,200

Cash

Credit

1,200

Which of the following could be an explanation for this transaction? A) Provided services on account. B) Paid cash to settle accounts payable. C) Collected cash from customers. D) Borrowed money to support operating activities.

98)

The following transaction has been recorded in the general journal:

Account Title Interest Expense Interest Payable

Debit 150

Credit

150

How will this transaction affect the company’s financial statements after it is posted to the ledger accounts? A) Decreases Total Liabilities B) Increases Retained Earnings C) Decreases Total Assets D) Decreases Stockholders’ Equity

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99) A transaction has been recorded in the general journal of Van Buren Company as follows: Account Title Cash

Debit 5,000

Credit

Service Revenue

5,000

Which of the following describes how this entry affects the company's financial statements when it is posted to the ledger accounts? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + N/A N/A + − N/A B.

N/A

+OA

N/A

+FA

N/A

+OA

A) Option A B) Option B C) Option C D) Option D

100)

A transaction has been recorded in the general journal of Todd Company as follows:

Account Title Supplies

Debit 800

Accounts Payable

Credit

800

Which of the following could be an explanation for this transaction?

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A) Incurred supplies expense B) Purchased supplies on account C) Used supplies D) Purchased supplies with cash

101) Kincaid Company provided consulting services of $6,100 to a customer who paid $3,100 and promised to pay the remainder next month. Which of the following journal entries correctly records this transaction? A)

Cash

3,100

Accounts Payable

3,000

Consulting Revenue

6,100

Cash

3,100

Accounts Receivable

3,000

Consulting Revenue

6,100

Cash Consulting Revenue

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3,100 3,100

Consulting Revenue

6,100

Cash

3,100

Accounts Receivable

3,000

102) Kincaid Company provided consulting services of $2,500 to a customer who paid $1,300 and promised to pay the remainder next month. Which of the following journal entries correctly records this transaction? A)

Cash

1,300

Accounts Payable

1,200

Consulting Revenue

2,500

Cash

1,300

Accounts Receivable

1,200

Consulting Revenue

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2,500

Cash

1,300

Consulting Revenue

1,300

Consulting Revenue

2,500

Cash

1,300

Accounts Receivable

1,200

103)

A transaction has been recorded in the general journal of Manella Company as follows:

Account Title Cash

Debit 6,000

Unearned Revenue

Credit

6,000

Which of the following could be an explanation for this transaction? A) Paid cash to a customer who requested a refund. B) Received cash in advance for work to be performed in future months. C) Recorded adjusting entry for work completed. D) Received cash for services completed.

104)

A transaction has been recorded in the general journal of Deluty Company as follows:

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Account Title Unearned Revenue

Debit 600

Credit

Consulting Revenue

600

Which of the following describes the effect of this transaction on the company’s financial statements? A) Increases Stockholders’ Equity B) Increases Liabilities C) Decreases Assets D) Increases Assets

105)

The Youngstown Company recorded the following adjustment in general journal format:

Account Title Supplies Expense

Debit 500

Credit

Supplies

500

Which of the following choices accurately reflects how this event would affect the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + N/A + N/A + +OA B.

−

N/A

−

N/A

−

−OA

−

N/A

−

N/A

−

+OA

−

N/A

−

N/A

−

N/A

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A) Option A B) Option B C) Option C D) Option D

106)

The Lazarus Company recorded the following adjustment in general journal format:

Account Title Rent Expense

Debit 1,200

Credit

Prepaid Rent

1,200

−

N/A

−

N/A

−

−OA

−

N/A

−

N/A

−

N/A

−

N/A

−

−IA

A) Option A B) Option B C) Option C D) Option D

107)

The following entry is taken from the journal of a merchandising company:

Account Title Cost of Goods Sold Merchandise Inventory

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Debit 6,000

Credit

6,000

What is the effect of this entry on the company’s financial statements? A) Assets and stockholders’ equity increase. B) Assets and liabilities increase. C) Assets and stockholders’ equity decrease. D) Assets decrease and stockholders’ equity increases.

108) Abbott Company purchased $8,300 of merchandise inventory on account. Which of the following entries would be required to record this transaction? A)

Cost of Goods Sold

8,300

Accounts Payable

8,300

Accounts Payable

8,300

Purchases

8,300

Accounts Payable Inventory

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8,300 8,300

Inventory

8,300

Accounts Payable

8,300

109) Abbott Company purchased $6,500 of merchandise inventory on account. Which of the following entries would be required to record this transaction? A)

Accounts Payable

6,500

Purchases

6,500

Inventory

6,500

Accounts Payable

6,500

Cost of Goods Sold

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6,500

Accounts Payable

6,500

Accounts Payable

6,500

Inventory

110)

6,500

Peterson Corporation recorded an adjusting entry using T-accounts as follows:

Depreciation Expense Debit Credit 750 Accumulated Depreciation Debit Credit 750

Which of the following reflects how this adjustment affects the company's financial statements? Balance Sheet Income Statement Statement of Cash Assets = Liabilities + Stockholders’ Revenue − Expense = Net Flows Equity Income A. + + N/A N/A N/A N/A +FA B.

−

N/A

−

N/A

−

N/A

+OA

−

N/A

−

−OA

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A) Option A B) Option B C) Option C D) Option D

111) On August 1, Year 1, Bellisa Company issued a $24,000 8%, 5-year note to Citizens Bank. Which of the following entries reflects the adjustment required as of December 31, Year 1? A)

Interest Payable

1,920

Interest Expense

1,920

Interest Expense

800

Notes Payable

800

Interest Expense Interest Payable

800 800

D) Version 1

Interest Expense Interest Payable

1,920 1,920

112) On August 1, Year 1, Bellisa Company issued a $10,000 6%, 1-year note to Citizens Bank. Which of the following entries reflects the adjustment required as of December 31, Year 1? A)

Interest Expense

600

Interest Payable

600

Interest Payable

600

Interest Expense

600

Interest Expense Notes Payable

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250 250

Interest Expense Interest Payable

250 250

113) The adjusting entry to record an expense related to the use of a delivery van would involve which of the following? A) A debit to Accumulated Depreciation B) A credit to Delivery Van C) A debit to Depreciation Expense D) A debit to Retained Earnings

114) A $200 credit to Interest Payable was instead recorded in error as a $200 credit to Cash in an adjusting entry, which has been posted to the ledger accounts. Which of the following is the result of this error? A) The trial balance is out of balance by $200. B) Total assets are understated by $200. C) Net income is overstated by $200. D) Total liabilities are overstated by $200.

115) Manhattan Company recorded an adjusting entry to accrue interest owed of $600 as of December 31, Year 1. When the related note was paid during Year 2, the company paid $1,050 in interest. Which of the following journal entries correctly records this Year 2 transaction? (Assume that the entry to record the payment of the note itself was recorded in a separate journal entry.) A)

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Interest Expense

450

Cash

450

Interest Expense

1,050

Cash

600

Interest Payable

450

Interest Expense

1,050

Cash

1,050

Interest Expense

450

Interest Payable

600

Cash

Version 1

1,050

116) Manhattan Company recorded an adjusting entry to accrue interest owed of $300 as of December 31, Year 1. When the related note was paid during Year 2, the company paid $450 in interest. Which of the following journal entries correctly records this Year 2 transaction? (Assume that the entry to record the payment of the note itself was recorded in a separate journal entry.) A)

Interest Expense

450

Cash

450

Interest Expense

450

Cash

300

Interest Payable

150

Interest Expense

150

Cash

150

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Interest Expense

150

Interest Payable

300

Cash

117)

450

Which of the following statements about the entry to record depreciation is true? A) The entry involves a credit to a liability. B) The entry involves a credit to Depreciation Expense. C) The entry involves a credit to the asset being depreciated. D) The entry involves a credit to a contra-asset account .

118)

A transaction has been recorded in the journal of Davis Company as follows:

Account Title Interest Expense Interest Payable

Debit 800

Credit

800

Which of the following describes the effect of this transaction on the company’s financial statements? A) Decreases Liabilities B) Increases Stockholders’ Equity C) Increases Liabilities D) Decreases Assets

119) Vargas Company purchased a computer for $3,400 on January 1, Year 1. The computer is estimated to have a 5-year useful life and a $700 salvage value. What adjusting entry would Vargas record on December 31, Year 1 to recognize expense related to use of the computer? A)

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Depreciation Expense

540

Computer

540

Accumulated Depreciation

540

Depreciation Expense

540

Depreciation Expense

680

Accumulated Depreciation

680

Depreciation Expense Accumulated Depreciation

540 540

120) Vargas Company purchased a computer for $3,000 on January 1, Year 1. The computer is estimated to have a 5-year useful life and a $500 salvage value. What adjusting entry would Vargas record on December 31, Year 1 to recognize expense related to use of the computer?

Version 1

Depreciation Expense

600

Accumulated Depreciation

600

Depreciation Expense

500

Computer

500

Depreciation Expense

500

Accumulated Depreciation

500

Accumulated Depreciation Depreciation Expense

Version 1

500 500

121)

Callahan Corporation recorded an adjusting entry using T-accounts as follows:

Interest Receivable Debit Credit 75 Interest Revenue Debit Credit 75

N/A

+OA

−

N/A

−

N/A

−

N/A

A) Option A B) Option B C) Option C D) Option D

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Answer Key Test name: Chap 13_2e_Test Bank_MCQs_TF 1) TRUE This is true. A fiscal year can be a calendar year; however, instead of using a calendar year, companies whose business is highly seasonal often choose “slow” periods to end their fiscal year. 2) FALSE This is false. A fiscal year can be a calendar year; however, instead of using a calendar year, companies whose business is highly seasonal often choose “slow” periods to end their fiscal year. 3) FALSE This is false. A chart of accounts is a list of a company's ledger accounts and their account numbers. 4) TRUE This is true. To simplify recordkeeping, businesses rely on source documents, such as cash register tapes, invoices, timecards, check registers, and deposit tickets. Data from source documents are initially recorded in journals and then they are entered into ledger accounts in the general ledger. 5) FALSE This is false. Journals provide a chronological record of business transactions. Transactions are recorded in journals before they are entered into ledger accounts. The collection of all the accounts used by a particular business is called the general ledger. 6) FALSE This is false. The chart of accounts is a list of all ledger accounts and their account numbers. 7) FALSE Version 1

This is false. Because dividends decrease stockholders’ equity (retained earnings), dividends normally carry a debit balance. The normal balance of an account is the side on which increases are recorded. 8) TRUE This is true. A liability account normally has a credit balance because increases to liabilities are recorded as credits. 9) TRUE This is true. Decreases to retained earnings are recorded as debits because stockholders’ equity is being decreased. 10) TRUE This is true. The left side of a T-account is the debit side. The right side is the credit side. 11) FALSE This is false. Debits increase asset accounts. 12) FALSE This is false. An increase to a liability account is recorded as a credit (rather than a debit). 13) TRUE This is true. Every entry must include at least one debit and at least one credit. 14) FALSE This is false. Office supplies are an asset and an asset is increased with a debit. Therefore, the purchase of office supplieson account would include a debit to the Supplies account (as well as a credit to accounts payable). 15) FALSE This is false. Accepting cash in advance from a customer creates an obligation to provide future services to the customer. The company will recognize a liability called unearned revenue by increasing that account with a credit. Version 1

16) TRUE This is true. An asset is increased in an asset source transaction, so the asset account is debited and the liability or stockholders’ equity account is credited. 17) FALSE This is false. This describes an asset exchange transaction (rather than an asset source transaction). 18) FALSE This is false. Accruing liabilities increases expenses and liabilities; no assets are involved. 19) TRUE This is true. Recognizing revenue earned on account increasesassets (debit accounts receivable) and increases stockholders’ equity (credit revenue). 20) TRUE This is true. Companies whose business is highly seasonal often choose “slow” periods to end their fiscal year. 21) TRUE This is true. Unrecorded accruals and deferrals must be recognized before the financial statements can be prepared. 22) TRUE This is true. Closing entries zero out temporary accounts and transfer the balances to the Retained Earnings account. 23) FALSE This is false. The chart of accounts is a list of all ledger accounts and their account numbers. A trial balance is an internal accounting schedule that ensures that debits and credits are equal. 24) TRUE This is true. The adjusted trial balance is used to prepare the income statement and the balance sheet. Version 1

25) FALSE This is false. Some companies prepare a trial balance daily; others may prepare one monthly, quarterly, or annually, depending on the needs of management. 26) TRUE This is true. Even if the debit and credit totals on the trial balance are equal, there may be errors in the accounting records. For example, equal trial balance totals would not disclose errors like the following: failure to record transactions; misclassifications (such as debiting the wrong account); or incorrectly recording the amount of a transaction. 27) TRUE This is true. Transactions are first recorded in the journal, and then posted to the ledger. 28) FALSE This is false. A company’s temporary accounts include revenues, expenses, and dividends. Dividends do not appear on the income statement. Dividends appear on the statement of changes in stockholders’ equity. 29) FALSE This is false. After transactions are initially recorded in a journal, the dollar amounts of each debit and credit are copied into the ledger accounts through a process called posting. 30) A Assets, such as prepaid insurance, normally have a debit balance; that is, debits increase those accounts. Liabilities, such as unearned revenue and accounts payable, normally have a credit balance; that is, credits increase those accounts. Stockholders’ equity accounts, such as common stock, normally have a credit balance; that is, credits increase those accounts. 31) B Version 1

A balance sheet reports assets, liabilities, and stockholders’ equity as of a selected date (usually the end of an accounting period). Cash and accounts receivable are asset accounts. Retained earnings is a stockholders' equity account. 32) A Asset, expense, and dividend accounts normally have debit balances; liability, stockholders’ equity, and revenue accounts normally have credit balances. Asset accounts include cash and accounts receivable. Dividends have a normal debit balance and appear on the statement of changes in stockholders’ equity. 33) B The left side of an account is the debit side. 34) A The right side of an account is the credit side. 35) D For any given account, the difference between the total debit and credit amounts is the account balance. 36) D Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. 37) D Beginning balance of accounts receivable + Sales on account − Collections on account = Ending balance of accounts receivable $54,000 + $120,000 − Cash collected on account = $27,000 Cash collected on account = $147,000 38) A

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Beginning balance of accounts receivable + Sales on account − Collections on account = Ending balance of accounts receivable $32,000 + $88,000 − Cash collected on account = $16,000 Cash collected on account = $104,000 39) D Land, an asset, is increased with a debit, and cash, another asset, is decreased with a credit. 40) C Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. Common Stock, a stockholders’ equity account, is increased with a credit. 41) C Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. 42) A Debits increase asset accounts; credits decrease asset accounts. Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. 43) A Debiting an expense account decreases stockholders’ equity. Debits decrease liability and stockholders’ equity accounts; credits increase liability and stockholders’ equity accounts. Debits increase asset accounts; credits decrease asset accounts. 44) B The purchase increased supplies, an asset account, and increased accounts payable, a liability account. Therefore, $1,000 will appear as a debit on the left side of the supplies T-account and as a credit on the right side of the accounts payable T-account. Version 1

45) D Cash, an asset, has been increased with a debit, and unearned revenue, a liability, has been increased with a credit. This indicates that Gibbs has collected cash for services to be provided in the future. 46) B In this transaction, common stock is issued for $25,000 cash. A debit to cash increases assets and a credit to common stock increases stockholders’ equity. The income statement is not affected, and the event is reported as a cash inflow from financing activities. 47) B Recognizing rent expense decreases both assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Prepaid Rent) will be recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Rent Expense) will be recorded with a debit. On the income statement, the event increases expenses and decreases net income. The event does not affect cash flows. 48) D The debit to the Land T-account increases total assets and the credit to the Cash T-account decreases total assets. The increase is offset by the decrease and total assets do not change as a result of this transaction. The income statement is not affected, and the transaction is reported as a cash outflow from investing activities. 49) A The event increases cash, an asset account, and common stock, a stockholders’ equity account. It is recorded as a debit in the Cash Taccount and a credit to the Common Stock account. 50) C

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Making an adjustment to recognize accrued salary expense increases liabilities and decreases stockholders' equity. Because credits increase liabilities, the increase in liabilities (Salaries Payable) is recorded with a credit and because debits decrease stockholders' equity, the decrease in stockholders' equity (Salaries Expense) is recorded with a debit. 51) D Earning $4,000 of revenue that had been deferred is recognized by transferring $4,000 from the liability account (Unearned Revenue) to an equity account (Revenue). Recognizing the revenue decreases liabilities and increases stockholders’ equity. Because debits decrease liabilities, the decrease in liabilities (Unearned Revenue) is recorded on the leftside of the t-account and because credits increase stockholders’ equity, the increase in stockholders’ equity (Revenue) is recorded on the right side of the t-account. 52) A The debit to Cash and credit to Notes Payable indicates that cash, an asset account, increased and notes payable, a liability account, increased. This would be caused by acquiring cash by issuing a note. 53) D The debit to Cash and credit to Notes Payable indicates that cash, an asset, and notes payable, a liability, both increased. There is no effect on the income statement, and the event is reported as a cash inflow from financing activities on the statement of cash flows. 54) D

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By December 31, Year 1, Benjamin and Associates would have provided legal services for 5 months (August through December), earning $7,500 of the revenue. This amount must be transferred from the liability account (Unearned Revenue) to an equity account (Revenue). Recognizing the revenue decreases liabilities and increases stockholders’ equity. Because debits decrease liabilities, the decrease in liabilities (Unearned Revenue) is recorded with a debit and because credits increase stockholders’ equity, the increase in stockholders’ equity (Revenue) is recorded with a credit. $18,000 ÷ 12 months = $1,500 per month. August through December is five months. $1,500 × 5 = $7,500. 55) B Able Company owes its employees for work done in Year 1 but will pay the salaries in Year 2. The required adjusting entry to recognize accrued salary expense increases liabilities and decreases stockholders’ equity. Because credits increase liabilities, the increase in liabilities (Salaries Payable) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Salaries Expense) is recorded with a debit. 56) D This is similar in concept to making a prepayment for insurance coverage. The monthly rent is $100 ($1,200 ÷ 12 months). By December 31, the company had rented (used) the office space for three months. The Prepaid Rent account has an adjusted balance of $900 ($1,200 − $300). The Rent Expense account will reflect the rent for those three months of $300 ($100 × 3). 57) A

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The company used $2,075 ($3,500 − $1,425) supplies during its first year of operations. Recognizing the supplies expense decreases both assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Supplies) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Supplies Expense) is recorded with a debit. 58) A The company used $1,475 ($2,300 − $825) supplies during its first year of operations. Recognizing the supplies expense decreases both assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Supplies) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Supplies Expense) is recorded with a debit. 59) C At the end of the accounting period, a company will have several unrecorded accruals and deferrals that must be recognized before the financial statements can be prepared. As a result, adjusting entries always involve (1) an asset or liability account and (2) a revenue or expense account. 60) B The monthly insurance cost is $200 ($1,200 ÷ 6 months). By December 31, Year 1 the company had used the insurance coverage for two months. Recognizing the insurance expense decreases both assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Prepaid Insurance) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Insurance Expense) is recorded with a debit. 61) B

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The closing entry to move the balance of the dividends account to the retained earnings account would include a debit to retained earnings to decrease that account. The credit to the dividends account leaves a zero balance in that account. 62) B Total assets = Cash of $4,300 + Land of $3,500 +Accounts receivable of $3,700 = $11,500 63) D Total assets = Cash of $4,000 + Land of $3,200 + Accounts receivable of $3,400 = $10,600 64) A Net income = Revenue of $3,300 − Expenses of $2,250 = $1,050 65) C Net income = Revenue of $3,200 − Expenses of $2,200 = $1,000 66) D Net income = Revenue of $5,000 − Expenses of $3,100 = $1,900 Ending retained earnings = Beginning retained earnings of $7,700 + Net income of $1,900 − Dividends of $3,800 = $5,800 67) D Net income = Revenue of $3,200− Expenses of $2,200 = $1,000 Ending retained earnings = Beginning retained earnings of $5,900 + Net income of $1,000 − Dividends of $2,000 = $4,900 68) B Closing entries move all current year data from the temporary accounts (revenues, expenses, and dividends) into the retained earnings account. The Unearned Revenue account is a liability account; it is not closed. 69) D

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Closing entries move all current year data from the temporary accounts (revenues, expenses, and dividends) into the retained earnings account. Ending retained earnings = Beginning retained earnings + Revenues − Expenses − Dividends. Ending retained earnings = $9,200 + $67,000 − $44,400 − $2,200 = $29,600. 70) A Closing entries move all current year data from the temporary accounts (revenues, expenses, and dividends) into the retained earnings account. Ending retained earnings = Beginning retained earnings + Revenues − Expenses − Dividends. Ending retained earnings = $14,000 + $43,000 − $38,400 − $1,000 = $17,600. 71) D Every entry (not only closing entries) must include at least one debit to an account and at least one credit to an account. This system is called double-entry accounting. Adjusting entries are recorded before (rather than after) the closing entries are recorded. If the debit total does not equal the credit total on the trial balance, the accountant knows to search for an error. Even if the totals are equal, however, there may be errors in the accounting records. Prior to posting closing entries, the balance in the retained earnings account will be the balance at the beginning of the accounting period. Only after closing entries are posted will the trial balance reflect the same retained earnings account balance as the balance sheet. 72) B

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Since the salaries expense account carries a debit balance, closing the account balance requires a credit entry. Since the retained earnings account carries a credit balance, decreasing the account balance requires a debit entry. 73) C Since the revenue account carries a credit balance, closing the account balance requires a debit entry.Since the retained earnings account carries a credit balance, increasing the account balance requires a credit entry. 74) D Closing entries transfer the balances from revenue, expense and dividend accounts into the retained earnings account. Closing a revenue account moves the balance in the revenue account into the retained earnings account. Since revenue has a positive effect on stockholders’ equity, moving its balance into retained earnings increases the retained earnings account balance. Expenses and dividends have the opposite effect. Moving balances from these accounts into retained earnings decreases the retained earnings account balance. 75) A Even if the debit and credit totals on the trial balance are equal, there may be errors in the accounting records. For example, equal trial balance totals would not disclose errors like the following: failure to record transactions; misclassifications (such as debiting the wrong account); or incorrectly recording the amount of a transaction. The income statement is prepared using the adjusted trial balance. 76) C The retained earnings balance in an adjusted trial balance will be its beginning balance because temporary accounts have not yet been closed. A beginning balance in retained earnings of zero is most likely due to the current year being the company’s first year in business. 77) C Version 1

Ending retained earnings = Beginning balance + Revenues − Expenses − Dividends Ending retained earnings = $18,700 + $27,500 − $16,700 − $6,200 = $23,300 78) A Ending retained earnings = Beginning balance + Revenues − Expenses − Dividends Ending retained earnings = $17,000 + $22,400 − $15,000 − $4,500 = $19,900 79) C A credit to retained earnings of $3,250 (to close the service revenue, interest expense, and operating expenses accounts) will increase retained earnings by $3,250. 80) C A credit to retained earnings of $2,550 (to close the service revenue, interest expense, and operating expenses accounts) will increase retained earnings by $2,550. 81) A The post-closing trial balance is prepared after the closing entries are transferred to the retained earnings account.The after-closing retained earnings balance is calculated as: $200 pre-closing retained earnings + $1,100 service revenue− $500 operating expenses− $100 dividends = $700 after closing retained earnings balance. As a result, the postclosing trial balance will appear as follows. Account Title Cash Equipment

Debit 400

Credit

1,000

Accounts Payable

400

Common Stock

300

Version 1

Retained Earnings

700

Service Revenue

Operating Expenses

Dividends

Totals

1,400

82) A The balance sheet accounts are permanent accounts; they contain information carried forward from one accounting period to the next (that is, the ending account balance of one period becomes the beginning account balance of the next period). Temporary accounts are used to collect retained earnings data applicable to only the current accounting period (that is, revenue, expenses, and distributions). The Dividend account is a temporary account; it collects distributions during the current account period only. 83) B Retained Earnings in the first year of operations is zero until revenues, expenses and dividends are closed to retained earnings. 84) B Retained Earnings in the first year of operations is zero until revenues, expenses and dividends are closed to retained earnings. 85) B $395 beginning balance + $840 revenue − $450 expenses − $190 dividends = $595 86) A $350 beginning balance + $750 revenue − $360 expenses − $100 dividends = $640 87) A

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Ending Cash balance = $3,800 − $1,900 + $1,700 = $3,600 Ending accounts receivable balance = $3,300 − $1,700 = $1,600 Debit balances = Cash of $3,600 + Accounts receivable of $1,600 + Land of $1,900 + Salaries expenses of $1,400 + Supplies of $500 = $9,000 To check: Credit balances = Accounts payable of $500 + Salaries payable of $1,400 + Revenue of $3,300 + Common stock of $3,800 = $9,000 88) B Ending Cash balance = $9,000 − $4,500 + $3,900 = $8,400 Ending accounts receivable balance = $7,500 − $3,900 = $3,600 Debit balances = Cash of $8,400 + Accounts receivable of $3,600 + Land of $4,500 + Salaries expenses of $3,000 + Supplies of $900 = $20,400 To check: Credit balances = Accounts payable of $900 + Salaries payable of $3,000 + Revenue of $7,500 + Common stock of $9,000 = $20,400 89) B The error would cause the debit column to be overstated by $600 and the credit column to be understated by $600. The difference between the two column totals would be $1,200. 90) C The two asset accounts listed on the trial balance are Cash and Accounts Receivable. Total assets = $14,200 + $4,100 = $18,300 91) C

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The two asset accounts listed on the trial balance are Cash and Accounts Receivable. Total assets = $12,500 + $3,250 = $15,750 92) C Credit balances = Accounts payable of $5,600 + Service revenue of $19,100 +Retained Earnings of $18,100 + Common Stock of $21,900 = $64,700 93) B Credit balances = Accounts payable of $7,400 + Service revenue of $34,400 + Retained earnings of $32,400 + Common stock of $40,000 = $114,200 94) D Equal trial balance totals would not disclose errors in misclassifications; that is, debiting the wrong account or crediting the wrong account. Even though the balances in the individual accounts would be incorrect as a result of each of the errors described, the totals in the trial balance would be in balance. 95) D The trial balance only proves the equality of debits and credits. It does not detect missing or incorrect entries that were recorded with equal debits and credits. If the debit total does not equal the credit total on the trial balance, adjusted trial balance, or post-closing trial balance, the accountant knows to search for an error. 96) A Recognizing revenue on account increases both assets and stockholder’ equity. Because debits increase assets, the increase in assets (Accounts Receivable) is recorded with a debit, and because credits increase stockholders’ equity, the increase in stockholders’ equity (Service Revenue) is recorded with a credit. Version 1

97) B The journal entry shows a decrease in cash with a credit and a decrease in accounts payable with a debit, which could be explained by the payment of cash to settle accounts payable. 98) D Accruing interest expense increases liabilities and decreases stockholders’ equity. Because credits increase liabilities, the liability account (Interest Payable) is recorded with a credit and because debits decrease stockholders’ equity, the stockholders’ equity account (Interest Expense) will be recorded with a debit. 99) D Earning revenue increases both assets and stockholders’ equity. Because debits increase assets, the increase to assets (Cash) is recorded with a debit, and because credits increase stockholders’ equity, the increase to stockholders’ equity (Service Revenue) is recorded with a credit. On the income statement, revenue increases which increases net income. There is a cash inflow from operating activities on the statement of cash flows. 100) B The purchase of supplies on account would increase supplies (a debit) and increase accounts payable (a credit). Asset accounts are increased with debits and decreased with credits. Liability accounts are increased with credits and decreased with debits. 101) B The company would record an increase in assets by debiting Cash by $3,100 and debiting Accounts Receivable by $3,000. The company would record an increase to stockholders’ equity by crediting Consulting Revenue by $6,100. 102) B

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The company would record an increase in assets by debiting Cash by $1,300 and debiting Accounts Receivable by $1,200. The company would record an increase to stockholders’ equity by crediting Consulting Revenue by $2,500. 103) B The debit to Cash increases this asset account and the credit to unearned revenue increases this liability account. That would be the journal entry recorded when cash is collected as an advance for work to be performed in the future. 104) A The debit to unearned revenue decreases that liability account and the credit to consulting revenue increases that revenue account, which increases stockholders’ equity (retained earnings). 105) D Recognizing supplies expense decreases both assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Supplies) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Supplies Expense) is recorded with a debit. Expenses are increased on the income statement which reduces net income. As is the case with all adjusting entries, it does not affect cash flows. 106) C Recognizing rent expense decreases assets and stockholders’ equity. Because credits decrease assets, the decrease in assets (Prepaid Rent) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease in stockholders’ equity (Rent Expense) is recorded with a debit. Expenses decrease net income. As is the case with all adjusting entries, it does not affect cash flows. 107) C

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The expense recognition is an asset use event. Both assets and stockholders’ equity decrease. Because credits decrease assets, the decrease in assets (Merchandise Inventory) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease to stockholders’ equity (Cost of goods sold) is recorded with a debit. 108) D The purchase of inventory on account increases both assets and liabilities. Because debits increase assets, the increase to assets (Inventory) is recorded with a debit, and because credits increase liabilities, the increase to liabilities (Accounts Payable) is recorded with a credit. 109) B The purchase of inventory on account increases both assets and liabilities. Because debits increase assets, the increase to assets (Inventory) is recorded with a debit, and because credits increase liabilities, the increase to liabilities (Accounts Payable) is recorded with a credit. 110) B Recognizing depreciation expense is an asset use event. Both assets and stockholders’ equity decrease. Because credits decrease assets, the decrease in assets (Accumulated Depreciation) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease to stockholders’ equity (Depreciation Expense) is recorded with a debit. On the income statement, expenses increase which decreases net income. The event does not affect cash flows. 111) C

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Five months have passed (August through December). Interest owed = $24,000 × 0.08 × 5 ÷ 12 = $800 Recognizing accrued interest expense increases liabilities and decreases stockholders’ equity. Because credits increase liabilities, the increase in liabilities (Interest payable) is recorded with a credit of $800, and because debits decrease stockholders’ equity, the decrease to stockholders’ equity (Interest Expense) is recorded with a debit of $800. 112) D Five months have passed (August through December). Interest owed = $10,000 × 0.06 × 5 ÷ 12 = $250 Recognizing accrued interest expense increases liabilities and decreases stockholders’ equity. Because credits increase liabilities, the increase in liabilities (Interest payable) is recorded with a credit of $250, and because debits decrease stockholders’ equity, the decrease to stockholders’ equity (Interest Expense) is recorded with a debit of $250. 113) C Recognizing depreciation expense is an asset use event. Both assets and stockholders’ equity decrease. Because credits decrease assets, the decrease in assets (Accumulated Depreciation) is recorded with a credit, and because debits decrease stockholders’ equity, the decrease to stockholders’ equity (Depreciation Expense) is recorded with a debit. On the income statement, expenses increase which decreases net income. 114) B This misclassification (crediting the wrong account) will not cause the debit and credit totals on the trial balance to be out of balance. Crediting an asset (Cash) instead of crediting a liability (Interest Payable) would understate total assets and understate total liabilities. That error has no effect on net income. Version 1

115) D The payment would be recorded with a credit to Cash for $1,050 to decrease that asset account, a debit to Interest Payable for $600 to decrease that liability account, and a debit to Interest Expense for $450 to balance the entry (for the interest expense to be recognized during Year 2). 116) D The payment would be recorded with a credit to Cash for $450 to decrease that asset account, a debit to Interest Payable for $300 to decrease that liability account, and a debit to Interest Expense for $150 to balance the entry (for the interest expense to be recognized during Year 2). 117) D The entry to record depreciation expense involves a debit to Depreciation Expense (to increase that expense account) and a credit to Accumulated Depreciation (to increase that contra-asset account). 118) C This journal entry to accrue interest expense increases Interest Payable (a liability) and increases interest expense. Accruing interest expense decreases net income and stockholders’ equity. 119) D Depreciation expense is determined as follows: ($3,400 cost − $700 salvage)÷ 5-years useful life = $540 per year The entry to record depreciation expense involves a debit to Depreciation Expense (which decreases stockholders’ equity) and a credit to the contra asset account Accumulated Depreciation (which decreases total assets) for $540. 120) C

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Depreciation expense is determined as follows: ($3,000 cost − $500 salvage) ÷ five-year useful life = $500 per year The entry to record depreciation expense involves a debit to Depreciation Expense (which decreases stockholders’ equity) and a credit tothe contra asset account Accumulated Depreciation (which decreases total assets) for $500. 121) B This adjusting entry records the accrued interest revenue as of the end of the accounting period. It increases revenue (interest revenue), which increases net income and stockholders’ equity (retained earnings). It also increases assets (interest receivable). The adjusting entry has no effect on cash flows.

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CHAPTER 14: PROBLEM MATERIAL ESSAY. Write your answer in the space provided or on a separate sheet of paper. 1) Describe the factors involved in communicating useful financial information.

2) What is a primary drawback with examining and comparing absolute amounts from two businesses' financial statements?

3) For Perez Corporation, return on equity is substantially higher than return on investment. What does that tell you about the company?

4) Describe the differences between the liquidity ratios, solvency ratios and profitability ratios. Identify examples of each type of ratio as well.

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5) Sable Company is seeking a short-term loan from its local bank. The banker needs assurance that the company will be able to repay the loan. Describe three financial ratios the banker should consider including in the loan approval process. What information does each of your selected ratios provide?

6) Crawford Company's current ratio for Year 2 was 1.42, which was slightly above the current ratio for similar companies in its industry. Crawford's quick ratio for Year 2 was 0.68, which is substantially lower than for similar companies in its industry. What conclusion would you draw based on this information?

Discuss the limitations that affect financial statement analysis.

8) Gamma Company and Chi Company are similar and similar-sized companies operating in the same industry. At the end of the most recent year, Gamma's price-earnings ratio was 22.0, and Chi's price-earnings ratio was 14.2. What conclusion would you draw based on the difference in price-earnings ratios for the two companies?

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9) Denver Corporation and Cheyenne Company are in different industries. Denver's current ratio is 1.89, while Cheyenne's current ratio is 1.65. Therefore, is it safe to conclude that Denver's liquidity position is better than that of Cheyenne?

10) Explain the difference between horizontal analysis and vertical analysis of a company's financial statements.

11) Indicate whether each of the following statements is true or false. 1.________ a) Some forms of financial statement analysis involve identifying changes in the same item for the same company over a period of time. 2.________ b) Some forms of financial statement analysis involve comparing operations of different companies in the same industry. 3.________ c) Vertical analysis is also called trend analysis. 4.________ d) Vertical analysis refers to studying the behavior of individual financial statement items over several periods. 5.________ e) Horizontal analysis could be done using changes in the absolute dollar amount of an item or trends in percentages.

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12) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Meaningful comparisons between two companies generally should be made using percentage analysis or ratio analysis, not absolute amounts. 2.________ b) The materiality of accounting information refers to whether it is viewed as favorable (good news) or unfavorable (bad news). 3.________ c) Companies must account for immaterial items in compliance with generally accepted accounting principles. 4.________ d) To judge the materiality of an absolute financial statement amount, one must consider the size of the company reporting it. 5.________ e) Comparing percentages derived from financial statement analysis has the drawback of varying materiality levels.

13) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) The reason behind a financial statement ratio or percentage analysis result is usually self-evident and does not require further study or analysis. 2.________ b) In horizontal percentage analysis, an item from the financial statements is expressed as a percentage of the same item from a previous year's financial statements. 3.________ c) Horizontal analysis for several years can be done by choosing one year as a base year and calculating increases or decreases in relation to that year. 4.________ d) One form of horizontal analysis is the preparation of common size financial statements. 5.________ e) Vertical analysis compares two or more financial statement items within the same time period.

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14) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Vertical analysis of a company's balance sheet is useful in assessing its liquidity. 2.________ b) Common size financial statements are a form of vertical analysis, but the common size statements for two or more years may usefully be compared. 3.________ c) Vertical analysis of a balance sheet involves converting each component to a percentage of stockholders' equity. 4.________ d) Small percentage changes resulting from vertical analysis may still represent large dollar amounts; therefore, changes in both absolute dollar amounts and percentages should be examined. 5.________ e) A common size income statement is prepared by converting each component to a percentage of net income.

15) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Ratio analysis may involve studying relationships between an item reported on the balance sheet and another reported on the income statement. 2.________ b) Comparing sales in Year 2 with sales for Year 1 is a form of vertical analysis. 3.________ c) Comparing net income in Year 2 with sales for Year 2 is a form of horizontal analysis. 4.________ d) Liquidity ratios measure a company's ability to generate cash flows in the short term. 5.________ e) Working capital is calculated by using the following formula: current assets − current liabilities.

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16) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Working capital is a measure of the amount of current assets a company would have left after paying its current liabilities. 2.________ b) If a transaction causes a company's working capital to increase, the transaction caused the company to become less liquid. 3.________ c) Interpretation of a company's current ratio can be difficult because it is an absolute amount. 4.________ d) The quick ratio is a more conservative variation of the current ratio. 5.________ e) The quick ratio is usually calculated by using the following equation: (cash + receivables + current marketable securities) ÷ current liabilities.

17) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Working capital measures a company's immediate debt-paying ability. 2.________ b) Accounts receivable turnover is a direct measure of a company's uncollectible accounts expense. 3.________ c) Accounts receivable turnover is calculated by using the following formula: net credit sales ÷ average accounts receivable. 4.________ d) Net credit sales are comprised of sales on account plus sales returns and discounts. 5.________ e) The amount of average receivables can be calculated using the amount of receivables shown on balance sheets for the current year and previous year.

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18) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Having too little inventory can hurt a company's profitability because of lost sales. 2.________ b) Having too much inventory can hurt a company's profitability because of excess costs. 3.________ c) Generally, a lower inventory turnover indicates that merchandise is being handled more efficiently. 4.________ d) Average days to sell inventory is the number of times, on average, that inventory is replaced during the year. 5.________ e) Values for the inventory turnover ratio vary widely among different industries.

19) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Solvency ratios measure a company's short-term debt paying ability and its financial structure. 2.________ b) A company with a high debt to assets ratio probably would be considered to have a high level of financial risk. 3.________ c) The debt to equity ratio and debt to assets ratio are two ways to measure the same relationship. 4.________ d) From the point of view of stockholders, a decline in the debt to equity ratio is always good news. 5.________ e) The lower the debt to equity ratio, the higher a company's financial leverage.

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20) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) The ratio, plant assets to long-term liabilities, is a measure of a company's ability to obtain additional long-term financing. 2.________ b) Generally, a company's current assets should be purchased using long-term financing such as bonds payable. 3.________ c) Ratios that measure a company's profitability provide some measure of the effectiveness of the company's management. 4.________ d) Net margin indicates the amount remaining from each sales dollar after cost of goods sold has been subtracted out. 5.________ e) Net margin is also sometimes called the return on assets ratio.

21) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) The asset turnover ratio is calculated by dividing net income by average total assets. 2.________ b) The asset turnover ratio is likely to be high in an industry in which operations require only a minimal investment in assets. 3.________ c) Return on equity measures the wealth generated by the amount of assets invested in a business. 4.________ d) A higher value for the return on investment ratio would generally indicate more effective company management. 5.________ e) The use of financial leverage often causes a business's return on equity to be lower than its return on investment.

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22) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) Both dividends and earnings performance are indicators of the value of a company's stock. 2.________ b) The most widely quoted measure of a company's earnings performance is return on equity. 3.________ c) Earnings per share is calculated for a company's common stock. 4.________ d) Investors need to understand that the value of a company's earnings per share is affected by its choices of accounting principles and assumptions. 5.________ e) The book value per share measures the market value of a corporation's stock.

23) Indicate whether each of the following statements about financial statement analysis is true or false. 1.________ a) The value of a corporation's price-earnings ratio indicates how optimistic investors are about a company's growth potential. 2.________ b) The dividend yield ratio indicates the percentage of a company's net income that it paid out in dividends. 3.________ c) Conservatism produces a positive bias in a company's financial statements and thus in the ratios calculated from the financial statements. 4.________ d) Changes in general economic conditions (such as rate of inflation) can cause the values for a company's financial statement ratios to change from one year to the next. 5.________ e) Comparing financial statement ratios of companies in different industries can give misleading results.

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24) Select the term from the list provided that best matches each of the following descriptions or definitions: Your Definition or Description Term Answer A. An indication of the relative 1. Absolute amounts importance of an item of financial information B. Analysis technique that compares 2. Book value per share amounts of the same item over two or more time periods C. Measures of the long-term debt 3. Current ratio paying ability of the firm D. Measure of profitability 4. Horizontal Analysis calculated by dividing net income by average total stockholders' equity E. Dollar amounts of individual 5. Liquidity ratios items on financial statements can be misleading because they make no reference to the size of the company F. Measurements of a firm's ability to 6. Materiality generate income G. Current assets divided by current 7. Average days to sell liabilities inventory H. Measures of short-term debt paying 8. Price-earning ratio ability I. Measure to compare values of 9. Profitability ratios different stocks, calculated by dividing market price per share by amount of income per share J. Another way of looking at 10. Return on equity inventory turnover by converting the inventory turnover ratio into a number of days K. Calculated by dividing total 11. Solvency ratios

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stockholders' equity less preferred rights by the number of common shares outstanding

25) Select the term from the list provided that best matches each of the following descriptions or definitions: Your Definition or Description Answer A. Another term for the current ratio B. Calculated by dividing dividends per share by the market price per share C. Presentation of too much information may serve to confuse users of the information D. Measure of efficiency in using assets; calculated as net sales divided by average total assets E. Measure of immediate debt paying ability F. A profitability measure, net income divided by net sales G. Measures the profitability of a company's asset base, also known as return on assets H. Analysis technique that compares an item from the financial statements with a key amount from the same year's financial statements I. Indicates the number of times, on average, that inventory is totally replaced during the year J. Net income available for common stock divided by average number of outstanding shares K. Current assets minus current

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Term 1. Accounts receivable turnover 2. Acid-test ratio 3. Dividend yield

4. Earnings per share 5. Information overload 6. Inventory turnover 7. Net margin

8. Average days to collect receivables

9. Return on investment 10. Asset turnover

11. Vertical

liabilities L. Ratio that measures how quickly a company collects its accounts receivable; calculated by dividing net credit sales by average net receivables M. Calculated by dividing 365 by the accounts receivable turnover ratio

analysis 12. Working capital

13. Working capital ratio

26) Various ratios are computed to assess different aspects of a company's financial condition and (or) strength. Required: In the table below, indicate which aspect of financial condition each specified ratio is designed to assess: Ratio

Liquidity Solvency

Profitability

Stock Market

1. Accounts receivable turnover 2. Average day to collect receivables 3. Book value per share 4. Current ratio 5. Debt to equity ratio 6. Dividend yield 7. Earnings per share 8. Inventory turnover 9. Net margin 10. Average days to sell inventory 11. Number of times

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interest is earned 12. Plant-assets to long term liabilities 13. Price-earnings ratio 14. Quick ratio 15. Return on equity 16. Return on investment 17. Debt to assets ratio 18. Asset turnover ratio 19. Working capital

27) Ratios can be used for different purposes. For example, a variety of ratios have been developed to assess a firm's liquidity. Similarly, ratios have been developed to assess solvency, profitability, and stock market strength. A sample of commonly used ratios for these purposes is provided in the table below. Required: In the middle column of the table, provide the formula to compute the specified ratio. In the final column, indicate the purpose (Liquidity, Solvency, Profitability, and Stock market strength) for which the ratio is most commonly used. The first item is completed as an example. Ratio 1. Accounts receivable turnover 2. Asset turnover

Computation Net credit sales/average receivable

Purpose Liquidity

3. Current ratio 4. Debt to equity ratio 5. Dividend yield

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6. Earnings per share 7. Inventory turnover 8. Net margin 9. Price-earnings ratio 10. Return on equity 11. Return on investment

28)

The following income statement was prepared by Case Company for Year 2:

Sales Cost of goods sold Gross margin Selling and administrative expense Interest expense Total expenses Income before taxes Income tax expense Net income

$ 100,000 56,500 43,500 26,000 5,000 31,000 12,500 4,000 $ 8,500

Required: Perform vertical analysis for Case Company's Year 2 income statement.

29)

Osgood Company provided the following income statement for Year 1 and Year 2:

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Sales Cost of goods sold Gross margin Less operating expenses:

Year 2

Year 1

$ 220,000 156,000 64,000

$ 160,000 105,000 55,000

26,000 2,000 36,000 10,800

15,000 3,000 37,000 11,100

$ 25,200

$ 25,900

Selling and administrative expenses Interest expense Income before taxes Income tax expense Net income

Required: (a) Perform vertical analysis on Osgood's income statements for Year 1 and Year 2. Round your answer to one decimal place (i.e. 22.4%) (b) Comment on the results, comparing Year 1 to Year 2.

30)

The following information applies to Acorn Construction Company (ACC):

Net sales Income before interest and taxes Net income Interest expense Stockholders' equity December 31 Common stock Preferred stock dividends

Year 2

Year 1

$ 880,000 127,500 59,000 24,500 810,300 750,300 24,000

$ 600,000 84,000 52,000 15,000 725,000 700,000 24,000

Information on the number of shares outstanding is provided below: Average number of outstanding Year 1 Average number of outstanding Year 2

38,000 33,000

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Required: Compute the following ratios for ACC for Year 2 and Year 1: 1.(a) Number of times interest is earned 2.(b) Earnings per share 3.(c) Price-earnings ratio (Market prices: Year 2 $17.50 per share, Year 1 $15.00 per share) 4.(d) Return on equity 5.(e) Net margin

31)

The following information applies to Markham Company:

Assets Cash Accounts receivable Inventory Plant and equipment, net Land Total assets

$ 6,000 13,000 16,000 21,000 19,000 $75,000

Liabilities and stockholders' equity Accounts payable Salaries payable Bonds payable (due 2020) Capital stock, no par Retained earnings Total liabilities and stockholders' equity

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$ 5,000 10,000 12,000 23,000 25,000 $75,000

Additional information: Net credit sales equal $220,000 and beginning accounts receivable were $11,000. Required: Compute Markham's: 1.(a) Quick ratio 2.(b) Current ratio 3.(c) Working capital 4.(d) Accounts receivable turnover 5.(e) Average days to collect receivables Round your answers to two decimal places.

32) Many companies have to monitor some of their financial statement ratios, such as the current ratio, due to debt covenants. Selected transactions are provided below for a company that uses a perpetual inventory system; sells its merchandise at a selling price that exceeds cost; and had a current ratio of 1.85 to 1 before the event occurred. Description of Transaction

Impact on Impact on Working Capital Current Ratio (+) or (−) or (+) or (−) or (0) (0)

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9. Purchased a building by issuing a long-term note 10. Purchased inventory on account 11. Purchased current marketable securities for cash 12. Recorded depreciation expense 13. Sold land (for a gain) for cash 14. Sold merchandise for cash 15. Sold merchandise on account

Required: In the above table, indicate whether each transaction would increase (+), decrease (−), or not affect (0) the company's working capital and the current ratio.

33) Many companies have to monitor closely certain ratios, such as the current ratio, due to debt covenants. Selected transactions are provided below for a company that uses a perpetual inventory system; sells its merchandise at a selling price that exceeds cost; and had a current ratio of 1.85 and a quick ratio of 1.19 before the event occurred. Description of Transaction

Impact on Current Ratio (+) or (−) or (0)

Impact on Quick Ratio (+) or (−) or (0)

1. Collected accounts receivable 2. Issued common stock for cash 3. Purchased one-year insurance policy 4. Paid previously declared cash dividend

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5. Paid the balance on an account payable 6. Purchased a building by issuing a long-term note 7. Purchased inventory on account 8. Purchased current marketable securities for cash 9. Sold merchandise for cash 10. Sold merchandise on account

Required: In the above table, indicate whether each transaction would increase (+), decrease (−), or not affect (0) the company's current ratio and quick ratio.

34)

The following information was provided by Joseph Company as of December 31, Year 2:

Net income Preferred stock, (20,000 shares at $10 par, 4%) Common stock, (220,000 shares at $1 par) Paid-in capital in excess of par-common Retained earnings

$ 528,000 $ 200,000 $ 220,000 $2,475,500 $3,824,500

On the most recent trading date, Joseph's common shares sold at $36 and the preferred shares sold at $14. The following information on industry averages is provided: Earnings per share $2.06 Price-earnings ratio 13.2:1 Required: 1. 2.1) Calculate Joseph Company's (a) earnings per share and (b) price-earnings ratios. Round your answer to two decimal places. 3.2) Discuss whether you would invest in this company.

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35)

Montana Company reported the following operating results for Year 1 and Year 2: Year 1

Sales

Amount $800,000

Cost of goods sold

440,000

Gross margin

360,000

Operating expenses

225,000

Income before taxes

135,000

Income taxes

40,000

Net income

$ 95,000 Year 2

Sales

Amount $960,000

Cost of goods sold

635,000

Gross margin

325,000

Operating expenses

275,000

Income before taxes

50,000

Income taxes

15,000

Net income

$ 35,000

% of Sales

Required: Express each income statement component for each year as a percentage of sales. Round your answer to one decimal place (i.e. 22.5%)

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36)

Comparative income statements for Pearle Company are provided below: Pearle Company Comparative Income Statement Years Ended December 31, Year 2

Sales Less cost of goods sold Gross margin Less operating expenses Income before taxes Income taxes Net income

$595,000 386,200 208,800 108,950 99,850 39,940 $ 59,910

Year 1 $532,200 357,650 174,550 99,770 74,780 29,912 $ 44,868

Required: Perform a horizontal analysis of Pearle Company's income statement by computing horizontal percentages for each item. Round your answer to one decimal place (i.e. 22.5%).

37) A careless accountant splattered spaghetti sauce on Kitchen Company's balance sheet. The balance sheet with its missing amounts is provided below: Assets: Current Assets: Cash Accounts receivable Inventory

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$ 32,200 (A) 85,100

Prepaid expenses Total current assets Long Term Assets: Building Less: Accumulated depreciation Total Long-term assets Total assets Equities

13,800 (B)

Liabilities Current liabilities: Accounts payable Notes payable Income tax payable Total current liabilities Mortgage payable Total Liabilities Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities + Equity

$ 16,100 (E) 18,400 $ 57,500 (F) (G)

161,000 195,900 (H) (I)

Kitchen Company's working capital is $138,000. Required: Compute the missing amounts. Record your answers in the following table: A. B. C. D. E. F.

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G. H. I.

38)

Comparative income statements for Chicago Company are provided below: Chicago Company Comparative Income Statement Years Ended December 31 Year 2

Sales Less cost of goods sold Gross margin Less operating expenses Income before taxes Income taxes Net income

$288,000 101,350 186,650 89,970 96,680 38,672 $ 58,008

Year 1 $302,190 115,400 186,790 99,770 87,020 34,808 $ 52,212

Required: Perform a horizontal analysis of Chicago Company's income statement by computing horizontal percentages for each item. Round your answer to one decimal place (i.e. 22.5%).

39)

Selected financial information for Martin Company for Year 2 follows:

Sales Cost of goods sold Merchandise inventory

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$498,000 320,000

Beginning of year End of year

72,000 80,000

Required: How many times did Martin's merchandise inventory turnover during Year 2? Round your answer to one decimal place.

40) On December 31, Year 1, Allen Company's total current assets were $600,000 and its total current liabilities were $380,000. On January 1, Year 2, Allen paid $20,000 on accounts payable. Required: 1.(a) Compute Allen's working capital (1) before and (2) after paying the account payable. 2.(b) Compute Allen's current ratio (1) before and (2) after paying the account payable. Round your answer to two decimal places.

41) On December 31, Year 1, Houston Company's total current assets were $560,000 and its total current liabilities were $420,000. On January 1, Year 2, Houston issued a long-term note to a bank for $30,000 cash. Required: 1.(a) Compute Houston's working capital (1) before and (2) after issuing the note payable. 2.(b) Compute Houston's current ratio (1) before and (2) after issuing the note payable. Round your answer to two decimal places.

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42) Longwood Company had a current ratio of 3:1 at the end of Year 1. The asset section of the company's balance sheet is provided below: Cash Accounts receivable Less allowance for uncollectible Accounts Inventory

$ 100,000 $400,000 50,000

350,000 550,000

Prepaid expenses

74,000

Property, plant, & equipment, net

926,000

Total assets

$2,000,000

Required: 1.1) Compute Longwood Company's end-of-year working capital. 2.2) Compute the company's quick (acid-test) ratio. 3.3) The company has a debt agreement with its bank that authorizes the bank to call in its loan to the company if the company's current ratio falls below 3:1 as of the last day of any month during the term of the loan. During January Year 2, the company engaged in the three following transactions: 1.(a) Collected $100,000 on account; 2.(b) Purchased inventory on account, $50,000 3.(c) Paid accounts payable, $60,000 Will the company be in default after completing these transactions? Justify your answer. Round your answers to two decimal places.

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43)

The following information is from the financial records of Newton Company for Year 2:

Sales Interest expense Income tax expense Net income

$620,000 26,000 46,000 104,000

Required: Calculate the number of times interest is earned for Newton in Year 2. Round your answer to one decimal place.

44)

Maynard Company's balance sheet and income statement are provided below: Maynard Company Balance Sheet As of December 31 Year 2

Year 1

$ 83,500 94,000 62,500 500,000 150,000 $890,000

$ 92,000 90,000 60,000 525,000 150,000 $917,000

$ 73,000 115,000 440,000 262,000 $890,000

$ 62,000 160,000 400,000 295,000 $917,000

Year 2

Year 1

Assets Cash Accounts receivable Inventory Plant and equipment, net Land Total assets Liabilities and Stockholders' Equity Accounts payable Notes payable Capital stock, no par Retained earnings Total liabilities and stockholders' equity Maynard Company Income Statement Years Ended December 31

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Sales Less cost of goods sold Gross margin Less operating expenses Income before taxes Income taxes Net income

$549,000 360,000 189,000 86,500 102,500 18,500 $ 84,000

$468,150 289,500 178,650 55,450 123,200 16,600 $106,600

The company paid cash dividends of $2.00 per share during Year 2. On December 31, Year 2, the stock was listed on the stock exchange at a price of $78.25 per share. Required: Compute the following ratios for Year 2: 1.(a) Accounts receivable turnover 2.(b) Average days to collect receivables 3.(c) Inventory turnover 4.(d) Average days to sell inventory 5.(e) Debt to assets ratio 6.(f) Debt to equity ratio 7.(g) Net margin 8.(h) Asset turnover 9.(i) Return on investment 10.(j) Dividend yield Round your answers to one decimal place.

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45) For Year 2, Weston Corporation reported after-tax net income of $1,200,000. During the year, the number of outstanding shares of 6% $100 par preferred stock remained constant at 5,000, and 500,000 shares of common stock were outstanding all year. The company's total stockholders' equity at December 31, Year 2, was $12,500,000. Weston's common stock was selling at $38 per share at the end of the year. All dividends for the year were paid, including a dividend of $2.50 per share to common stockholders. Required: Compute the following: 1.(a) Earnings per share (Round your answer to the nearest cent.) 2.(b) Book value per share of common stock 3.(c) Price-earnings ratio (Round your answer to one decimal place.) 4.(d) Dividend yield (Round your answer to one decimal place.)

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Answer Key Test name: Chap 14_2e_Problem Materials 1) Answers will vary. The primary factors involved in communicating useful information include the following: understanding who the users are, knowing for what purpose the information will be used, and understanding the process by which the information is analyzed. According to the FASB, financial statement information should be understandable to a person with a reasonable knowledge or one who has the capacity and willingness to achieve a reasonable knowledge of business. Financial statements are general purpose statements, meaning they are prepared for use by a wide variety of parties rather than being aimed at one specific group. Because of this, some disclosed information may be irrelevant to some users but vital to others. Finally, because of the many categories of users, the different levels of knowledge, the varying needs of users, and the general nature of financial statements, users must be prepared to apply a wide variety of analysis techniques to fully understand the information received. 2) Answers will vary. The primary drawback is that absolute amounts are affected by the size of a company. A change in absolute amount that would be important for one company might be immaterial (too small to matter) for another company.

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3) Answers will vary. Return on equity is higher than return on investment as a result of financial leverage. When a company uses debt effectively, stockholders' benefit and return on equity exceeds return on investment. 4) Answers will vary. Liquidity ratios indicate a company's ability to pay short-term debts. They focus on current assets and current liabilities. Examples include current ratio, quick ratio, accounts receivable ratios, and inventory ratios. Solvency ratios are used to analyze a company's long-term debtpaying ability and its financing structure. Solvency ratios include debt to assets ratio, debt to equity ratio, and times interest earned ratio. Profitability measures concern a company's ability to generate earnings. These ratios include net margin, asset turnover ratio, return on investment, and return on equity. 5) Answers will vary. The banker needs to assess the short-term debt-paying ability of Sable Company. Consequently, the banker should calculate liquidity ratios. Students should describe three of the following measures (ratios): a. Working capital

The amount by which current assets exceed current liabilities b. Current ratio Measures the ability to pay current liabilities from the most liquid of current assets c. Quick ratio Measures collectibility of receivables d. Accounts receivable Measures collectibility of receivables turnover e. Average collection Measeures how many days ut takes to collect period average receivables f. Inventory turnover Measure of the sale ability of inventory g. Days in inventory Measeures how many days would be required to sell the inventory on hand

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6) Answers will vary. The primary difference between the current ratio and the quick ratio is that the current ratio includes inventories in the numerator, and the quick ratio does not. Therefore, based on this information, one might suspect that Crawford carries more inventory than other, similar companies. The managers of Crawford Company might want to examine the company's inventory and determine whether it could operate effectively with less inventory. 7) Answers will vary. The results of financial statement analysis can be difficult to interpret and explain because of differences among industries, changing economic conditions, and the varying accounting principles and estimates made by different companies. Financial statement analysis is useful in giving an overview of a company. Studying a company's financial statements over a period of years and comparing the results to other companies in the same industry can help to reduce the ambiguity associated with the analysis results. 8) Answers will vary. The price-earnings ratio is a measure of what investors in the stock market expect for a company. A high P/E ratio means that investors hold the company in high esteem and expect its earnings to increase in the future. The difference between P/E ratios for Gamma and Chi suggests that investors think more highly of Gamma and its future than for Chi.

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9) Answers will vary. The acceptable (or desirable) level of liquidity varies from one industry to another. A company's ability to pay its current liabilities depends on how reliably current operations generate cash. Therefore, comparisons between Denver and Cheyenne cannot be made based on this limited information. 10) Answers will vary. Horizontal analysis means examining individual items from the financial statements over a period of time; it is also called trend analysis. For example, calculating the percentage change in sales over the past four years would be a form of horizontal analysis. Vertical analysis is conducted within the financial statements for a single period. For example, the amounts of cost of goods sold, gross margin, operating income, and net income for the current year might all be compared to the amount of sales revenue for that year. 11) a) T b) T c) F d) F e) T 1.a) Some forms of financial statement analysis involve identifying changes in the same item for the same company over a period of time. 2.b) Some forms of financial statement analysis involve comparing operations of different companies in the same industry. 3.c) Horizontal analysis is also called trend analysis. 4.d) Horizontal analysis refers to studying the behavior of individual financial statement items over several periods. 5.e) Horizontal analysis could be done using changes in the absolute dollar amount of an item or trends in percentages.

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12) a) T b) F c) F d) T e) F a) Meaningful comparisons between two companies generally should be made using percentage analysis or ratio analysis, not absolute amounts. b) The materiality of accounting information refers to its relative importance. c) Companies must account for material items in compliance with generally accepted accounting principles. d) To judge the materiality of an absolute financial statement amount, one must consider the size of the company reporting it. e) Comparing absolute amounts derived from financial statement analysis has the drawback of varying materiality levels. 13) a) F b) T c) T d) F e) T 1.a) The reason behind a financial statement ratio or percentage analysis result is not usually self-evident and requires further study or analysis. 2.b) In horizontal percentage analysis, an item from the financial statements is expressed as a percentage of the same item from a previous year's financial statements. 3.c) Horizontal analysis for several years can be done by choosing one year as a base year and calculating increases or decreases in relation to that year. 4.d) One form of vertical analysis is the preparation of common size financial statements. 5.e) Vertical analysis compares two or more financial statement items within the same time period.

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14) a) T b) T c) F d) T e) F 1.a) Vertical analysis of a company's balance sheet is useful in assessing its liquidity. 2.b) Common size financial statements are a form of vertical analysis, but the common size statements for two or more years may usefully be compared. 3.c) Vertical analysis of a balance sheet involves converting each component to a percentage of total assets. 4.d) Small percentage changes resulting from vertical analysis may still represent large dollar amounts; therefore, changes in both absolute dollar amounts and percentages should be examined. 5.e) A common size income statement is prepared by converting each component to a percentage of sales. 15) a) T b) F c) F d) T e) T 1.a) Ratio analysis may involve studying relationships between an item reported on the balance sheet and another reported on the income statement. 2.b) Comparing sales in Year 2 with sales for Year 1 is a form of horizontal analysis. 3.c) Comparing net income in Year 2 with sales for Year 2 is a form of vertical analysis. 4.d) Liquidity ratios measure a company's ability to generate cash flows in the short term. 5.e) Working capital is calculated by using the following formula: current assets − current liabilities.

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16) a) T b) F c) F d) T e) T 1.a) Working capital is a measure of the amount of current assets a company would have left after paying its current liabilities. 2.b) If a transaction causes a company's working capital to increase, the transaction may have caused the company to become more liquid. 3.c) Interpretation of a company's working capital can be difficult because it is an absolute amount. 4.d) The quick ratio is a more conservative variation of the current ratio. 5.e) The quick ratio is usually calculated by using the following equation: cash + receivables + current marketable securities ÷ current liabilities. 17) a) T b) F c) T d) F e) T 1.a) Working capital measures a company's immediate debt-paying ability. 2.b) Accounts receivable turnover is not a direct measure of a company's uncollectible accounts expense. 3.c) Accounts receivable turnover is calculated by using the following formula: net credit sales ÷ average accounts receivable. 4.d) Net credit sales are comprised of sales on account less sales returns and discounts. 5.e) The average receivables can be calculated using the amount of receivables shown on balance sheets for the current year and previous year.

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18) a) T b) T c) F d) F e) T 1.a) Having too little inventory can hurt a company's profitability because of lost sales. 2.b) Having too much inventory can hurt a company's profitability because of excess costs. 3.c) Generally, a lower inventory turnover indicates that merchandise is being handled less efficiently. 4.d) Average days to sell inventory is the number of times, on average, that inventory is sold during the year. 5.e) Values for the inventory turnover ratio vary widely among different industries. 19) a) F b) T c) T d) F e) F 1.a) Solvency ratios measure a company's long-term debt paying ability and its financial structure. 2.b) A company with a high debt to assets ratio probably would be considered to have a high level of financial risk. 3.c) The debt to equity ratio and debt to assets ratio are two ways to measure the same relationship. 4.d) From the point of view of stockholders, a decline in the debt to equity ratio is not necessarily always good news. 5.e) The lower the debt to equity ratio, the lower a company's financial leverage.

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20) a) T b) F c) T d) F e) F 1.a) Plant assets to long-term liabilities shows the amount of assets per each dollar of long-term debt. 2.b) A company’s current assets should be purchased using shortterm liabilities. Long-lived assets should be financed with long-term liabilities. 3.c) Profitability measures gauge what percentage of sales result in earnings and how productive assets are in generating those sales. Therefore, profitability ratios provide some indication of management’s effectiveness. 4.d) Net margin, sometimes called operating margin, profit margin, or return-on-sales ratio, describes the percentage of each sales dollar remaining after subtracting other expenses, as well as cost of goods sold. 5.e) Net margin is sometimes called operating margin, profit margin, or return-on-sales ratio. It is not called return on assets. Return on assets is the ratio of wealth generated (net income) to the amount invested (average total assets) to generate the wealth. Return on assets is also called return on investment or earning power.

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21) a) F b) T c) F d) T e) F 1.a) The asset turnover ratio is calculated by dividing net sales by average total assets. 2.b) The asset turnover ratio is likely to be high in an industry in which operations require only a minimal investment in assets. 3.c) The return on assets ratio measures the wealth generated by the amount of assets invested in a business. 4.d) A higher value for the return on investment ratio would generally indicate more effective company management. 5.e) The use of financial leverage often causes a business's return on equity to be higher than its return on investment. 22) a) T b) F c) T d) T e) F 1.a) Both dividends and earnings performance are indicators of the value of a company's stock. 2.b) The most widely quoted measure of a company's earnings performance is earnings per share. 3.c) Earnings per share is calculated for a company's common stock. 4.d) Investors need to understand that the value of a company's earnings per share is affected by its choices of accounting principles and assumptions. 5.e) The market value per share measures the market value of a corporation's stock.

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23) a) T b) F c) F d) T e) T 1.a) The value of a corporation's price-earnings ratio indicates how optimistic investors are about a company's growth potential. 2.b) The dividend yield ratio indicates the percentage of a company's market price that it paid out in dividends. 3.c) Conservatism produces a negative bias in a company's financial statements and thus in the ratios calculated from the financial statements. 4.d) Changes in general economic conditions (such as rate of inflation) can cause the values for a company's financial statement ratios to change from one year to the next. 5.e) Comparing financial statement ratios of companies in different industries can give misleading results. 24) Your Definition or Description Term Answer 6 A. An indication of the relative 1. Absolute amounts importance of an item of financial information 4 B. Analysis technique that compares 2. Book value per share amounts of the same item over two or more time periods 11 C. Measures of the long-term debt 3. Current ratio paying ability of the firm 10 D. Measure of profitability 4. Horizontal Analysis calculated by dividing net income by average total stockholders' equity 1 E. Dollar amounts of individual 5. Liquidity ratios items on financial statements can be misleading because they make no reference to the size of the company 9 F. Measurements of a firm's ability to 6. Materiality generate income 3 G. Current assets divided by current 7. Average days to sell liabilities inventory 5 H. Measures of short-term debt paying 8. Price-earning ratio

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ability I. Measure to compare values of different stocks, calculated by dividing market price per share by amount of income per share J. Another way of looking at inventory turnover by converting the inventory turnover ratio into a number of days K. Calculated by dividing total stockholders' equity less preferred rights by the number of common shares outstanding

9. Profitability ratios

10. Return on equity

11. Solvency ratios

25) Your Definition or Description Answer 13 A. Another term for the current ratio 3 5

2 7 9

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B. Calculated by dividing dividends per share by the market price per share C. Presentation of too much information may serve to confuse users of the information D. Measure of efficiency in using assets; calculated as net sales divided by average total assets E. Measure of immediate debt paying ability F. A profitability measure, net income divided by net sales G. Measures the profitability of a company's asset base, also known as return on assets H. Analysis technique that compares an item from the financial statements with a key amount from the same year's financial statements I. Indicates the number of times, on average, that inventory is totally replaced during the year J. Net income available for common stock divided by average number of

Term 1. Accounts receivable turnover 2. Acid-test ratio 3. Dividend yield

4. Earnings per share 5. Information overload 6. Inventory turnover 7. Net margin

8. Average days to collect receivables

9. Return on investment 10. Asset turnover

12 1

outstanding shares K. Current assets minus current liabilities L. Ratio that measures how quickly a company collects its accounts receivable; calculated by dividing net credit sales by average net receivables M. Calculated by dividing 365 by the accounts receivable turnover ratio

11. Vertical analysis 12. Working capital

13. Working capital ratio

26) Ratio

Liquidity Solvency

1. Accounts receivable turnover 2. Average day to collect receivables 3. Book value per share

4. Current ratio

Profitability

Stock Market

X X

5. Debt to equity ratio

6. Dividend yield

7. Earnings per share

8. Inventory turnover

9. Net margin

10. Average days to sell inventory 11. Number of times interest is earned 12. Plant-assets to long term liabilities 13. Price-earnings ratio

14. Quick ratio

X X X

15. Return on equity

16. Return on investment

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17. Debt to assets ratio

18. Asset turnover ratio 19. Working capital

X X

27) Ratio 1. Accounts receivable turnover 2. Asset turnover 3. Current ratio

Computation Purpose Net credit sales/average Liquidity receivable Net sales/Average total assets Profitability Current assets/current Liquidity liabilities 4. Debt to equity Total liabilities/Total Solvency ratio stockholders' equity 5. Dividend yield Dividends per share/Market price Stock Market per share 6. Earnings per share Earnings available for common Stock Market stock/Average common stock outstanding 7. Inventory turnover Cost of goods sold/Average Liquidity inventory 8. Net margin Net income/Net sales Profitability 9. Price-earnings Market price per share/Earnings Stock Market ratio per share 10. Return on equity Net income/Average total Profitability stockholders' equity 11. Return on Net income/Average total assets Profitability investment

28) Sales Cost of goods sold Gross margin Selling and administrative expense Interest expense Total expenses Income before taxes Income tax expense Net income

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100.0% 56.5% 43.5% 26.0% 5.0% 31.0% 12.5% 4.0% 8.5%

29) Answers will vary. (a) Year 2

Year 1

Sales Cost of goods sold Gross margin Less operating expenses:

100.0% 70.9% 29.1%

100.0% 65.6% 34.4%

Selling and administrative expenses Interest expense Income before taxes Income tax expense

11.8% 0.9% 16.4% 4.9%

9.4% 1.9% 23.1% 6.9%

Net income

11.5%

16.2%

1.(b) The most important difference between Year 1 and Year 2 is that cost of goods sold was 65.6% of sales in Year 1 and 70.9% in Year 2. Another difference is that selling and administrative expenses were 9.4% of sales in Year 1 and 11.8% of sales in Year 2. As a result, net income was 16.2% of sales in Year 1, and it fell to 11.5% in Year 2. 30) a) 5.2 and 5.6 b) $1.06 and $0.74 c) 16.51 and 20.27 d) 7.3% and 7.2% e) 6.7% and 8.7% Year 2 a.

Year 1

Number of times interest is earned: Income before taxes and interest/bond interest expenses (127,500/24,500) (84,000/15,000)

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5.2 5.6

Earnings per share (Net income − preferred dividends)/Average common shares outstanding (59,000 − 24,000)/33,000

$ 1.06

(52,000 − 24,000)/38,000 c.

$ 0.74

Price-earnings ratio: Market price/earnings per share $17.50/$1.06

16.51

$15.00/$0.74 d.

20.27

Return on equity Net income/total stockholders' equity 59,000/810,300

7.3%

52,000/725,000 e.

7.2%

Net margin: Net income/net sales 59,000/880,000 52,000/600,000

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6.7% 8.7%

31) 1.(a) 1.27 Quick ratio = ($6,000 + $13,000) ÷ ($5,000 + $10,000) = 1.27 2.(b) 2.33 Current ratio = ($6,000 + 13,000 + $16,000) ÷ ($5,000 + $10,000) = 2.33 3.(c) $20,000 Working Capital = ($6,000 + $13,000 + $16,000) − ($5,000 + $10,000) = $20,000 4.(d) 18.33 times Accounts Receivable Turnover = $220,000 ÷ (($11,000 + $13,000) ÷ 2)) = 18.33 times 5.(e) 365 ÷ 18.33 = 19.91 Average days to collect receivables = 365 ÷ 18.33 = 19.91 32) Description of Transaction

1. Collected accounts receivable 2. Declared a stock dividend 3. Issued common stock for cash 4. Paid advertising cost 5. Paid cash for a patent 6. Paid previously declared cash dividend 7. Paid sales commissions 8. Paid the balance on an account payable 9. Purchased a building by issuing a long-term note 10. Purchased inventory on account 11. Purchased current marketable securities for cash 12. Recorded depreciation expense

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Impact on Working Capital (+) or (−) or (0) 0 0 + − − 0

Impact on Current Ratio (+) or (−) or (0) 0 0 + − − +

− 0

− +

0 0

− 0

13. Sold land (for a gain) for cash 14. Sold merchandise for cash 15. Sold merchandise on account

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+ + +

Working capital = Current assets − Current liabilities Current ratio = Current assets ÷ Current liabilities Impact of each transaction on these components: 1.1) No change in current assets (since increase in cash equals decrease in accounts receivable) and no change in current liabilities 2.2) No change in current assets or current liabilities 3.3) Increase in current assets (cash) but no change in current liabilities 4.4) Decrease in current assets (cash) but no change in current liabilities 5.5) Decrease in current assets (cash) but no change in current liabilities 6.6) Decrease in current assets (cash) and decrease in current liabilities (dividends payable). To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the dividend payment was for $10,000. The new current ratio would then equal ($185,000 − $10,000) ÷ ($100,000 − $10,000) = $175,000 ÷ $90,000 = 1.94 (which is an increase from 1.85 to 1). 7.7) Decrease in current assets (cash) but no change in current liabilities 8.8) Decrease in current assets (cash) and decrease in current liabilities (accounts payable) To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the payment on account was for $10,000. The new current ratio would then equal ($185,000 − $10,000) ÷ ($100,000 − $10,000) = $175,000 ÷ $90,000 = 1.94 (which is an increase from 1.85 to 1). 9.9) No change in current assets or current liabilities 10.10) No change in current assets (inventory) and increase in current Version 1

liabilities (accounts payable) 11.11) No change in current assets (since increase in cash equals decrease in current marketable securities) and no change in current liabilities 12.12) No change in current assets or current liabilities 13.13) Increase in current assets (cash) and no change in current liabilities 14.14) Increase in current assets (since increase in cash exceeds decrease in inventory) and no change in current liabilities 15.15) Increase in current assets (since increase in account receivable exceeds decrease in inventory) and no change in current liabilities 33) Description of Transaction

1. Collected accounts receivable 2. Issued common stock for cash 3. Purchased one-year insurance policy 4. Paid previously declared cash dividend 5. Paid the balance on an account payable 6. Purchased a building by issuing a long-term note 7. Purchased inventory on account 8. Purchased current marketable securities for cash 9. Sold merchandise for cash 10. Sold merchandise on account

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Impact on Current Ratio (+) or (−) or (0) 0 + 0

Impact on Quick Ratio (+) or (−) or (0)

− 0

+ +

0 + −

Current ratio = Current assets ÷ Current liabilities Quick ratio = Quick assets (which include cash, accounts receivable, and current marketable securities) ÷ Current liabilities Impact of each transaction on these components: 1.1) No change in current assets or quick assets (since increase in cash equals decrease in accounts receivable) and no change in current liabilities 2.2) Increase in current assets (cash) and quick assets (cash) and no change in current liabilities 3.3) No change in current assets (since decrease in cash equals increase in prepaid insurance), increase in quick assets (cash) and no change in current liabilities 4.4) Decrease in current assets (cash), decrease in quick assets (cash), and decrease in current liabilities (dividends payable). To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the dividend payment was for $10,000. The new current ratio would then equal ($185,000 − $10,000) ÷ ($100,000 − $10,000) = $175,000 ÷ $90,000 = 1.94 (which is an increase from 1.85 to 1). To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the dividend payment was for $10,000. The new quick ratio would then equal ($119,000 − $10,000) ÷ ($100,000 − $10,000) = $109,000 ÷ $90,000 = 1.21 (which is an increase from 1.19 to 1). 5.5) Decrease in current assets (cash) and decrease in current liabilities (accounts payable) To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current Version 1

liabilities were $100,000 and the payment on account was for $10,000. The new current ratio would then equal ($185,000 − $10,000) ÷ ($100,000 − $10,000) = $175,000 ÷ $90,000 = 1.94 (an increase from 1.85 to 1). To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the payment on account was for $10,000. The new quick ratio would then equal ($119,000 − $10,000) ÷ ($100,000 − $10,000) = $109,000 ÷ $90,000 = 1.21 (which is an increase from 1.19 to 1). 6.6) No change in current assets or current liabilities 7.7) Increase in current assets (inventory) and increase in current liabilities (accounts payable) To determine the impact on the current ratio, assume that the current ratio of 1.85 to 1 meant that current assets were $185,000 and current liabilities were $100,000 and the purchase of inventory on account was for $10,000. The new quick ratio would then equal ($185,000 + $10,000) ÷ ($100,000 + $10,000) = $195,000 ÷ $110,000 = 1.77 (a decrease from 1.85 to 1). To determine the impact on the quick ratio, assume that the quick ratio of 1.19 to 1 meant that current assets were $119,000 and current liabilities were $100,000 and the purchase of inventory on account was for $10,000. The new quick ratio would then equal ($119,000 + 10,000) ÷ ($100,000 + $10,000) = $129,000 ÷ $110,000 = 1.1 (which is a decrease from 1.19 to 1). 8.8) No change in current assets or quick assets (since decrease in cash equals increase in current marketable securities) and no change in current liabilities 9.14) Increase in current assets and quick assets (since increase in cash exceeds decrease in inventory) and no change in current liabilities Version 1

10.15) Increase in current assets and quick assets (since increase in account receivable exceeds decrease in inventory) and no change in current liabilities 34) Answers will vary. 1.1) (a) $2.36 Earnings per share = ($528,000 − $8,000 preferred dividends) ÷ 220,000 common shares = $2.36 (b) 15.25:1 Price-earnings ratio = $36 ÷ $2.36 = 15.25:1 the price-earnings ratio for Joseph is above the average for the industry. 2.2) It would be prudent to perform a much more thorough analysis of this company prior to making an investment decision. For example, the above ratios should be computed for more than one year to identify trends in the company's performance. Furthermore, additional ratios should be computed to assess the company's debt-paying ability and managerial effectiveness. Finally, non-quantitative factors would need to be considered (e.g., you may have heard that the company is about to be awarded a major contract). However, based on this limited information, Joseph outperformed the industry: the earnings per share ratio and the price-earnings ratio for Joseph are above average for the industry. 35) Year 1 Sales Cost of goods sold Gross margin Operating expenses Income before taxes Income taxes

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Amount $ 800,000 440,000 360,000 225,000 135,000 40,000

% of Sales 100.00% 55.0% 45.0% 28.1% 16.9% 5.0%

Net income

$ 95,000 Year 2

Amount $ 960,000 635,000 325,000 275,000 50,000 15,000 $ 35,000

Sales Cost of goods sold Gross margin Operating expenses Income before taxes Income taxes Net income

11.9% % of Sales 100.0% 66.1% 33.9% 28.6% 5.2% 1.6% 3.6%

36) Pearle Company Comparative Income Statement Years Ended December 31, Year 2 Year 1 Sales Less cost of goods sold Gross margin Less operating expenses Income before taxes Income taxes Net income

$595,000 386,200 208,800 108,950 99,850 39,940 $ 59,910

$532,200 357,650 174,550 99,770 74,780 29,912 $ 44,868

Percentage Change 11.8% 8.0% 19.6% 9.2% 33.5% 33.5% 33.5%

37) A. B. C. D. E. F. G. H. I.

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$ 64,400 $ 195,500 $ 388,700 $ 524,400 $ 23,000 $ 110,000 $ 167,500 $ 356,900 $ 524,400

Note: Solve in the following order: C, E, B, A, D, I, H, G, F Building − Accumulated Depreciation = Total Long-Term Assets C − $59,800 = $328,900 C = $388,700 Accounts Payable + Notes Payable + Income Taxes Payable = Total Current Liabilities $16,100 + E + $18,400 = $57,500 E = $23,000 Working Capital = Current Assets − Current Liabilities $138,000 = B − $57,500 B = $195,500 Cash + Accounts Receivable + Inventory + Prepaid Expenses = Total Current Assets $32,200 + A + $85,100 + $13,800 = $195,500 A = $64,400 Total Current Assets + Total Long-Term Assets = Total Assets $195,500 + $328,900 = D $195,500 + $328,900 = $524,400 Total Assets = Total Liabilities & Equity $524,400 = I $524,400 = $524,400 Total Stockholders’ Equity = Common Stock + Retained Earnings H = $161,000 + $195,900 Total Stockholders’ Equity = $356,900 Total Liabilities = Total Liabilities & Equity − Total Stockholders’ Equity G = $524,400 − $356,900 G = $167,500 Mortgage Payable = Total Liabilities − Current Liabilities F = $167,500 − $57,500 Version 1

F = $110,000 38) Chicago Company Comparative Income Statement Years Ended December 31 Year 2 Year 1 Sales Less cost of goods sold Gross margin Less operating expenses Income before taxes Income taxes Net income

$288,000 101,350 186,650 89,970 96,680 38,672 $ 58,008

$302,190 115,400 186,790 99,770 87,020 34,808 $ 52,212

Percentage Change −4.7% −12.2% −0.1% −9.8% 11.1% 11.1% 11.1%

39) 4.2 times Inventory turnover = cost of goods sold ÷ average inventory Average inventory = ($72,000 + $80,000) ÷ 2 = $76,000 Inventory turnover = $320,000 ÷ $76,000 = 4.2 times 40) 1.a) 1.(1) $220,000 Working capital before paying the account payable = $600,000 − $380,000 = $220,000 2.(2) $220,000 Working capital after paying the account payable = $580,000 − $360,000 = $220,000 1.b) 1.(1) 1.58 Current ratio before paying the account payable = $600,000 ÷ $380,000 = 1.58 2.(2) 1.61 Current ratio after paying the account payable = $580,000 ÷ $360,000 = 1.61

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41) 1.a) 1.(1) $140,000 Working capital before issuing note payable = $560,000 − $420,000 = $140,000 2.(2) $170,000 Working capital after issuing note payable = $590,000 − $420,000 = $170,000 1.b) 1.(1) 1.33 Current ratio before issuing note payable = $560,000 ÷ $420,000 = 1.33 2.(2) 1.40 Current ratio after issuing note payable = $590,000 ÷ $420,000 = 1.40

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42) Answer to part c will vary. 1.1) $716,000 Current assets = $2,000,000 − $926,000 = $1,074,000; Current assets ÷ current liabilities = 3 Thus, current liabilities = $1,074,000 ÷ 3 = $358,000; Finally, working capital = current assets − current liabilities. Thus, $1,074,000 − $358,000 = $716,000 2.2) 1.26:1 Acid-test = (current assets − inventory − prepaid expenses) ÷ current liabilities = ($1,074,000 − $550,000 − $74,000) ÷ $358,000 = $450,000 ÷ $358,000 = 1.26:1 3.3) Impact of transactions on current ratio: 1.(a) Collection on account has no impact on the current ratio. 2.(b) Purchase of inventory on account reduces the current ratio. Adding $50,000 to both the numerator and the denominator decreases the current ratio from 3:1 to 2.75:1. 3.(c) Payment on account increases the current ratio. Decreasing both the numerator and the denominator increases the current ratio from 2:75:1 to 3.06:1. Therefore, the company is not in default after these transactions. 43) 6.8 times Number of times interest is earned = Earnings before interest and taxes ÷ income tax expense Earnings before interest and taxes = $104,000 + $46,000 + $26,000 = $176,000 Number of times interest is earned = $176,000 ÷ $26,000 = 6.8 times

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44) 1.a) 6.0 times 2.b) 60.8 days 3.c) 5.9 times 4.d) 61.9 days 5.e) 21.1% 6.f) 26.8% 7.g) 15.3% 8.h) 61.7% 9.i) 9.3% 10.j) 2.6% 11. Financial Ratios a. Accounts receivable turnover: Net credit sales/average net receivables 549,000/(94,000 + 90,000)/2 b. Average days to collect receivables

6.0

times

Days in a year/accounts receivable turnover 365/6.0 c. Inventory turnover

60.8

days

Cost of goods sold/average inventory 360,000/(62,500 + 60,000)/2 d. Average days to sell inventory

5.9

times

Days in a year/inventory turnover 365/5.9 e. Debt to assets

61.9

days

Total liabilities/total assets (73,000 + 115,000)/890,000 f. Debt to equity ratio

21.1%

Total liabilities/stockholders' equity (73,000 + 115,000)/(440,000 + 262,000)

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26.8%

g. Net margin Net income/net sales 84,000/549,000 h. Asset turnover

15.3%

Net assets/average total assets 549,000/(890,000 + 917,000)/2 i. Return on investment

61.7%

Net income/average total assets 84,000/(890,000 + 917,000)/2 j. Dividend yield

9.3%

Dividends per share/market price per share 2/78.25

2.6%

45) 1.(a) $2.34 Earnings per share = ($1,200,000 − $30,000) ÷ 500,000 = $2.34 2.(b) $24 per share Book value per share = ($12,500,000 − $500,000) ÷ 500,000 = $24 per share 3.(c) 16.2 Price-earnings ratio = $38 ÷ $2.34 = 16.2 4.(d) 6.6% Dividend yield = $2.50 ÷ $38 = 6.6%

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CHAPTER 14 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The only requirement involved in communicating useful information is that the information be accurate. ⊚ true ⊚ false

2) The accounting profession assumes that financial statement users have an expert knowledge of business. ⊚ true ⊚ false

3) A company has an obligation to provide highly detailed information on its financial statements. ⊚ true ⊚ false

4) A vertical analysis uses percentages to compare each of the parts of an individual statement to a key statement figure. For example, on an income statement each item would be shown as a percentage of net sales. ⊚ true ⊚ false

5) Vertical analysis always involves comparing financial statement elements over a span of time. ⊚ true ⊚ false

6) Financial analysis typically involves some form of comparison such as changes in the same item over a number of years. ⊚ true ⊚ false

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7) The drawback of studying absolute amounts reported in financial statements is the problem of differing materiality levels. ⊚ true ⊚ false

8) While horizontal analysis examines one item over many time periods, vertical analysis examines many items in the same interval of time. ⊚ true ⊚ false

9) Financial ratio analysis is a form of horizontal analysis in that comparisons are made between different accounts in the same set of financial statements. ⊚ true ⊚ false

10) A banker may perform a financial ratio analysis to assess a firm's ability to repay debt in a timely manner. ⊚ true ⊚ false

11)

The current ratio is one of the most common measures of solvency. ⊚ true ⊚ false

12)

Working capital is current assets minus current liabilities. ⊚ true ⊚ false

13) Jenkins Company's current ratio is higher than the average for its industry, while its quick ratio is below the industry average. One possible interpretation for these results is that Jenkins carries less inventory than most companies in its industry. ⊚ true ⊚ false

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14)

The quick ratio although similar to the current ratio is more conservative. ⊚ true ⊚ false

15) Solvency ratios are used to analyze the long-term debt-paying ability and the composition of the financing structure of the firm. ⊚ true ⊚ false

16)

The accounts receivable turnover ratio can be used to assess a firm's solvency. ⊚ true ⊚ false

17)

In terms of solvency, the larger the number of times interest is earned, the better. ⊚ true ⊚ false

18) When debt is used to finance the purchase of assets, the term or time span of the debt should always be shorter than the lifespan of the assets. ⊚ true ⊚ false

19)

Profitability ratios attempt to assess the company's ability to generate earnings. ⊚ true ⊚ false

20) The most frequently quoted measure of earnings performance is the stockholders' equity ratio. ⊚ true ⊚ false

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21) A limitation of financial statement analysis stems from the discretion of management to choose accounting procedures that cast the best light on the firm's performance. ⊚ true ⊚ false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 22) Factor(s) involved in communicating useful information is (are): A) Attributes of the users B) Purpose for which the information will be used C) Process by which the information is analyzed D) All of these answer choices are correct.

23)

Current financial reporting standards assume that users of accounting information:

A) Have an expert's understanding of economic and financial events and conditions. B) Have a reasonably informed knowledge of business. C) Have widely differing levels of knowledge about business, and that financial reporting must meet these differing needs. D) Have only minimal knowledge of business.

24) Which of the following statements regarding the information disclosed in financial statements is not true? A) The costs of providing all possible information about a firm would be prohibitively high for the business. B) Some information disclosed in financial statements may be irrelevant to some users. C) Financial statements should be detailed enough to answer any financial-related question an investor might have. D) When too much information is presented users may suffer from information overload.

25)

Common methods of financial statement analysis include all of the following except:

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A) Incremental analysis. B) Horizontal analysis. C) Vertical analysis. D) Ratio analysis.

26)

Financial statement analysis involves forms of comparison including: A) Comparing changes in the same item over a number of periods. B) Comparing key relationships within the same year. C) Comparing key items to industry averages. D) All of these answer choices are correct.

27) The study of an individual financial statement item over several accounting periods is called: A) Horizontal analysis. B) Vertical analysis. C) Ratio analysis. D) Time and motion analysis.

28) Which of the following statements regarding the analysis of absolute amounts of various accounts reported on the financial statements is not true? A) Financial statement users with expertise in particular industries can look at absolute amounts and assess a company's performance in a certain area. B) To correctly evaluate an absolute amount, the analyst must consider its relative importance. C) Economic statistics such as the gross national product are built upon totals of absolute amounts reported by businesses. D) Using absolute amounts eliminates the problem of varying materiality levels.

29)

Which of the following statements regarding horizontal analysis is not true?

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A) Percentage analysis involves computing the percentage relationship between two amounts. B) A horizontal analysis of cost of goods sold on the income statement includes dividing gross margin by total revenue. C) Horizontal analysis attempts to eliminate the materiality problem of comparing firms of different sizes. D) In horizontal percentage analysis, a financial statement line item is expressed as a percentage of the previous balance of the same item.

30) An analysis procedure that uses percentages to compare each of the parts of an individual statement to a key dollar amount from the financial statements is: A) Ratio analysis. B) Contribution analysis. C) Horizontal analysis. D) Vertical analysis.

31)

Select the correct statement regarding vertical analysis.

A) Vertical analysis of the income statement involves showing each item as a percentage of sales. B) Vertical analysis of the balance sheet involves showing each asset as a percentage of total assets. C) Vertical analysis examines two or more items from the financial statements of one accounting period. D) All of these answer choices are correct.

32)

Which of the following statements regarding ratio analysis is not true?

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A) Ratio analysis is a specific form of horizontal analysis. B) There are many different ratios available for evaluating a firm's performance. C) Some ratios involve an account from the balance sheet and one from the income statement. D) Ratio analysis involves making comparisons between different accounts in the same set of financial statements.

33)

Which of the following is (are) objective(s) of ratio analysis? A) Assessing past performance. B) Assessing the prospects for future performance. C) Analyzing how a company finances its operations. D) All of these answer choices are correct.

34) Financial ratios can be used to assess which of the following aspects of a firm's performance? A) Liquidity B) Solvency C) Profitability D) All of these answer choices are correct.

35)

All of the following are measures of a company's short-term debt-paying ability except: A) Current ratio. B) Earnings per share. C) Inventory turnover. D) Average collection period.

36) Rialto Company collected $5,000 on account. What impact will this transaction have on the firm's current ratio?

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A) No impact B) Increase it C) Decrease it D) Not enough information is provided to answer the question.

37) Knell Company paid its sales employees $15,000 in sales commissions. What impact will this transaction have on the firm's working capital? A) No impact B) Increase it C) Decrease it D) Not enough information is provided to answer the question.

38)

Working capital is defined as: A) Current assets divided by current liabilities. B) Total assets minus total liabilities. C) Current assets minus current liabilities. D) Current liabilities divided by total liabilities.

39)

Which of the following statements regarding the quick ratio is not true? A) The quick ratio is also known as the acid-test ratio. B) The quick ratio ignores some current assets that are less liquid than others. C) The quick ratio is a conservative variation of the current ratio. D) The quick ratio equals quick assets divided by total liabilities.

40) Darden Company has cash of $21,000, accounts receivable of $31,000, inventory of $16,500, and equipment of $51,000. Assuming current liabilities of $24,500, this company's working capital is:

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A) $27,500. B) $6,500. C) $44,000. D) $74,000.

41) Darden Company has cash of $40,000, accounts receivable of $60,000, inventory of $32,000, and equipment of $100,000. Assuming current liabilities of $48,000, this company's working capital is: A) $12,000. B) $52,000. C) $144,000. D) $84,000.

42) Milton Company has total current assets of $60,000, including inventory of $17,500, and current liabilities of $36,000. The company's current ratio is: A) 1.18. B) 2.15. C) 0.60. D) 1.67.

43) Milton Company has total current assets of $46,000, including inventory of $10,000, and current liabilities of $20,000. The company's current ratio is: A) 0.4. B) 1.8. C) 2.8. D) 2.3.

44)

The following balance sheet information is provided for Greene Company for Year 2:

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Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 7,400 13,550 15,700 2,500 20,400 14,300 $73,850

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 3,330 7,330 16,500 12,000 34,690 $73,850

What is the company's quick (acid-test) ratio? (Round your answer to 2 decimal places.) A) 1.97 B) 0.77 C) 1.35 D) 3.67

45)

The following balance sheet information is provided for Greene Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 15,500 18,000 1,600 20,200 19,950 $80,650

Liabilities and Stockholders' Equity Accounts payable

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$ 4,500

Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

11,500 19,000 30,000 15,650 $80,650

What is the company's quick (acid-test) ratio? (Round your answer to 1 decimal place.) A) 0.7 B) 1.4 C) 1.3 D) 3.8

46)

The following balance sheet information is provided for Duke Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 4,600 10,750 14,300 1,100 19,000 12,900 $62,650

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 2,490 8,730 9,500 19,000 22,930 $62,650

What is the company's current ratio? (Round your answer to 2 decimal places.)

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A) 2.74 B) 0.74 C) 1.37 D) 1.43

47)

The following balance sheet information is provided for Duke Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 15,500 18,000 1,600 20,200 19,950 $80,650

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 4,500 11,500 19,000 30,000 15,650 $80,650

What is the company's current ratio? (Round your answer to 2 decimal places.) A) 1.16 B) 1.31 C) 2.53 D) 3.79

48)

The following balance sheet information is provided for Apex Company for Year 2:

Assets Cash

$ 5,800

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Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

11,950 14,900 1,700 19,600 13,500 $67,450

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 2,850 8,130 12,500 16,000 27,970 $67,450

What is the company's working capital? A) $29,800 B) $6,770 C) $23,370 D) $9,170

49)

The following balance sheet information is provided for Apex Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 15,500 18,000 1,600 20,200 19,950 $80,650

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par

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$ 4,500 11,500 19,000 30,000

Retained earnings

15,650

Total liabilities and stockholders' equity

$80,650

What is the company's working capital? A) $20,300 B) $4,900 C) $22,900 D) $24,500

50)

The following balance sheet information was provided by O'Connor Company:

Assets Cash Accounts receivable Inventory

Year 2 $3,000 8,000 30,000

Year 1 $2,000 6,000 31,000

If net credit sales for Year 2 totaled $155,000, what is the company's most recent accounts receivable turnover? A) 19.38 times B) 22.14 times C) 11.07 times D) 25.83 times

51)

The following balance sheet information was provided by O'Connor Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 4,000 15,000 35,000

Year 1 $ 2,000 12,000 38,000

If net credit sales for Year 2 totaled $270,000, what is the company's most recent accounts receivable turnover?

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A) 18 times B) 20 times C) 22.5 times D) 7.7 times

52)

The following balance sheet information was provided by Western Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 2,100 15,500 25,000

Year 1 $ 1,600 13,500 31,000

Assuming Year 2 net credit sales totaled $121,000, what was the company's average days to collect receivables? (Use 365 days in a year. Do not round your intermediate calculations. Round your answer to 2 decimal places.) A) 40.72 days B) 43.74 days C) 46.76 days D) 87.48 days

53)

The following balance sheet information was provided by Western Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 4,000 15,000 35,000

Year 1 $ 2,000 12,000 38,000

Assuming Year 2 net credit sales totaled $270,000, what was the company's average days to collect receivables? (Use 365 days in a year. Do not round your intermediate calculations.) A) 18.25 days B) 47.31 days C) 16.22 days D) 20.28 days

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54)

The following balance sheet information is provided for Gaynor Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 3,450 16,200 36,500

Year 1 $ 2,700 14,200 44,000

Assuming Year 2 cost of goods sold is $122,000, what is the company's inventory turnover? A) 2.77 times B) 3.03 times C) 3.34 times D) None of these answers choices are correct.

55)

The following balance sheet information is provided for Gaynor Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 4,000 15,000 35,000

Year 1 $ 2,000 12,000 38,000

Assuming Year 2 cost of goods sold is $153,300, what is the company's inventory turnover? A) 4.0 times B) 4.4 times C) 4.2 times D) None of these answers choices are correct.

56)

The following balance sheet information was provided by Western Company:

Assets Cash Accounts receivable Inventory

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Year 2 $ 2,800 12,300 24,500

Year 1 $ 2,400 14,300 31,500

Assuming Year 2 net credit sales totaled $368,000, what was the company's average days to collect receivables? (Use 365 days in a year. Do not round your intermediate calculations. Round your answer to 2 decimal places.) A) 27.77 days B) 24.30 days C) 31.24 days D) 53.00 days

57)

The following balance sheet information is provided for Patton Company:

Assets Cash Accounts receivable Inventory

Year 2 $ 4,000 15,000 35,000

Year 1 $ 2,000 12,000 38,000

Assuming Year 2 cost of goods sold is $730,000, what is the company's average days to sell inventory? (Use 365 days in a year. Do not round your intermediate calculations.) A) 17.5 days B) 18.25 days C) 19 days D) 20.86 days

58) You are considering an investment in Apple stock and wish to assess the firm's shortterm debt-paying ability. All of the following ratios are used to assess liquidity except: A) Debt to equity ratio. B) Inventory turnover. C) Quick ratio. D) Accounts receivable turnover.

59) You are considering an investment in IBM stock and wish to assess the firm's long-term debt-paying ability and its use of debt financing. All of the following ratios can be used to assess solvency except: Version 1

A) Number of times interest is earned. B) Debt to assets ratio. C) Debt to equity ratio. D) Net margin.

60)

Solvency ratios are used to assess a company's: A) Long-term debt paying ability. B) Profitability. C) Short-term debt paying ability. D) Efficiency in use of its assets.

61)

The following balance sheet information is provided for Santana Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,800 11,950 14,900 1,700 19,600 13,500 $67,450

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 2,850 8,130 12,500 16,000 27,970 $67,450

What is the company's debt to equity ratio?

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A) 33.65% B) 39.50% C) 136.71% D) 53.40%

62)

The following balance sheet information is provided for Santana Company for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 15,500 18,000 1,600 20,200 19,950 $80,650

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 4,500 11,500 19,000 30,000 15,650 $80,650

What is the company's debt to equity ratio? (Rounded to nearest whole percent.) A) 42% B) 130% C) 43% D) 77%

63)

The following partial balance sheet is provided for Groom Company:

Liabilities and Stockholders' Equity Accounts payable

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$ 9,000 19

Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

12,000 20,000 30,000 54,000 $125,000

What is the company's debt to assets ratio? (Rounded to nearest whole percent.) A) 49% B) 16% C) 33% D) Cannot be determined with the information given.

64)

The Fortune Company reported the following income for Year 2:

Sales Cost of goods sold Gross margin Selling and administrative expense Operating income Interest expense Income before taxes Income tax expense

$132,000 81,000 $ 51,000 17,000 $ 34,000 5,200 $ 28,800 8,640

Net income

$ 20,160

What is the company's number of times interest earned ratio? A) 3.9 times B) 5.5 times C) 6.5 times D) None of these answers choices are correct.

65)

The Fortune Company reported the following income for Year 2:

Sales Cost of goods sold Gross margin

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$130,000 80,000 $ 50,000 20

Selling and administrative expense Operating income Interest expense Income before taxes Income tax expense

15,000 $ 35,000 5,000 $ 30,000 10,000

Net income

$ 20,000

What is the company's number of times interest earned ratio? A) 7 times B) 6 times C) 4 times D) None of these answers choices are correct.

66)

Alpha Company provided the following balance sheet for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 17,400 19,900 3,500 26,900 21,850 $94,950

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 6,400 13,400 11,900 31,900 31,350 $94,950

What is the company's plant assets to long-term liabilities ratio?

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A) 2.26 B) 4.10 C) 1.88 D) None of these answers choices are correct.

67)

Alpha Company provided the following balance sheet for Year 2:

Assets Cash Accounts receivable Inventory Prepaid expenses Plant and equipment, net of depreciation Land Total assets

$ 5,400 15,500 18,000 1,600 25,000 19,950 $85,450

Liabilities and Stockholders' Equity Accounts payable Salaries payable Bonds payable (due in ten years) Common stock, no par Retained earnings Total liabilities and stockholders' equity

$ 4,500 11,500 10,000 30,000 29,450 $ 85,450

What is the company's plant assets to long-term liabilities ratio?

A) 2.5 B) 4.5 C) 1.7 D) None of these answers choices are correct.

68) You are considering an investment in Frontier Airlines stock and wish to assess the firm's earnings performance. All of the following ratios can be used to assess profitability except:

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A) Average days to collect receivables. B) Asset turnover. C) Return on investment. D) Net margin.

69)

The Poole Company reported the following income for Year 2:

Sales Cost of goods sold Gross margin Selling and administrative expense Operating income Interest expense Income before taxes Income tax expense

$32,000 8,400 $23,600 10,400 $13,200 4,400 $8,800 2,640

Net income

$ 6,160

What is the company's net margin? A) 41.25% B) 27.50% C) 73.75% D) 19.25%

70)

The Poole Company reported the following income for Year 2:

Sales Cost of goods sold Gross margin Selling and administrative expense Operating income Interest expense Income before taxes Income tax expense

$30,000 8,000 $22,000 10,000 $12,000 4,000 $ 8,000 2,500

Net income

$ 5,500

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What is the company's net margin? (Rounded to the nearest whole percent.) A) 73% B) 40% C) 18% D) 27%

71)

Which of the following statements regarding net margin is not true?

A) Net margin refers to the percentage of each sales dollar remaining after all expenses are subtracted. B) Net margin may be calculated in several ways. C) The amount of net margin is affected by a company's choices of accounting principles. D) The larger the net margin the better.

72) Miller Company reported gross sales of $880,000, sales returns and allowances of $5,300 and sales discounts of $5,300. The company has average total assets of $530,000, of which $265,000 is property, plant, and equipment. What is the company's asset turnover ratio? A) 1.64 times B) 1.66 times C) 1.68 times D) 0.61 times

73) Miller Company reported gross sales of $850,000, sales returns and allowances of $15,000 and sales discounts of $5,000. The company has average total assets of $500,000, of which $250,000 is property, plant, and equipment. What is the company's asset turnover ratio? A) 3.32 times B) 1.67 times C) 1.66 times D) 1.70 times

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74) Martin Company reported net income of $15,600 on gross sales of $86,000. The company has average total assets of $121,200, of which $106,000 is property, plant and equipment. What is the company's return on investment? (Round your answer to 2 decimal places.) A) 70.96% B) 18.14% C) 14.72% D) 12.87%

75) Martin Company reported net income of $15,000 on gross sales of $80,000. The company has average total assets of $135,000, of which $102,000 is property, plant and equipment. What is the company's return on investment? (Round your answer to 1 decimal place.) A) 18.8% B) 11.1% C) 14.7% D) 12.5%

76) true?

Which of the following statements regarding the return on equity (ROE) measure is not

A) ROE is used to measure the profitability of the firm in relation to the amount invested by stockholders. B) ROE equals net income divided by average total stockholders' equity. C) ROE is affected by a company's use of leverage. D) A company's ROE is lower than its return on investment because ROE does not consider that part of the business that is financed by debt.

77) Dennis Company reported net income of $56,000 on sales of $360,000. The company has average total assets of $590,000 and average total liabilities of $160,000. What is the company's return on equity ratio?

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A) 35.00% B) 15.56% C) 9.49% D) 13.02%

78) Dennis Company reported net income of $50,000 on sales of $300,000. The company has average total assets of $500,000 and average total liabilities of $100,000. What is the company's return on equity ratio? A) 10.0% B) 16.7% C) 12.5% D) 50.0%

79)

The return on investment measure is also referred to as: A) Net margin. B) Return on equity. C) Return on debt. D) Return on assets.

80) You are considering an investment in Facebook stock and wish to assess the company's position in the stock market. All of the following ratios can be used except: A) Dividend yield. B) Earnings per share. C) Working capital. D) Price-earnings ratio.

81)

Abel Company provided the following information from its financial records:

Net income $275,000 Common stock dividends $ 25,000

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Common shares outstanding 1/1 410,000 Common shares outstanding 470,000

Preferred stock dividends Sales

$ 27,500 $950,000

12/31 Preferred shares outstanding 1/1 Preferred shares outstanding 12/31

25,000 21,000

What is the company's earnings per share? A) $0.63 B) $0.70 C) $28.95 D) $0.56

82)

Abel Company provided the following information from its financial records:

Net income

$250,000

Common stock dividends Preferred stock dividends Sales

$ 20,000 $ 25,000 $1,000,000

Common shares outstanding 200,000 1/1 Common shares outstanding 300,000 12/31 Preferred shares outstanding 10,000 1/1 Preferred shares outstanding 6,000 12/31

What is the company's earnings per share? A) $0.82 B) $1.00 C) $0.90 D) $0.75

83)

Bernard Company provided the following information from its financial records:

Net income Common dividends

$320,000 $ 22,000

Preferred rights

$270,000

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Total stockholders' equity Common shares outstanding 12/31

$920,000 132,000

What is the company's book value per share? A) $6.97 B) $4.92 C) $2.26 D) $2.42

84)

Bernard Company provided the following information from its financial records:

Net income Common dividends

$250,000 $ 15,000

Preferred rights

$175,000

Total stockholders' equity Common shares outstanding, 12/31

$1,000,000 150,000

What is the company's book value per share? A) $0.50 B) $5.50 C) $6.67 D) $1.67

85) Crestar Company reported net income of $59,400 on 13,000 average outstanding common shares. Preferred dividends total $11,300. On the most recent trading day, the preferred shares sold at $43 and the common shares sold at $73. What is this company's current priceearnings ratio? (Do not round your intermediate calculations.) A) 15.98 B) 19.73 C) 21.89 D) None of these answers choices are correct.

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86) Crestar Company reported net income of $112,000 on 20,000 average outstanding common shares. Preferred dividends total $12,000. On the most recent trading day, the preferred shares sold at $50 and the common shares sold at $95. What is this company's current priceearnings ratio? A) 19 B) 17 C) 20 D) None of these answers choices are correct.

87) Phips Company paid total cash dividends of $106,600 on 26,000 outstanding common shares. On the most recent trading day, the common shares sold at $81. What is this company's dividend yield? (Do not round your intermediate calculations.) A) 5.06% B) 16.29% C) 24.39% D) 3.26%

88) Phips Company paid total cash dividends of $200,000 on 25,000 outstanding common shares. On the most recent trading day, the common shares sold at $80. What is this company's dividend yield? A) 25% B) 6.4% C) 16.9% D) 10%

89)

Which of the following statements is generally not true from an investor's perspective?

A) A 1:1 current ratio is generally preferred over a 1.5:1 current ratio. B) A 20-day average collection period for accounts receivable is generally preferred over a 30-day average collection period. C) A 5% dividend yield is generally preferred over a 3% dividend yield. D) A 10% net margin is generally preferred over an 8% net margin.

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90)

Which of the following is a potential limitation of financial statement analysis?

A) Lack of comparability of firms in different industries B) The impact of changing economic conditions C) The impact of having more than one acceptable alternative accounting principle for accounting for a given transaction or economic event D) All of these answers choices are correct.

91)

Accrual accounting requires the use of many estimates, including: A) Uncollectible accounts expense. B) Warranty costs. C) Assets' useful lives. D) All of these answers choices are correct.

92) The accounting concept or principle that is perhaps the greatest single culprit in distorting the results of financial statement analysis is the: A) Matching principle. B) Conservatism concept. C) Historic cost principle. D) Time value of money concept.

93) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant issued common stock at par value for $10,000 cash. Which of the following statements is true?

A) Gant's current ratio will decrease. B) Gant's current ratio will increase. C) Gant's quick ratio will decrease. D) Gant's working capital will decrease.

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94) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant sold inventory on account for $6,000. Which of the following statements is not true?

A) Gant's current ratio will decrease. B) Gant's quick ratio will increase. C) Gant's working capital will increase. D) None of these answers choices are correct.

95) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant recorded the sale of inventory. As a result of this transaction, Gant's quick ratio will: A) Decrease. B) Increase. C) Remain the same. D) Cannot be determined.

96) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant collected $5,200 of accounts receivable. As a result of this transaction, Gant's working capital will:

A) Increase. B) Decrease. C) Remain the same. D) Cannot be determined.

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97) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant purchased merchandise on account for $4,000. Which of the following statements is true? A) Gant's current ratio will decrease. B) Gant's quick ratio will increase. C) Gant's working capital will increase. D) Gant's quick ratio will increase and its current ratio will decrease.

98) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2 Gant paid $3,600 on accounts payable. Which of the following statements is not true? A) Gant's quick ratio will increase and its current ratio will decrease. B) Gant's quick ratio will increase. C) Gant's working capital will remain the same. D) Gant's current ratio will increase.

99) As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $29,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant paid $250 for transportation-in cost on merchandise it had received. Which of the following statements is not true?

A) Gant’s current ratio will remain the same. B) Gant’s quick ratio will increase. C) Gant’s working capital will remain the same. D) Gant’s quick ratio will decrease and its current ratio will remain the same.

100) Benson Company declared and paid a cash dividend totaling $500,000 on its common stock. As a result of this transaction, the company's debt to assets ratio will:

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A) Decrease. B) Increase. C) Remain the same. D) Cannot be determined.

101) Benson Company received cash of $1,000,000 from issuing common stock at par value. As a result of this transaction, the company's debt-to-equity ratio will: A) Decrease. B) Increase. C) Remain the same. D) Cannot be determined.

102) Benson Company received cash of $5,000,000 by issuing 20-year bonds payable. As a result of this transaction, the company's current ratio will: A) Remain the same. B) Increase. C) Decrease. D) Cannot be determined.

103)

Horizontal analysis is also known as: A) Liquidity analysis. B) Trend analysis. C) Revenue analysis. D) Variance analysis.

104) The study of an individual item or account over several periods in the same financial year or over many years is known as:

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A) Liquidity analysis B) Ratio analysis C) Vertical analysis D) Horizontal analysis

105) Which type of approach may be used when evaluating corporate results using horizontal analysis? A) Study of absolute amounts B) Percentages C) Trends D) All of these answers choices are correct.

106)

In vertical analysis of an income statement, each item is expressed as a percentage of: A) Total expenses. B) Net income. C) Sales. D) None of these answers choices are correct.

107)

In vertical analysis of a balance sheet, each item is expressed as a percentage of: A) Total assets. B) Total cash. C) Total current assets. D) None of these answers choices are correct.

108)

Short-term creditors are usually most interested in assessing:

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A) Liquidity. B) Solvency. C) Managerial effectiveness. D) Profitability.

109) Which ratio would you use to examine a company's ability to pay its debts in the shortterm? A) Earnings per share B) Acid-test ratio C) Debt to assets ratio D) Return on equity

110)

Long-term creditors are usually most interested in evaluating: A) Liquidity. B) Managerial effectiveness. C) Solvency. D) Profitability.

111) Lilly Corporation has working capital of $620,000, and Harmon Corporation has working capital of $840,000. Which of the following statements is not true? A) The current assets of both corporations are greater than the current liabilities. B) Since working capital is an absolute amount, other factors such as size of the company and materiality will help to determine liquidity of these two companies. C) Since Harmon's working capital exceeds Lilly's working capital, it is safe to conclude that Harmon is more liquid than Lilly. D) If Lilly Corporation is smaller than Harmon or has lower current liabilities; Lilly could be more liquid than Harmon.

112)

Which of the following statements is correct regarding the quick ratio?

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A) The numerator for the quick ratio is current assets minus inventory minus accounts receivable. B) The numerator for the quick ratio is current assets. C) The quick ratio is also called the working capital ratio. D) The quick ratio is a more conservative variation of the current ratio.

113) are:

Two ratios that provide insight on the relationship between credit sales and receivables

A) Current ratio and inventory turnover ratio. B) Accounts receivable turnover and average days to collect receivables. C) Average days to collect receivables and asset turnover. D) Accounts receivable turnover and current ratio.

114) Cost of goods sold divided by average inventory is the formula for which of these analytical measures? A) Number of day's sales in inventory B) Return on investment C) Inventory turnover D) Debt to assets ratio

115) Which type of ratios measure a company's long-term debt paying ability and its financing structure? A) Solvency B) Liquidity C) Profitability D) None of these answers choices are correct.

116) Assume that you are considering purchasing some of a company's long-term bonds as an investment. Which of the company's financial statement ratios would you probably be most interested in? Version 1

A) Debt to assets ratio B) Debt to equity C) Plant assets to long-term liabilities D) All of these answers choices are correct.

117) Starwood Corporation has current assets of $200,000, total current liabilities of $750,000 net credit sales of $1,300,000, beginning accounts receivable of $65,000 and ending accounts receivable of $69,000. What is Starwood's accounts receivable turnover? A) 21.8 times B) 19.4 times C) 22.4 times D) 5.8 times

118) Earnings before interest and taxes divided by interest expense is the formula for which of these analytical measures? A) Debt to assets ratio B) Earnings per share C) Return on investment D) Number of times interest is earned

119)

Net income divided by net sales is the formula for which of these analytical measures? A) Return on assets B) Return on equity C) Earnings per share D) Net margin

120) If a company purchased a $60,000 piece of equipment by paying $30,000 and having the rest financed with a short-term note from the bank. Immediately after this transaction what is the expected impact on the components of the current ratio?

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A) Current assets decrease and current liabilities increase by the same amount. B) Current liabilities decrease. C) Current assets and current liabilities decrease by the same amount. D) Current assets increase.

121)

Which ratio measures how effectively a company is using assets to generate revenue? A) Net margin B) Plant assets to long-term liabilities C) Asset turnover D) Inventory turnover

122)

Which ratio measures the percentage of a company's assets that are financed by debt? A) Debt to assets ratio B) Asset turnover C) Debt to equity D) Return on investment

123)

Which of the following statements about financial statement analysis is not true?

A) In horizontal percentage analysis, an item from the financial statements is expressed as a percentage of the same item from a previous year's financial statements. B) Vertical analysis compares two or more financial statement items within the same time period. C) Horizontal analysis for several years can be done by choosing one year as a base year and calculating increases or decreases in relation to that year. D) The reason behind a financial statement ratio or percentage analysis result is usually self-evident and does not require further study or analysis.

124)

Which of the following statements is true?

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A) Investors need to understand that the value of a company's earnings per share is affected by its choices of accounting principles and assumptions. B) Earnings per share is calculated for a company's preferred stock. C) The most widely quoted measure of a company's earnings performance is return on equity. D) The book value per share measures the market value of a corporation's stock.

125)

Which of the following statements about financial statements is not true? A) The net margin ratio is a profitability ratio. B) The current ratio is a liquidity ratio. C) The debt-to-assets ratio is a liquidity ratio. D) The dividend yield is a stock market ratio.

126)

Which of the following is not included in the computation of the quick ratio? A) Cash B) Prepaid expenses C) Accounts receivable D) Marketable securities

127) Which ratio compares the earnings per share of a company to the market price for a share of the company's stock? A) Price-earnings ratio B) Dividend yield C) Book value per share D) Return on equity

128) Grove Corporation had sales of $3,000,000, cost of sales of $2,250,000, and average inventory of $500,000. What was Grove's inventory turnover ratio for the period?

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A) 1.6 times B) 6 times C) 4.5 times D) 23 times

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Answer Key Test name: Chap 14_2e_Test Bank_MCQs_TF 1) FALSE The primary objective of accounting is to provide information useful for decision making. To provide information that supports this objective, accountants must consider the intended users, the types of decisions users make with financial statement information, and available means of analyzing the information. 2) FALSE Current reporting standards target users that have a reasonably informed knowledge of business, though that level of sophistication is difficult to define. 3) FALSE Financial statements can provide only highly summarized economic information. The costs to a company of providing excessively detailed information would be prohibitive. In addition, too much detail leads to information overload, the problem of having so much data that important information becomes obscured by trivial information. 4) TRUE 5) FALSE Vertical analysis of an income statement (also called a common size income statement) involves converting each income statement component to a percentage of sales. Although vertical analysis suggests examining only one period, it is useful to compare common size income statements for several years. 6) TRUE 7) TRUE

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Comparing only absolute amounts has drawbacks, however, because materiality levels differ from company to company or even from year to year for a given company. The materiality of information refers to its relative importance. An item is considered material if knowledge of it would influence the decision of a reasonably informed user. 8) TRUE 9) FALSE Ratio analysis involves studying various relationships between different items reported in a set of financial statements. 10) TRUE Ratio analysis involves studying various relationships between different items reported in a set of financial statements. Creditors are interested in whether a company will be able to repay its debts on time. Ratios are grouped into categories such as measures of debt-paying ability and measures of profitability. 11) FALSE The current ratio is one of the most common measures of liquidity. 12) TRUE 13) FALSE The current ratio, also called the working capital ratio, is calculated by dividing current assets by current liabilities. The quick ratio is a conservative variation of the current ratio. Only cash, receivables, and current marketable securities (quick assets) are included in the numerator. Less liquid current assets, such as inventories and prepaid expenses, are omitted. One possible interpretation for these results is that Jenkins carries more (rather than less) inventory than most companies in its industry. 14) TRUE 15) TRUE 16) FALSE Version 1

The accounts receivable turnover ratio can be used to assess a firm's liquidity. 17) TRUE 18) FALSE Effective financial management principles dictate that asset purchases should be financed over a time span about equal to the expected lives of the assets. Long-lived assets should be financed with long-term liabilities. 19) TRUE Profitability refers to a company’s ability to generate earnings. Both management and external users employ profitability ratios to assess a company’s success in generating profits and how these profits are used to reward investors. 20) FALSE Perhaps the most frequently quoted measure of earnings performance is earnings per share (EPS). 21) TRUE 22) D To provide information that is useful for decision making, accountants must consider the intended users, the types of decisions users make with financial statement information, and available means of analyzing the information. 23) B Current reporting standards target users that have a reasonably informed knowledge of business, though that level of sophistication is difficult to define. 24) C Financial statements can provide only highly summarized economic information. The costs to a company of providing excessively detailed information would be prohibitive. Version 1

25) A Categories of common analysis methods include horizontal analysis, vertical analysis, and ratio analysis. 26) D Financial statement analysis should focus primarily on isolating information useful for making a particular decision. The information required can take many forms but usually involves comparisons, such as comparing changes in the same item for the same company over a number of years, comparing key relationships within the same year, or comparing the operations of several different companies in the same industry. 27) A Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. 28) D Comparing only absolute amounts has drawbacks because materiality levels differ from company to company or even from year to year for a given company. 29) B Horizontal analysis compares items over many time periods; vertical analysis compares many items within the same time period. As such, vertical analysis of cost of goods sold on the income statement includes dividing gross margin by total revenue. 30) D Horizontal analysis compares items over many time periods; vertical analysis compares many items within the same time period. 31) D

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Vertical analysis uses percentages to compare individual components of financial statements to a key statement figure where the comparison is among many items within the same time period. 32) A Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. These periods may be several quarters within the same fiscal year or they may be several different years. Ratio analysis involves studying various relationships between different items reported in a set of financial statements. 33) D Various users approach financial statement analysis with many different objectives. Creditors are interested in whether a company will be able to repay its debts on time. Both creditors and stockholders are concerned with how the company is financed, whether through debt, equity, or earnings. Stockholders and potential investors analyze past earnings performance and dividend policy for clues to the future value of their investments. In addition to using internally generated data to analyze operations, company managers find much information prepared for external purposes useful for examining past operations and planning future policies. 34) D Liquidity ratios indicate a company’s ability to pay short-term debts. Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. Profitability ratios assess a company’s success in generating profits and how these profits are used to reward investors. 35) B

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Liquidity ratios indicate a company’s ability to pay short-term debts. These ratios include working capital, current ratio, quick ratio, accounts receivable ratios, and inventory ratios. The earnings per share (EPS) ratio is a measure of earnings performance. 36) A A collection on account is an asset exchange transaction; the current asset account Cash increases and the current asset account Accounts Receivable decreases. The current ratio is calculated by dividing current assets by current liabilities. Since there is no impact on either the numerator or denominator, this transaction has no impact on the current ratio. 37) C A payment of commissions to sales employees is an asset use transaction; the current asset account Cash decreases and theRetained Earnings account decreases. Working capital is calculated by subtracting current liabilities from current assets. Since this transaction causes a decrease in current assets, it decreases the amount of working capital. 38) C Working capital is calculated by subtracting current liabilities from current assets. 39) D The quick ratio is calculated by dividing quick assets by current liabilities. 40) C Working capital = Current assets − Current liabilities Working capital = ($21,000 + $31,000 + $16,500) − $24,500 = $44,000 41) D Working capital = Current assets − Current liabilities Working capital = ($40,000 + $60,000 + $32,000) − $48,000 = $84,000 42) D Version 1

Current ratio = Current assets ÷ Current liabilities Current ratio = $60,000 ÷ $36,000 = 1.67 43) D Current ratio = Current assets ÷ Current liabilities Current ratio = $46,000 ÷ $20,000 = 2.3 44) A Quick ratio = Quick assets ÷ Current liabilities Quick ratio = (Cash + Receivables + Current marketable securities) ÷ Current liabilities Quick ratio = ($7,400 + $13,550 + $0) ÷ ($3,330 + $7,330) = $20,950 ÷ $10,660 = 1.97 45) C Quick ratio = Quick assets ÷ Current liabilities Quick ratio = (Cash + Receivables + Current marketable securities) ÷ Current liabilities Quick ratio = ($5,400 + $15,500 + $0) ÷ ($4,500 + $11,500) = $20,900 ÷ $16,000 = 1.3 46) A Current ratio = Current assets ÷ Current liabilities Current ratio = ($4,600 + $10,750 + $14,300 + $1,100) ÷ ($2,490 + $8,730) = $30,750 ÷ $11,220 = 2.74 47) C Current ratio = Current assets ÷ Current liabilities Current ratio = ($5,400 + $15,500 + $18,000 + $1,600) ÷ ($4,500 + $11,500) = $40,500 ÷ $16,000 = 2.53 48) C Working capital = Current assets − Current liabilities Working capital = ($5,800 + $11,950 + $14,900 + $1,700) − ($2,850 + $8,130) = $34,350 − $10,980 = $23,370 49) D Version 1

Working capital = Current assets − Current liabilities Working capital = ($5,400 + $15,500 + $18,000 + $1,600) − ($4,500 + $11,500) = $40,500 − $16,000 = $24,500 50) B Accounts receivable turnover = Net credit sales ÷ [(Beginning accounts receivable + ending accounts receivable) ÷ 2] Accounts receivable turnover = $155,000 ÷ [($6,000 + $8,000) ÷ 2] = $155,000 ÷ $7,000 = 22.14 times 51) B Accounts receivable turnover = Net credit sales ÷ [(Beginning accounts receivable + ending accounts receivable) ÷ 2] Accounts receivable turnover = $270,000 ÷ [($12,000 + $15,000) ÷ 2] = $270,000 ÷ $13,500 = 20 times 52) B Accounts receivable turnover = Net credit sales ÷ [(Beginning accounts receivable + ending accounts receivable) ÷ 2] Accounts receivable turnover = $121,000 ÷ [($13,500 + $15,500) ÷ 2] = $121,000 ÷ $14,500 = 8.34 times Average days to collect receivables = 365 days ÷ 8.34 = 43.74 days 53) A Accounts receivable turnover = Net credit sales ÷ [(Beginning accounts receivable + ending accounts receivable) ÷ 2] Accounts receivable turnover = $270,000 ÷ [($12,000 + $15,000) ÷ 2] = $270,000 ÷ $13,500 = 20 times Average days to collect receivables = 365 days ÷ 20 = 18.25 days 54) B

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Inventory turnover = Cost of goods sold ÷ [(Beginning inventory + ending inventory) ÷ 2] Inventory turnover = $122,000 ÷ [($44,000 + $36,500) ÷ 2] = $122,000 ÷ $40,250 = 3.03 times 55) C Inventory turnover = Cost of goods sold ÷ [(Beginning inventory + ending inventory) ÷ 2] Inventory turnover = $153,300 ÷ [($38,000 + $35,000) ÷ 2] = $153,000 ÷ $36,500 = 4.2 times 56) A Inventory turnover = Cost of goods sold ÷ [(Beginning inventory + ending inventory) ÷ 2] Inventory turnover = $368,000 ÷ [($31,500 + $24,500) ÷ 2] = $368,000 ÷ $28,000 = 13.14 times Average days to sell inventory = 365 days ÷ Inventory turnover Average days to sell inventory = 365 days ÷ 13.14 times = 27.77 days 57) B Inventory turnover = Cost of goods sold ÷ [(Beginning inventory + ending inventory) ÷ 2] Inventory turnover = $730,000 ÷ [($38,000 + $35,000) ÷ 2] = $730,000 ÷ $36,500 = 20 times Average days to sell inventory = 365 days ÷ Inventory turnover Average days to sell inventory = 365 days ÷ 20 times = 18.25 days 58) A Liquidity ratios indicate a company’s ability to pay short-term debts. These ratios include working capital, current ratio, quick ratio, accounts receivable ratios, and inventory ratios. The debt to equity ratio is a measure of solvency. 59) D

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Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. Solvency ratios include the debt to assets ratio, the debt to equity ratio, the number of times interest earned, and the plant assets to long-term liabilities ratio. The net margin ratio describes the percentage of each sales dollar remaining after subtracting other expenses as well as cost of goods sold. It is used to assess managerial effectiveness. 60) A Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. 61) D Debt to equity = Total liabilities ÷ Total stockholders’ equity Debt to equity = ($2,850 + $8,130 + $12,500) ÷ ($16,000 + $27,970) = $23,480 ÷ $43,970 = 53.40% 62) D Debt to equity = Total liabilities ÷ Total stockholders’ equity Debt to equity = ($4,500 + $11,500 + $19,000) ÷ ($30,000 + $15,650) = $35,000 ÷ $45,650 = 77% 63) C Recall that total assets equal total liabilities and stockholders’ equity. Debt to assets = Total liabilities ÷ Total assets Debt to assets = ($9,000 + $12,000 + $20,000) ÷ $125,000 = $41,000 ÷ $125,000 = 33% 64) C Number of times interest earned = (Net income + Taxes + Interest expense) ÷ Interest expense Number of times interest earned = $34,000 ÷ $5,200 = 6.5 times 65) A

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Number of times interest earned = (Net income + Taxes + Interest expense) ÷ Interest expense Number of times interest earned = $35,000 ÷ $5,000 = 7 times 66) B Plant assets to long-term liabilities ratio = Plant assets ÷ Long-term liabilities Plant assets to long-term liabilities ratio = $48,750 ÷ $11,900 = 4.10 67) B Plant assets to long-term liabilities ratio = Plant assets ÷ Long-term liabilities Plant assets to long-term liabilities ratio = $44,950 ÷ $10,000 = 4.495, which rounds to 4.5 68) A Both management and external users employ profitability ratios to assess a company’s success in generating profits and how these profits are used to reward investors. The average days to collect receivables ratio is a liquidity ratio. It assesses a company’s collection record. 69) D Net margin = Net income ÷ Net sales Net margin = $6,160 ÷ $32,000 = 19.25% 70) C Net margin = Net income ÷ Net sales Net margin = $5,500 ÷ $30,000 = 18% (rounded) 71) B Net margin, sometimes called operating margin, profit margin, or the return on sales ratio, describes the percentage of each sales dollar remaining after subtracting other expenses as well as cost of goods sold. Obviously, the larger the percentage, the better. 72) A

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Asset turnover = Net sales ÷ Average assets Asset turnover = ($880,000 − $5,300 − $5,300) ÷ $530,000 = $869,400 ÷ $530,000 = 1.64 times 73) C Asset turnover = Net sales ÷ Average assets Asset turnover = ($850,000 − $15,000 − $5,000) ÷ $500,000 = $830,000 ÷ $500,000 = 1.66 times 74) D Return on investment = Net income ÷ Average total assets Return on investment = $15,600 ÷ $121,200 = 12.87% 75) B Return on investment = Net income ÷ Average total assets Return on investment = $15,000 ÷ $135,000 = 11.1% 76) D Return on equity (ROE) is often used to measure the profitability of the stockholders’ investment. ROE is usually higher than ROI because of financial leverage. Financial leverage refers to using debt. 77) D Return on equity = Net income ÷ Average stockholders’ equity Return on equity = Net income ÷ (Average total assets − Average total liabilities) Return on equity = $56,000 ÷ ($590,000 − $160,000) = 13.02% 78) C Return on equity = Net income ÷ Average stockholders’ equity Return on equity = Net income ÷ (Average total assets − Average total liabilities) Return on equity = $50,000 ÷ ($500,000 − $100,000) = 12.5% 79) D

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Return on investment (ROI), also called return on assets or earning power, is the ratio of wealth generated (net income) to the amount invested (average total assets) to generate the wealth. 80) C Ratios for assessing a company’s position in the stock market include earnings per share, book value, price-earnings ratio, and dividend yield. Working capital measures the excess funds the company will have available for operations, excluding any new funds it generates during the year. This ratio is used to assess liquidity. 81) D Earnings per share = (Net income− Preferred stock dividends) ÷ Average shares outstanding Earnings per share = (Net income− Preferred stock dividends) ÷ [(Beginning shares outstanding + ending shares outstanding) ÷ 2] Earnings per share = ($275,000 − $27,500) ÷ [(410,000 shares outstanding + 470,000 shares outstanding) ÷ 2] = $247,500 ÷ 440,000 shares = $0.56 per share 82) C Earnings per share = (Net income− Preferred stock dividends) ÷ Average shares outstanding Earnings per share = (Net income− Preferred stock dividends) ÷ [(Beginning shares outstanding + ending shares outstanding) ÷ 2] Earnings per share = ($250,000 − $25,000) ÷ [(200,000 shares outstanding + 300,000 shares outstanding) ÷ 2] = $225,000 ÷ 250,000 shares = $0.90 per share 83) B

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Book value per common share = (Stockholders’ equity − Preferred rights) ÷ Outstanding common shares Book value per common share = ($920,000 − $270,000) ÷ 132,000 = $650,000 ÷ 132,000 = $4.92 per share 84) B Book value per common share = (Stockholders’ equity − Preferred rights) ÷ Outstanding common shares Book value per common share = ($1,000,000 − $175,000) ÷ 150,000 = $825,000 ÷ 150,000 = $5.50 per share 85) B Earnings per share = (Net income − Preferred stock dividends) ÷ Average shares outstanding Earnings per share = ($59,400 − $11,300) ÷ 13,000 shares = $48,100 ÷ 13,000 shares = $3.70 per share Price-earnings ratio = Market price per share ÷ Earnings per share Price-earnings ratio = $73 per share ÷ $3.70 per share = 19.73 86) A Earnings per share = (Net income − Preferred stock dividends) ÷ Average shares outstanding Earnings per share = ($112,000 − $12,000) ÷ 20,000 shares = $100,000 ÷ 20,000 shares = $5 per share Price-earnings ratio = Market price per share ÷ Earnings per share Price-earnings ratio = $95 per share ÷ $5 per share = 19 87) A Dividend yield = Dividends per share ÷ Market price per share Dividend yield = ($106,600 ÷ 26,000 shares) ÷ $81 per share = $4.10 per share ÷ $81 per share = 5.06% 88) D

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Dividend yield = Dividends per share ÷ Market price per share Dividend yield = ($200,000 ÷ 25,000 shares) ÷ $80 per share = $8 per share ÷ $80 per share = 10% 89) A The current ratio is expressed as the number of dollars of current assets for each dollar of current liabilities. A company with a current ratio of 1.5:1 appears to have a stronger working capital position than one with a current ratio of 1:1. 90) D 91) D 92) C The pervasive use of the historical cost concept is probably the greatest single cause of distorted financial statement analysis results. The historical cost of an asset does not represent its current value. The asset purchased years ago for $10,000 is not comparable in value to the asset purchased in the current year for $10,000 because of changes in the value of the dollar. Using historical cost produces financial statements that report dollars with differing purchasing power in the same statement. 93) B The issuance of common stock for cash is an asset source transaction; the current asset account Cash increases and the stockholders’ equity account Common Stock increases. The current ratio is calculated by dividing current assets by current liabilities. Since this transaction increases the numerator but does not affect the denominator, it increases the current ratio. 94) A

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The sale of inventory on account for an amount in excess of its cost is an asset source transaction; the current asset account Accounts Receivable and the stockholders' equity account Retained Earnings increase by $6,000. In addition, the current asset account Inventory and the stockholders' equity account Retained Earnings decrease. The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash, Accounts Receivable, and Current Marketable Securities) by current liabilities. Since this transaction increases the numerator (that is, the quick asset Accounts Receivable) but does not affect the denominator, it increases (rather than decreases) the quick ratio. The current ratio is calculated by dividing current assets by current liabilities. Since this transaction increases the numerator (that is, the current asset Accounts Receivable) but does not affect the denominator, it increases the current ratio. Working capital is calculated by subtracting current liabilities from current assets. Since this transaction increases current assets (that is, the current asset Accounts Receivable) but does not affect current liabilities, it also increases working capital. 95) B The sale of inventory for an amount in excess of its cost is an asset source transaction; the current asset account Cash (or Accounts Receivable, if on account) and the stockholders’ equity account Retained Earnings increase. In addition, the current asset account Inventory and the stockholders’ equity account Retained Earnings decrease. The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash, Accounts Receivable, and Current Marketable Securities) by current liabilities. Since this transaction increases the numerator but does not affect the denominator, it increases the quick ratio. 96) C

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The collection from a customer on account is an asset exchange transaction; the current asset account Cash increases and the current asset account Accounts Receivable decreases. Working capital is calculated by subtracting current liabilities from current assets. Since this transaction does not affect total current assets or total current liabilities, the amount of working capital does not change. 97) A The purchase of inventory on account is an asset use transaction; the current asset account Inventory and the current liability account Accounts Payable increase. The current ratio is calculated by dividing current assets by current liabilities. This transaction impacts both the numerator and denominator. To determine the impact, assume that the current ratio of 1.29 suggests that current assets are $129,000 and current liabilities are $100,000 (that is $129,000 ÷ $100,000 = 1.29); the current ratio would decrease as a result of this transaction as follows: Current ratio = Current assets ÷ Current liabilities Current ratio = ($129,000 + $4,000) ÷ ($100,000 + $4,000) = $133,000 ÷ $104,000 = 1.28. The new current ratio of 1.28 is lower than the old current ratio of 1.29. The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash, Accounts Receivable, and Current Marketable Securities) by current liabilities. Since this transaction does not affect the numerator but increases the denominator, it decreases the quick ratio. 98) A

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A payment on account is an asset use transaction; the current asset account Cash and the current liability account Accounts Payable decrease. The current ratio is calculated by dividing current assets by current liabilities. This transaction impacts both the numerator and denominator. To determine the impact, assume that the current ratio of 1.29 suggests that current assets are $129,000 and current liabilities are $100,000 (that is $129,000 ÷ $100,000 = 1.29); the current ratio would increase as a result of this transaction as follows: Current ratio = Current assets ÷ Current liabilities Current ratio = ($129,000 − $3,600) ÷ ($100,000 − $3,600) = $125,400 ÷ $96,400 = 1.30. The new current ratio of 1.30 (rounded) is higher than the old current ratio of 1.29. The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash, Accounts Receivable, and Current Marketable Securities) by current liabilities. This transaction impacts both the numerator and denominator. To determine the impact, assume that the quick ratio of 1.05 suggests that quick assets are $105,000 and current liabilities are $100,000 (that is $105,000 ÷ $100,000 = 1.05); the quick ratio would increase as a result of this transaction as follows: Quick ratio = Current assets ÷ Current liabilities Quick ratio = ($105,000 − $3,600) ÷ ($100, 000 − $3,600) = $101,400 ÷ $96,400 = 1.05. The new quick ratio of 1.0519 (rounded) is higher than the old quick ratio of 1.05. Version 1

99) B A payment for transportation costs on merchandise received is an asset exchange transaction; the asset account Cash decreases and the asset account Merchandise Inventory increases. The quick ratio is calculated by dividing quick assets (which include the asset accounts Cash, Accounts Receivable, and Current Marketable Securities) by current liabilities. This transaction decreases the numerator, but has no effect on the denominator. As a result, this transaction causes the quick ratio to decrease (rather than increase). 100) B The payment of a cash dividend is an asset use transaction; the current asset account Cash and the stockholders’ equity account Retained Earnings decrease. The debt to assets ratio is calculated by dividing total liabilities by total assets. This transaction does not affect the numerator but decreases the denominator. As a result, this transaction causes the debt to assets ratio to increase. 101) A The receipt of cash from the issuance of common stock is an asset source transaction; the asset account Cash and the stockholders’ equity account Common Stock increase. The debt to equity ratio is calculated by dividing total stockholders’ equity by total liabilities. This transaction does not affect the numerator but increases the denominator. As a result, this transaction causes the debt to equity ratio to decrease. 102) B The receipt of cash from the issuance of bonds is an asset source transaction; the asset account Cash and the liability account Bonds Payable increase. The current ratio is calculated by dividing current assets by current liabilities. This transaction impacts the numerator but not the denominator. As a result, this transaction causes the current ratio to increase. Version 1

103) B Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. These periods may be several quarters within the same fiscal year or they may be several different years. The analysis of a given item may focus on trends in the absolute dollar amount of the item or trends in percentages. 104) D Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. These periods may be several quarters within the same fiscal year or they may be several different years. The analysis of a given item may focus on trends in the absolute dollar amount of the item or trends in percentages. 105) D Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. These periods may be several quarters within the same fiscal year or they may be several different years. The analysis of a given item may focus on trends in the absolute dollar amount of the item or trends in percentages. 106) C Vertical analysis of an income statement (also called a common- size income statement) involves converting each income statement component to a percentage of sales. 107) A Vertical analysis of the balance sheet involves converting each balance sheet component to a percentage of total assets. 108) A

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Creditors are interested in whether a company will be able to repay its debts on time. Liquidity ratios indicate a company’s ability to pay shortterm debts. They focus on current assets and current liabilities. 109) B The quick ratio, also known as the acid-test ratio, is a conservative variation of the current ratio. The quick ratio measures a company’s immediate debt-paying ability. Only cash, receivables, and current marketable securities (quick assets) are included in the numerator. 110) C Solvency ratios are used to analyze a company's long-term debt-paying ability and its financing structure. 111) C Working capital is calculated as current assets minus current liabilities. Current assets include assets most likely to be converted into cash in the current operating period. Current liabilities represent debts that must be satisfied in the current period. Working capital therefore measures the excess funds the company will have available for operations, excluding any new funds it generates during the year. Think of working capital as the cushion against short-term debt-paying problems. Harmon's working capital exceeds Lilly's working capital. However, it is not necessarily safe to assume that Harmon is more liquid than Lilly. Whether Harmon’s working capital is sufficient or not depends on such factors as the industry in which it operates, its size, and the maturity dates of its current obligations. 112) D The quick ratio, also known as the acid-test ratio, is a conservative variation of the current ratio. The quick ratio is computed by dividing quick assets by current liabilities. Only cash, receivables, and current marketable securities (quick assets) are included in the numerator. 113) B Version 1

Two relationships are often examined to assess a company’s collection record: accounts receivable turnover and average days to collect receivables (average collection period). 114) C Inventory turnover = Cost of goods sold ÷ Average inventory 115) A Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. Creditors are concerned with a company’s ability to satisfy outstanding obligations. The larger a company’s liability percentage, the greater the risk that the company could fall behind or default on debt payments. Stockholders, too, are concerned about a company’s solvency. If a company is unable to pay its debts, the owners could lose their investment. 116) D The debt to assets ratio measures the percentage of a company’s assets that are financed by debt. The debt to equity ratio compares creditor financing to owner financing. Financial statement users may analyze a firm’s ability to obtain long-term financing on the strength of its asset base. Short-term assets should be financed with short-term liabilities; the current ratio, introduced earlier, indicates how well a company manages current debt. Long-lived assets should be financed with long-term liabilities, and the plant assets to long-term liabilities ratio shows the amount of assets per each dollar of long-term debt. 117) B Accounts receivable turnover = Net credit sales ÷ [(Beginning accounts receivable + ending accounts receivable) ÷ 2] Accounts receivable turnover = $1,300,000 ÷ [($65,000 + $69,000) ÷ 2] = $1,300,000 ÷ $67,000 = 19.4 times 118) D

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Number of times interest is earned = (Net income + Taxes + Interest expense) ÷ Interest expense 119) D Net margin = Net income ÷ Net sales 120) A The current ratio is calculated by dividing current assets by current liabilities. The purchase of equipment for cash with the remainder on account is an asset source transaction; the current asset account Cash decreases by $30,000, the long-term asset account Property, plant, and equipment increases by $60,000, and the current liability account Shortterm Notes Payable increases by $30,000. The current ratio is calculated by dividing current assets by current liabilities. Current assets decrease and current liabilities increase by $30,000 as a result of this transaction. The reason Notes Payable is classified as a current liability is due to its short-term classification. 121) C The asset turnover ratio (sometimes called turnover of assets ratio) measures how many sales dollars were generated for each dollar of assets invested. 122) A The debt to assets ratio measures the percentage of a company’s assets that are financed by debt. 123) D

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Whether basing their analyses on absolute amounts, percentages, or ratios, users must avoid drawing overly simplistic conclusions about the reasons for the results. Numerical relationships flag conditions requiring further study. Recall that a change that appears favorable on the surface may not necessarily be a good sign. Users must evaluate the underlying reasons for the change. In other words, the reason behind a financial statement ratio or percentage analysis result is not usually self-evident and, as such, it does require further study or analysis. 124) A EPS pertains to shares of common stock. Perhaps the most frequently quoted measure of earnings performance is earnings per share (EPS). Book value per share is another frequently quoted measure of a share of stock. It is calculated by dividing stockholders’ equity less preferred rights by outstanding common shares. A company’s accounting records reflect book values, not worth. As a result, the book value per share is not a measure of the market value of a corporation’s stock. 125) C Solvency ratios are used to analyze a company’s long-term debt-paying ability and its financing structure. Included in these ratios is the debt to assets ratio, which measures the percentage of a company’s assets that are financed by debt. 126) B The quick ratio, also known as the acid-test ratio, is a conservative variation of the current ratio. The quick ratio measures a company’s immediate debt-paying ability. Only cash, receivables, and current marketable securities (quick assets) are included in the numerator. Less liquid current assets, such as inventories and prepaid expenses, are omitted. 127) A Price-earnings ratio = Market price per share ÷ Earnings per share. Version 1

128) C Inventory turnover = Cost of goods sold ÷ Average inventory Inventory turnover = $2,250,000 ÷ $500,000 = 4.5 times

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