ACCOUNTING TOOLS FOR BUSINESS DECISION MAKERS 6TH EDITION PAUL KIMMEL, JERRY WEYGANDT, DONALD KIESO by QuentinAxel

ACCOUNTING TOOLS FOR BUSINESS DECISION MAKERS 6TH EDITION PAUL KIMMEL, JERRY WEYGANDT, DONALD KIESO SOLUTIONS MANUAL

CHAPTER 1 Introduction to Financial Statements Learning Objectives 1. 2. 3.

Identify the forms of business organization and the uses of accounting information. Explain the three principal types of business activity. Describe the four financial statements, and how they are prepared.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

Questions 1. 2. 3. 4. 5. 1. 2. 3.

1 1 1 1 1 1 1 2

K K K C C K K K

6. 7. 8. 9.

4. 5.

1 2 3 3

3 3

C C K C

10. 11. 12. 13.

3 3 3 3

C K C AP

14. 15. 16. 17.

3 3 3 3

K K AP C

18. 19. 20. 21.

3 3 3 3

K C K C

C AP

Brief Exercises 6. 3 K 7. 3 K

8. 9.

3 3

AP AP

10. 11.

3 3

K K

3b.

12. 13. 14.

3 3 3

AP AP AP

15. 16. 17.

3 3 3

AP AN K

Do It! Exercises 1.

3a.

Exercises 1. 1, 2, 3 K 2. 2 C 3. 2, 3 C AP 4. 3

5. 6. 7. 8.

3 3 3 3

AP AP AP C

9. 10. 11.

3 3 3

AN AP AP

Problems: Set A 1.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine forms of business organization.

Simple

15–20

Identify users and uses of financial statements.

Simple

15–20

Prepare an income statement, retained earnings statement, and balance sheet; discuss results.

Moderate

40–50

Determine items included in a statement of cash flows, prepare the statement, and comment.

Moderate

30–40

Comment on proper accounting treatment and prepare a corrected balance sheet.

Moderate

40–50

ANSWERS TO QUESTIONS 1.

The three basic forms of business organizations are (1) sole proprietorship, (2) partnership, and (3) corporation.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA BB: Legal/Regulatory Perspective

Advantages of a corporation are limited liability (stockholders not being personally liable for corporate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a corporation are increased taxation and government regulations.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA BB: Legal/Regulatory Perspective

Proprietorships and partnerships receive favorable tax treatment compared to corporations and are easier to form than corporations. They are also owner controlled. Disadvantages of proprietorships and partnerships are unlimited liability (proprietors/partners are personally liable for all debts) and difficulty in obtaining financing compared to corporations.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA BB: Legal/Regulatory Perspective

Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Accounting provides financial information to interested users through the preparation and distribution of financial statements.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

Internal users are managers who plan, organize, and run a business. To assist management, accounting provides timely internal reports. Examples include financial comparisons of operating alternatives, projections of income from new sales campaigns, forecasts of cash needs for the next year, and financial statements.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

External users are those outside the business who have either a present or potential direct financial interest (investors and creditors) or an indirect financial interest (taxing authorities, regulatory agencies, labor unions, customers, and economic planners).

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

The three types of business activities are financing activities, investing activities, and operating activities. Financing activities include borrowing money and selling shares of stock. Investing activities include the purchase and sale of property, plant, and equipment. Operating activities include selling goods, performing services, and purchasing inventory.

LO 2 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

(a) Income statement. (b) Balance sheet. (c) Income statement.

(d) Balance sheet. (e) Balance sheet. (f) Balance sheet.

LO 3 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

When a company pays dividends, it reduces the amount of assets available to pay creditors. Therefore, banks and other creditors monitor dividend payments to ensure they do not put a company’s ability to make debt payments at risk.

LO 3 BT: AN Diff: M TOT: 2 min. AACSB: Reflective Thinking AICPA BB: Critical Thinking

10.

Yes. Net income does appear on the income statement—it is the result of subtracting expenses from revenues. In addition, net income appears in the retained earnings statement—it is shown as an addition to the beginning-of-period retained earnings. Indirectly, the net income of a company is also included in the balance sheet. It is included in the retained earnings account which appears in the stockholders’ equity section of the balance sheet.

LO 3 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

11.

The primary purpose of the statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

12.

The three categories of the statement of cash flows are operating activities, investing activities, and financing activities. The categories were chosen because they represent the three principal types of business activities.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

13.

Retained earnings is the net income retained in a corporation. Retained earnings is increased by net income and is decreased by dividends and a net loss.

LO 3 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

14.

The basic accounting equation is Assets = Liabilities + Stockholders’ Equity.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

15.

(a) Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put more simply, liabilities are existing debts and obligations. Stockholders’ equity is the ownership claim on net assets. (b) The items that affect stockholders’ equity are common stock, retained earnings, dividends, revenues, and expenses.

LO 3 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

16.

The liabilities are (b) Accounts payable and (g) Salaries and wages payable.

LO 3 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

17.

(a) Net income from the income statement is reported as an increase to retained earnings on the retained earnings statement. (b) The ending amount on the retained earnings statement is reported as the retained earnings amount on the balance sheet. (c)

The ending amount on the statement of cash flows is reported as the cash amount on the balance sheet.

LO 3 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

18.

The purpose of the management discussion and analysis section is to provide management’s views on its ability to pay short-term obligations, its ability to fund operations and expansion, and its results of operations. The MD&A section is a required part of the annual report.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

19.

An unqualified opinion shows that, in the opinion of an independent auditor, the financial statements have been presented fairly, in conformity with generally accepted accounting principles. This gives investors more confidence that they can rely on the figures reported in the financial statements.

LO 3 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

20.

Information included in the notes to the financial statements clarifies information presented in the financial statements and includes descriptions of accounting policies, explanations of uncertainties and contingencies, and statistics and details too voluminous to be reported in the financial statements.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

21.

Using dollar amounts, Apple’s accounting equation is: Assets $231,839,000

Liabilities $120,292,000

LO 3 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

Stockholders’ Equity $111,547,000

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 (a)

Shared control, tax advantages, increased skills and resources.

(b)

Simple to set up and maintains control with owner.

(c)

Easier to transfer ownership and raise funds, no personal liability.

LO 1 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA BB: Legal

BRIEF EXERCISE 1-2 (a) (b) (c) (d) (e)

4 3 2 5 1

Investors in common stock Marketing managers Creditors Chief Financial Officer Internal Revenue Service

LO 1 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 1-3 O F F O I

(a) (b) (c) (d) (e)

Cash received from customers. Cash paid to stockholders (dividends). Cash received from issuing new common stock. Cash paid to suppliers. Cash paid to purchase a new office building.

LO 2 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Measurement & Reporting

BRIEF EXERCISE 1-4 E R E E D R E NSE C

(a) (b) (c) (d) (e) (f) (g) (h) (i)

Advertising expense Service revenue Insurance expense Salaries and wages expense Dividends Rent revenue Utilities expense Cash purchase of equipment Issued common stock for cash.

LO 3 BT: C Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Measurement & Reporting

BRIEF EXERCISE 1-5 KAROL COMPANY Balance Sheet December 31, 2017 Assets Cash ............................................................................... Accounts receivable ..................................................... Total assets ...................................................................

$22,000 71,000 $93,000

Liabilities and Stockholders’ Equity Liabilities Accounts payable .................................................. Stockholders’ equity Common stock....................................................... Retained earnings.................................................. Total liabilities and stockholders’ equity.....................

$65,000 $18,000 10,000

LO 3 BT: AP Difficulty: Medium TOT: 4.0 min. AACSB: Analytic AICPA FC: Reporting

28,000 $93,000

BRIEF EXERCISE 1-6 IS BS BS BS BS IS IS BS BS IS

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Income tax expense Inventory Accounts payable Retained earnings Equipment Sales revenue Cost of goods sold Common stock Accounts Receivable Interest expense

LO 3 BT: K Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 1-7 IS BS SCF BS

(a) (b) (c) (d)

Revenue during the period. Supplies on hand at the end of the year. Cash received from issuing new bonds during the period. Total debts outstanding at the end of the period.

LO 3 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 1-8 (a) $90,000 + $230,000 = $320,000 (Total assets) (Liabilities + Stockholder’s equity = Assets)

(b) $170,000 – $80,000 = $90,000 (Total liabilities) (Assets – Stockholder’s equity = Liabilities)

(c) $800,000 – 0.25($800,000) = $600,000 (Stockholders’ equity) (Assets – (1/4 × Assets) = Stockholder’s equity) LO 3 BT: AP Difficulty: Medium TOT: 4.0 min. AACSB: Analytic AICPA: FC: Measurement

BRIEF EXERCISE 1-9 (a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000 (Stockholders’ equity) [(Assets ± Change in assets) – (Liabilities ± Change in liabilities) = Stockholders’ equity]

(b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000 (Assets) [(Liabilities ± Change in liabilities) + (Stockholders’ equity ± Change in stockholders’ equity) = Assets]

(c) ($800,000 – $80,000) – ($800,000 – $500,000 + $110,000) = $310,000 (Liabilities) [(Assets ± Change in assets) – (Stockholders’ equity ± Change in stockholders’ equity) = Liabilities] LO 3 BT: AP Difficulty: Medium TOT: 5.0 min. AACSB: Analytic AICPA FC: Measurement

BRIEF EXERCISE 1-10 A L A A SE L

(a) (b) (c) (d) (e) (f)

Accounts receivable Salaries and wages payable Equipment Supplies Common stock Notes payable

LO 3 BT: K Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 1-11 (d) All of these are required. LO 3 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 1-1 (a) Easier to transfer ownership: corporation (b) Easier to raise funds: corporation (c) More owner control: sole proprietorship (d) Tax advantages: sole proprietorship and partnership (e) No personal legal liability: corporation LO 1 BT: C Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA BB: Legal

DO IT! 1-2 (a) Issuance of ownership shares is classified as common stock. (b) Land purchased is classified as an asset. (c) Amounts owed to suppliers are classified as liabilities. (d) Bonds payable are classified as liabilities. (e) Amount earned from selling a product is classified as revenue. (f) Cost of advertising is classified as expense. LO 2 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Reporting

DO IT! 1-3a GRAY CORPORATION Income Statement For the Year Ended December 31, 2017 Revenues Service revenue........................................... Expenses Rent expense............................................... Advertising expense ................................... Supplies expense........................................ Total expenses.................................. Net income ..........................................................

[Revenues – Expenses = Net income or (loss)]

$25,000 $10,000 4,000 1,700 15,700 $ 9,300

DO IT! 1-3a (Continued) GRAY CORPORATION Retained Earnings Statement For the Year Ended December 31, 2017 $ –0– 9,300 9,300 2,500 $6,800

Retained earnings, January 1.................................. Add: Net income .................................................... Less: Dividends....................................................... Retained earnings, December 31 ............................

(Beginning retained earnings ± Changes in retained earnings = Ending retained earnings)

GRAY CORPORATION Balance Sheet December 31, 2017 Assets Cash .......................................................................... Accounts receivable ................................................ Supplies .................................................................... Equipment................................................................. Total assets ..............................................................

$ 3,100 2,000 1,900 26,800 $33,800

Liabilities and Stockholders’ Equity Liabilities Notes payable.................................................... Account payable ............................................... Total liabilities ........................................ Stockholder’s equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity ..................... Total liabilities and stockholder’s equity................

$ 7,000 5,000 $12,000 15,000 6,800

(Assets = Liabilities + Stockholders’ equity) LO 3 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

21,800 $33,800

DO IT! 1-3b (a) Description of ability to pay near-term obligations: MD&A (b) Unqualified opinion: auditor’s report (c) Details concerning liabilities, too voluminous to be included in the statements: notes (d) Description of favorable and unfavorable trends: MD&A (e) Certified Public Accountant (CPA): auditor’s report (f) Descriptions of significant accounting policies: notes LO 3 BT: K Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 1-1 (a) (b) (c) (d) (e) (f) (g) (h)

8. 1. 6. 7. 3. 2. 5. 4.

Auditor’s opinion Corporation Common stock Accounts payable Accounts receivable Creditor Stockholder Partnership

LO 1-3 BT: K Difficulty: Easy TOT: 2.0 min. AACSB: None AICPA FC: Measurement & Reporting

EXERCISE 1-2 (a)

Answers will vary.

Abitibi Consolidated Inc. Cal State—Northridge Stdt Union

Financing Sale of stock Borrow money from a bank

Investing Purchase long-term investments Purchase office equipment

Oracle Corporation

Sale of bonds

Purchase other companies

Sportsco Investments

Payment of dividends to stockholders Distribute earnings to partners Sale of stock

Purchase hockey equipment

Grant Thornton LLP

Southwest Airlines

Purchase computers Purchase airplanes

Operating Sale of newsprint Payment of wages and benefits Payment of research expenses Payment for rink rentals Bill clients for professional services Payment for jet fuel

EXERCISE 1-2 (Continued) (b) Financing Sale of stock is common to all corporations. Borrowing from a bank is common to all businesses. Payment of dividends is common to all corporations. Sale of bonds is common to large corporations. Investing Purchase and sale of property, plant, and equipment would be common to all businesses—the types of assets would vary according to the type of business and some types of businesses require a larger investment in long-lived assets. A new business or expanding business would be more apt to acquire property, plant, and equipment while a mature or declining business would be more apt to sell it. Operating The general activities identified would be common to most businesses, although the service or product would differ. LO 2 BT: C Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Measurement & Reporting

EXERCISE 1-3 Accounts payable Accounts receivable Equipment Sales revenue Service revenue Inventory Mortgage payable Supplies expense Rent expense Salaries and wages expense

L A A R R A L E E E

LO 3 BT: C Difficulty: Easy TOT: 3.0 min AACSB: None AICPA FC: Measurement & Reporting

EXERCISE 1-4 BENSER CO. Income Statement For the Year Ended December 31, 2017 Revenues Service revenue ...................................................... Expenses Salaries and wages expense ................................. Rent expense .......................................................... Utilities expense ..................................................... Advertising expense............................................... Total expenses ................................................ Net income......................................................................

$58,000 $30,000 10,400 2,400 1,800 44,600 $13,400

BENSER CO. Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1.......................................................... Add: Net income ............................................................................ Less: Dividends............................................................................... Retained earnings, December 31 ....................................................

$67,000 13,400 80,400 6,000 $74,400

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings) LO 3 BT: AP Difficulty: Medium TOT: 6.0 min. AACSB: Analytic AICPA FC: Reporting

Get complete Order files download link below https://www.mediafire.com/file_premium/uho6z0riclb 1hkx/SM_Accounting_Tools_for_Business_Decision_M akers_6e_Paul_Kimmel_Jerry Weygandt_Donald_Kies o.zip/file

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

EXERCISE 1-5 (a)

MERCK AND CO. Income Statement For the Year Ended December 31, 2017 (in millions) Revenues Sales revenue................................................. $38,576.0 Expenses Cost of goods sold......................................... $ 9,018.9 Selling and administrative expenses............ 8,543.2 Research and development expense ........... 5,845.0 Income tax expense ....................................... 2,267.6 Total expenses ........................................... 25,674.7 Net income .............................................................. $12,901.3

MERCK AND CO. Retained Earnings Statement For the Year Ended December 31, 2017 (in millions) Retained earnings, January 1 ................................ Add: Net income................................................... Less: Dividends ..................................................... Retained earnings, December 31...........................

$43,698.8 12,901.3 56,600.1 3,597.7 $53,002.4

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings)

(b) The short-term implication would be a decrease in expenses of $2,922.5 ($5,845 X 50%) resulting in a corresponding increase in income (ignoring income taxes). If all other revenues and expenses remain unchanged, decreasing research and development expenses would produce 22.7% more net income ($2,922.5 ÷ $12,901.3).

EXERCISE 1-5 (Continued) The long-term implications would be more difficult to quantify but it is safe to predict that a reduction in research and development expenses would probably result in lower sales revenues in the future. Pharmaceutical companies are usually able to charge higher prices for newly developed products while lower cost generic versions usually replace older products. Decreasing research and development activities will probably mean fewer new products. The stock market’s initial reaction might be positive since Merck’s net income would increase significantly. Such a reaction would probably be very short-lived as more knowledgeable investors reviewed Merck’s financial statements and discovered the cause of the increase. LO 3 BT: AP Difficulty: Hard TOT: 8.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-6 ZHENG INC. Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1.................................. Add: Net income ....................................................

$130,000 225,000* 355,000 65,000 $290,000

Less: Dividends....................................................... Retained earnings, December 31 ............................ *Service revenue ...................................................... Total expenses ........................................................ Net income ..............................................................

$400,000 175,000 $225,000

(Beginning retained earnings ± Changes in retained earnings = Ending retained earnings) LO 3 BT: AP Difficulty: Medium TOT: 4.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-7 (a) Lee Corporation is distributing nearly all of this year’s net income as dividends. This suggests that Lee is not pursuing rapid growth. Companies that have a lot of opportunities for growth pay low dividends. (b) Steele Corporation is not generating sufficient cash provided by operating activities to fund its investing activities. Instead it generates additional cash through financing activities. This is common for companies in their early years of existence. LO 3 BT: AP Difficulty: Medium TOT: 4.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-8 (a)

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

Cash Retained earnings Cost of goods sold Salaries and wages expense Prepaid insurance Inventory Accounts receivable Sales revenue Notes payable Accounts payable Service revenue Interest expense

EXERCISE 1-8 (Continued) (b)

LONYEAR INC. Income Statement For the Year Ended December 31, 2017 Revenues Sales revenue...................................... Service revenue .................................. Total revenues ................................. Expenses Cost of goods sold ............................. Salaries and wages expense.............. Interest expense ................................. Total expenses ................................ Net income ..................................................

$584,951 4,806 $589,757 438,458 115,131 1,882 555,471 $ 34,286

[Revenues – Expenses = Net income or (loss)] LO 3 BT: C Difficulty: Medium TOT: 5.0 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE 1-9 First note that the retained earnings statement shows that (b) equals $27,000. Accounts payable + Common stock + Retained earnings = Total liabilities and stockholders’ equity

$5,000 + a + $27,000 = $62,000 a + $32,000 = $62,000 a = $30,000 Beginning retained earnings + Net income – Dividends = Ending retained earnings

$12,000 + e – $5,000 = $27,000 $7,000 + e = $27,000 e = $20,000

EXERCISE 1-9 (Continued) From above, we know that net income (d) equals $20,000. Revenue – Cost of goods sold – Salaries and wages expense = Net income

$85,000 – c – $10,000 = $20,000 $75,000 – c = $20,000 c = $55,000 LO 3 BT: AN Difficulty: Hard TOT: 7.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-10 (a)

Service revenue ............................................ Sales revenue................................................ Total revenue......................................... Expenses ....................................................... Net income ....................................................

$132,000 25,000 $157,000 126,000 $ 31,000

[Revenues – Expenses = Net income or (loss)]

(b)

OTAY LAKES PARK Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1 ................................................ Add: Net income ................................................................... Less: Dividends ..................................................................... Retained earnings, December 31...........................................

$ 5,000 31,000 36,000 9,000 $27,000

(Beginning retained earnings ± Changes in retained earnings = Ending retained earnings)

EXERCISE 1-10 (Continued) OTAY LAKES PARK Balance Sheet December 31, 2017 Assets Cash.................................................................... Supplies ............................................................. Equipment .......................................................... Total assets........................................................

8,500 5,500 114,000 $128,000

Liabilities and Stockholders’ Equity Liabilities Notes payable............................................. Accounts payable ...................................... Total liabilities..................................... Stockholders’ equity Common stock ........................................... Retained earnings ...................................... Total liabilities and stockholders’ equity .........

$50,000 11,000 $ 61,000 40,000 27,000

67,000 $128,000

(Assets = Liabilities + Stockholders’ equity)

(c) The income statement indicates that revenues from the general store were only about 16% ($25,000 ÷ $157,000) of total revenue which tends to support Walt’s opinion. In order to decide if the store is “more trouble than it is worth,” I would need to know the amount of expenses attributable to the general store. The income statement reports all expenses in a single category rather than separating them into camping and general store expenses to correspond with revenues. A break down into two categories would help me decide if the general store is generating a profit or loss. Even if the general store is operating at a loss, I might recommend retaining it if campers indicated that the convenience of having a general store on site was an important amenity in selecting a camp ground. LO 3 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-11 (a)

(b)

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

Retained earnings Cost of goods sold Selling and administrative expenses Cash Notes payable Interest expense Bonds payable Inventory Sales revenue Accounts payable Common stock Income tax expense

KELLOGG COMPANY Income Statement For the Year Ended December 31, 2017 (in millions) Revenues Sales revenue ........................................... Expenses Cost of goods sold................................... Selling and administrative expenses ...... Income tax expense ................................. Interest expense ....................................... Total expenses.................................. Net income .......................................................

$12,575 $7,184 3,390 498 295

[Revenues – Expenses = Net income or (loss)] LO 3 BT: AP Difficulty: Medium TOT: 6.0 min. AACSB: Analytic AICPA FC: Reporting

11,367 $ 1,208

EXERCISE 1-12 (a)

WILLIAMS CORPORATION Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Cash received from customers..........................$ 50,000 Cash paid to suppliers ...................................... (16,000) Net cash provided by operating activities ..... $ 34,000 Cash flows from investing activities Cash paid for new equipment ........................... (28,000) Net cash used by investing activities ............ (28,000) Cash flows from financing activities Cash received from lenders ........................... 20,000 Cash dividends paid ....................................... (8,000) Net cash provided by financing activities ..... 12,000 Net increase in cash ............................................... 18,000 Cash at beginning of period................................... 12,000 Cash at end of period ............................................. $ 30,000

(Cash flows from operating, investing, and financing activities = Net change in cash)

(b) As a creditor, I would feel reasonably confident that Williams has the ability to repay its lenders. During 2017, Williams generated $34,000 of cash from its operating activities. This amount more than covered its expenditures for new equipment but not both equipment purchases and dividends. LO 3 BT: AP Difficulty: Medium TOT: 6.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-13 (a)

SOUTHWEST AIRLINES Statement of Cash Flows For the Year Ended December 31, 2017 (in millions) Cash flows from operating activities Cash received from customers ............................. $9,823 Cash paid for goods and services ......................... (6,978) Net cash provided by operating activities ........ Cash flows from investing activities Cash paid for property and equipment ................ (1,529) Net cash used by investing activities ............... Cash flows from financing activities Cash received from issuance of long-term debt................................................. 500 Cash received from issuance of common stock................................................. 144 Cash paid for repurchase of common stock ..... (1,001) Cash paid for repayment of debt........................ (122) Cash paid for dividends...................................... (14) Net cash used by financing activities ................ Net increase in cash.................................................. Cash at beginning of period ..................................... Cash at end of period................................................

$2,845

(1,529)

(493) 823 1,390 $2,213

(Cash flows from operating, investing, and financing activities = Net change in cash)

(b) Southwest reported $2,845,000,000 cash from operating activities but spent $1,529,000,000 to invest in new property and equipment. Its cash from operating activities was sufficient to finance its investing activities. Southwest supplemented the cash from operating activities by issuing long-term debt and additional shares of common stock. It used excess cash to repurchase stock, pay down debt, and pay dividends. In total, it generated more cash from operating activities than it paid for investing and financing activities resulting in a net increase in cash for 2017. LO 3 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-14 BEESON COMPANY Balance Sheet December 31, 2017 Assets Cash .............................................................................. Accounts receivable .................................................... Supplies ........................................................................ Equipment..................................................................... Total assets ..................................................................

$18,000 12,000 9,500 40,000 $79,500

Liabilities and Stockholders’ Equity Liabilities Accounts payable ................................................. Stockholders’ equity Common stock...................................................... Retained earnings................................................. Total liabilities and stockholders’ equity....................

$16,000 $40,000 23,500*

*$31,500 – $8,000 (Assets = Liabilities + Stockholders’ equity) LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

63,500 $79,500

EXERCISE 1-15 All dollars are in millions. (a) Assets Cash........................................................................................... $ 2,291.1 Accounts receivable ................................................................. 2,883.9 Inventory ................................................................................... 2,357.0 Equipment ................................................................................. 1,957.7 Buildings...................................................................................... 3,759.9 Total assets ................................................................................. $13,249.6 Liabilities Notes payable ........................................................................... $ 342.9 Accounts payable ..................................................................... 2,815.8 Mortgage payable ..................................................................... 1,311.5 Income taxes payable ................................................................. 86.3 Total liabilities........................................................................... $ 4,556.5 Stockholders’ Equity Common stock .......................................................................... $ 2,874.2 Retained earnings ....................................................................... 5,818.9 Total stockholders’ equity........................................................ $ 8,693.1 (b)

Assets $13,249.6

Liabilities $4,556.5

Stockholders’ Equity $8,693.1

(c) Nike has relied more heavily on equity than debt to finance its assets. Debt (liabilities) financed 34% of its assets ($4,556.5 ÷ $13,249.6) compared to equity financing of 66% ($8,693.1 ÷ $13,249.6). LO 3 BT: AP Difficulty: Medium TOT: 8.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-16 (a)

Assets $110,000 (a)

= = =

Liabilities $70,000 $40,000

+ +

Stockholders’ Equity (a)

(b)

Assets (b) (b)

= = =

Liabilities $120,000 $180,000

+ +

Stockholders’ Equity $60,000

(c)

Beginning Stockholders’ Equity $40,000(a)

Revenues

–

215,000 $ 90,000

– 165,000 – (c) (c)

Expenses

– Dividends

– (c)

= = =

Ending Stockholders’ Equity $60,000 $60,000 $30,000

(d)

Assets $150,000 (d)

= = =

Liabilities (d) $80,000

+ +

Stockholders’ Equity $70,000

(e)

Assets $180,000 (e)

= = =

Liabilities $ 55,000 $125,000

+ +

Stockholders’ Equity (e)

(f)

Beginning Stockholders’ Equity $70,000 (f)

Revenues

–

Expenses

– Dividends

+ =

(f) $140,000

–

80,000

– 5,000

Ending Stockholders’ Equity $125,000(e)

LO 3 BT: AN Difficulty: Hard TOT: 12.0 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 1-17 (a) (b) (c) (d) (e) (f)

Financial statements Auditor’s opinion Notes to the financial statements Financial statements Management discussion and analysis Not disclosed

LO 3 BT: K Difficulty: Easy TOT: 3.0 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO PROBLEMS PROBLEM 1-1A

(a) The concern over legal liability would make the corporate form a better choice over a partnership. Also, the corporate form will allow the business to raise cash more easily, which may be of importance in a rapidly growing industry. (b) Bob should run his business as a sole proprietor. He has no real need to raise funds, and he doesn’t need the expertise provided by other partners. The sole proprietorship form would provide the easiest form. One should avoid a more complicated form of business unless the characteristics of that form are needed. (c) The fact that the combined business expects that it will need to raise significant funds in the near future makes the corporate form more desirable in this case. (d) It is likely that this business would form as a partnership. Its needs for additional funds would probably be minimal in the foreseeable future. Also, the three know each other well and would appear to be contributing equally to the firm. Service firms, like consulting businesses, are frequently formed as partnerships. (e) One way to ensure control would be for Don to form a sole proprietorship. However, in order for this business to thrive it will need a substantial investment of funds early. This would suggest the corporate form of business. In order for Don to maintain control over the business he would need to own more than 50 percent of the voting shares of common stock. In order for the business to grow, he may have to be willing to give up some control. LO 1 BT: C Difficulty: Medium TOT: 6.0 min. AACSB: None AICPA BB: Legal

PROBLEM 1-2A

(a) In deciding whether to extend credit for 30 days, The North Face would be most interested in the balance sheet because the balance sheet shows the assets on hand that would be available for settlement of the debt in the near-term. (b) In purchasing an investment that will be held for an extended period, the investor must try to predict the future performance of Amazon.com. The income statement provides the most useful information for predicting future performance. (c) In extending a loan for a relatively long period of time, the lender is most interested in the probability that the company will generate sufficient income to meet its interest payments and repay its principal. The lender would therefore be interested in predicting future net income using the income statement. It should be noted, however, that the lender would also be very interested in both the balance sheet and statement of cash flows—the balance sheet because it would show the amount of debt the company had already incurred, as well as assets that could be liquidated to repay the loan. And the company would be interested in the statement of cash flows because it would provide useful information for predicting the company’s ability to generate cash to repay its obligations. (d) The president would probably be most interested in the statement of cash flows since it shows how much cash the company generates and how that cash is used. The statement of cash flows can be used to predict the company’s future cash-generating ability. LO 3 BT: C Difficulty: Medium TOT: 6.0 min AACSB: None AICPA FC: Reporting

PROBLEM 1-3A

(a)

ELITE SERVICE CO. Income Statement For the Month Ended June 30, 2017 Revenues Service revenue .............................................. Expenses Salaries and wages expense.......................... Supplies expense............................................ Maintenance and repairs expense ................. Advertising expense ....................................... Utilities expense.............................................. Total expenses ........................................ Net income ...............................................................

$7,500 $1,400 1,000 600 400 300 3,700 $3,800

ELITE SERVICE CO. Retained Earnings Statement For the Month Ended June 30, 2017 Retained earnings, June 1 ....................................................... Add: Net income..................................................................... Less: Dividends....................................................................... Retained earnings, June 30 .....................................................

0 3,800 3,800 1,400 $2,400

PROBLEM 1-3A (Continued) ELITE SERVICE CO. Balance Sheet June 30, 2017 Assets Cash ........................................................................... Accounts receivable.................................................. Supplies ..................................................................... Equipment.................................................................. Total assets................................................................

$ 4,600 4,000 2,400 26,000 $37,000

Liabilities and Stockholders’ Equity Liabilities Notes payable .................................................... $12,000 Accounts payable .............................................. 500 Total liabilities ............................................ Stockholders’ equity 22,100 Common stock ................................................... Retained earnings.............................................. 2,400 Total liabilities and stockholders’ equity ....................

$12,500 24,500 $37,000

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings) (Assets = Liabilities + Stockholders’ equity)

(b) Elite had a very successful first month, earning $3,800 or 51% of service revenues ($3,800 ÷ $7,500). Its net income represents a 17% return on the initial investment ($3,800 ÷ $22,100). (c) Distributing a dividend after only one month of operations is probably unusual. Most new businesses choose to build up a cash balance to provide for future operating and investing activities or pay down debt. Elite distributed 37% ($1,400 ÷ $3,800) of its first month’s income but it had adequate cash to do so and still showed a significant increase in retained earnings. LO 3 BT: AP Difficulty: Hard TOT: 15.0 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 1-4A

(a) Rojo Corporation should include the following items in its statement of cash flows: Cash paid to suppliers Cash dividends paid Cash at beginning of period Cash paid to purchase equipment Cash received from customers Cash received from issuing common stock ROJO CORPORATION Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Cash received from customers ........................... $132,000 Cash paid to suppliers ........................................ (104,000) Net cash provided by operating activities ....... $28,000 Cash flows from investing activities Cash paid to purchase equipment ...................... (12,000) Net cash used by investing activities .............. (12,000) Cash flows from financing activities Cash received from issuing common stock.... 22,000 Cash dividends paid.......................................... (7,000) Net cash provided by financing activities ....... 15,000 Net increase in cash ................................................ 31,000 Cash at beginning of period.................................... 9,000 Cash at end of period .............................................. $40,000

(Cash flows from operating, investing, and financing activities = Net change in cash)

(b) Rojo Corporation’s operating activities provided $28,000 cash which was adequate to fund its investing activities ($12,000) and make ($7,000) of dividend payments. LO 3 BT: AP Difficulty: Medium TOT: 10.0 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 1-5A

(a) 1. Since the boat actually belongs to Miko Liu—not to Micado Corporation—it should not be reported on the corporation’s balance sheet. Likewise, the boat loan is a personal loan of Miko’s—not a liability of Micado Corporation.

(b)

The inventory should be reported at $25,000, the amount paid when it was purchased. Micado Corporation will record $36,000 as revenues when the inventory is sold.

The $10,000 receivable is not an asset of Micado Corporation—it is a personal asset of Miko Liu. MICADO CORPORATION Balance Sheet December 31, 2017

Assets Cash.......................................................................... Accounts receivable ................................................ Inventory .................................................................. Total assets ..............................................................

$20,000 40,000* 25,000 $85,000

Liabilities and Stockholders’ Equity Liabilities Notes payable ...................................................... $15,000 Accounts payable................................................ 30,000 Total liabilities.......................................................... Stockholders’ equity................................................ Total liabilities and stockholders’ equity ............... *$50,000 – $10,000 **$85,000 – $45,000 (Total assets minus total liabilities) (Assets = Liabilities + Stockholders’ equity) LO 3 BT: AN Difficulty: Medium TOT: 12.0 min. AACSB: Analytic AICPA FC: Reporting

$45,000 40,000** $85,000

CT 1-1

FINANCIAL REPORTING PROBLEM

(a) Apple’s total assets at September 27, 2014 were $231,839,000 and at September 28, 2013 were $207,000,000. (b) Apple had $13,844,000 of cash and cash equivalents at September 27, 2014. (c) Apple had accounts payable totaling $30,196,000 on September 27, 2014 and $22,367,000 on September 28, 2013. (d) Apple reported net sales in 2014 of $182,795,000, in 2013 of $170,910,000, and in 2012 of $156,508,000. (e) Apple’s net income increased by $2,473,000 from 2013 to 2014, from $37,037,000 to $39,510,000. LO 3 BT: AN Difficulty: Medium TOT: 5.0 min. AACSB: Analytic AICPA FC: Reporting

CT 1-2

COMPARATIVE ANALYSIS PROBLEM

(a) (amounts in thousands) 1. Total liabilities 2. Net property, plant and equipment 3. Net cash provided (used) by investing activities. 4. Net income

Columbia Sportswear Company $436,975

VF Corporation

$291,563

$ 942,181

$(184,027) $141,859

$(329,555) $1,047,505

$4,349,258*

*$1,620,241 + $1,423,581 + $1,305,436 (b) Both companies are profitable. VF’s net property, plant, and equipment and net income suggest that it is a substantially bigger company than Columbia. VF’s net property, plant, and equipment are more than three times as big as those of Columbia and its net income is more than 7 times as big as that of Columbia. LO 3 BT: AN Difficulty: Medium TOT: 8.0 min. AACSB: Analytic AICPA FC: Reporting

CT 1-3

(a)

COMPARATIVE ANALYSIS PROBLEM

(in millions) 1. Total assets 2. Accounts receivable (net) 3. Net sales 4. Net income (loss)

Amazon $54,505 $5,612 $88,988 $(241)

Wal-Mart $203,706 $6,778 $482,229 $16,363

(b) Wal-Mart’s total assets were approximately 374% greater than Amazon’s total assets, and Wal-Mart’s net sales were over 5 times greater than Amazon’s net sales. Wal-Mart’s accounts receivable were 21% greater than Amazon’s and represent about 1% of its net sales. Amazon’s accounts receivable amount to 6% of its net sales. Both Amazon’s and Wal-Mart’s accounts receivable are at satisfactory levels. Wal-Mart’s net income was substantially greater than Amazon’s, since Amazon reported a loss. It appears that these two companies’ operations are comparable in some ways, but Wal-Mart’s operations are substantially more profitable. LO 3 BT: AN Difficulty: Medium TOT: 10.0min AACSB: Analytic AICPA FC: Reporting

CT 1-4

INTERPRETING FINANCIAL STATEMENTS

(a) Creditors lend money to companies with the expectation that they will be repaid at a specified point in time in the future. If a company is generating cash from operations in excess of its investing needs, it is more likely that it will be able to repay its creditors. Not only did Xerox actually have negative cash from operations, but all of the cash it received in order to meet its cash deficiency was from issuing new debt. Both of these facts would be of concern to the company’s creditors, since it would suggest it will be less likely to be able to repay its debts. (b) As a stockholder you are interested in the long-term performance of a company and how that translates into its stock price. Often during the early years of a company’s life its cash provided by operations is not sufficient to meet its investment needs, so the company will have to get cash from outside sources. However, in the case of Xerox, the company has operated for many years and has a well-established name brand. The negative cash from operations might suggest operating deficiencies. (c) The statement of cash flows reports information on a cash basis. An investor cannot get the complete story on the company’s performance and financial position without looking at the income statement and balance sheet. Also, investors would want to look at more than one year’s worth of data. The current year might not be representative of past or future years. (d) Xerox is a well known company. It has a past record of paying dividends. Its management probably decided to continue to pay a dividend to demonstrate confidence in the company’s future. They may have felt that by not paying the dividend for the year they would send a negative message to investors. However, by choosing to pay a cash dividend the company obviously weakened its cash position, and decreased its ability to repay its debts. LO 3 BT: S Difficulty: Hard TOT: 15.0 min. AACSB: Analytic AICPA FC: Reporting and PC: Problem Solving/Decision Making

CT 1-5

REAL-WORLD FOCUS

Answers to this question will differ depending on the companies chosen by the student, and the year. We provide the following solution for Apple for the year ended September 27, 2014. (a) During the year ended September 27, 2014, Apple reported net income of $39,510 million. (b) During the year ended September 27, 2014, Apple reported sales of $182,795 million. (c) The “Industry” label on the left side of the Profile site tells us that Apple is in the Electronic Equipment industry. (d) Companies also in this industry would include Daktronics, Inc., e. Digital Corporation, Sony Corporation, and Universal Electronics Inc. (e) We chose Sony. During the year ended March 31, 2014, Sony reported sales of $75.421 million and net loss of $1,246 million. LO 3 BT: AP Difficulty: Medium TOT: 15.0 min. AACSB: Technology AICPA FC: Reporting

CT 1-6

RESEARCH CASE

(a) The ideas that the Public Company Accounting Oversight Board proposed for expanding the role of auditors in “passing judgement on more of what a company does and says” include weighing in on the quality of a company’s disclosures in its earnings releases and commenting on what the company says in its Management’s Discussion and Analysis section of its annual report. (b) Many people were surprised by the fact that many of the financial institutions that failed or required government support received “clean” audit opinions shortly before they announced their troubles. This caused some people to think that auditors should reveal more specific information. (c) The proposed Auditor’s Discussion and Analysis report would include information about the auditor’s views on the company’s use of judgments, estimates and accounting policies. The auditor would also discuss whether it believes the company’s financial reporting practices are aggressive. (d) It is likely that auditors would have mixed opinions of these proposals. On-the-one-hand, the expansion of the auditor’s role would create new revenue opportunities for auditors. However, the expansion of duties could very well create additional tension between the auditor and the client. Since the company is actually the one that hires the auditor, auditors might be reluctant to reveal too much. Also, many of these new duties appear to be less clearly defined than expressing an opinion on whether statements are presented in accordance with GAAP. This lack of clearly defined criteria could increase the auditor’s legal exposure. LO 3 BT: S Difficulty: Hard TOT: 25.0 min. AACSB: Technology and Reflective-Thinking AICPA PC: Problem Solving/Decision Making

CT 1-7

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The Report of Independent Registered Public Accounting Firm indicates that Ernst & Young LLP performed the audit of Apple’s financial statements. (b) The Consolidated Statements of Operations states that its earnings per share were $6.49 in 2014. (c) Management Discussion and Analyses of Financial Condition and Results of Operations, Item 7, Sales Data indicates that net sales in foreign countries were $96,101 million in 2014. (d) Per Part II, Item 6, Selected Financial Data, Net Sales in 2012 were $156,508 million. (e) The Shareholders’ Equity section of the Consolidated Balance Sheets states that 12,600,000,000 shares were authorized. (f) Per the Consolidated Statements of Cash Flows, $9,571 million was spent on capital expenditures. (g) Note 1 states that depreciation is based on “the lesser of 30 years or the remaining life of the underlying buildings.” (h) Per the Consolidated Statement of Financial Position, inventories were $2,111 million in 2013. LO 3 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 1-8

COMMUNICATION ACTIVITY

To:

Marci Ling

From:

Student

I have received the balance sheet of Samco Company, Inc. as of December 31, 2017. The purpose of a balance sheet is to report a company’s financial position at a point in time. It reports what the company owns (assets) and what it owes (liabilities) and the net amount attributed to owners (equity). A number of items in this balance sheet are not properly reported. They are: (1) The balance sheet should be dated as of a specific date, not for a period of time. Therefore, it should be stated “December 31, 2017.” (2) Equipment should be below Supplies on the balance sheet. (3) Accounts receivable should be shown as an asset and reported between Cash and Supplies on the balance sheet. (4) Accounts payable should be shown as a liability, not an asset. Therefore, it should be reported in the liability section, after notes payable. (5) Liabilities and stockholders’ equity should be shown separately on the balance sheet. Common stock, Retained earnings, and Dividends are not liabilities. (6) Common stock, Retained earnings, and Dividends are part of stockholders’ equity. The Dividends account is not reported on the balance sheet but is subtracted from beginning retained earnings to arrive at the ending balance. A correct balance sheet is as follows:

CT 1-8 (Continued) SAMCO COMPANY, INC. Balance Sheet December 31, 2017 Assets Cash .............................................................................. Accounts receivable .................................................... Supplies ........................................................................ Equipment..................................................................... Total assets ..................................................................

$ 9,000 6,000 1,000 18,000 $34,000

Liabilities and Stockholders’ Equity Liabilities Notes payable ....................................................... Accounts payable ................................................. Total liabilities ............................................... Stockholders’ equity Common stock...................................................... Retained earnings................................................. Total liabilities and stockholders’ equity.................... *Retained earnings....................................................... Less: Dividends ......................................................... Ending retained earnings ...........................................

$10,000 4,000 $14,000 12,000 8,000*

$10,000 2,000 $ 8,000

(Assets = Liabilities + Stockholders’ equity)

LO 3 BT: C Difficulty: Medium TOT: 15.0 min. AACSB: None AICPA FC: Reporting

20,000 $34,000

CT 1-9

ETHICS CASE

(a) Investors rely on auditors to perform an independent assessment of a company. If the auditor owns stock in that company, he or she might not be able to act in an independent and impartial manner. (b) There are pros and cons to this argument. On the positive side, it could be argued that as long as a person has no direct relationship with a client company, that person will not influence the findings of the work. However, a counter argument is that an influential partner within a firm, who had an investment in a client that he or she didn’t work on, might be tempted to try to influence the findings of the audit if he or she feared that the findings were going to negatively affect the value of his or her investment. (c) The fact that four firms have become so big means that prohibiting employees of those accounting firms from buying stock in clients of the firm would bar those employees from investing in roughly 25% of publicly traded firms. Some have argued that such restrictive rules would create undue hardship, and unfairly restrict the investment options of these people. They also argue that in such a large organization it is increasingly unlikely that an individual who does not work on a particular audit will be able to influence the outcome of that audit. As a consequence, rules that focus on restricting investments by those employees actually involved in the audit of a client may be most reasonable and most effective. (d) Answers to this question will vary. This is a particularly difficult issue since the rule effectively eliminates the individual’s control over their investment portfolio. They did nothing wrong when they bought the shares, but now they are being forced to sell when it is not advantageous. (e) The management of PricewaterhouseCoopers noted that auditor independence is vitally important to the audit function. If investors don’t think the auditor is independent of the client they will lose faith in auditing, which would have dire consequences for securities markets. Therefore, it was important that the firm make a bold, unambiguous response to address this problem. LO 3 BT: E Difficulty: Hard TOT: 30.0 min. AACSB: Ethics AICPA FC: Reporting and PC: Professional Demeanor

CT 1-10 (a)

ALL ABOUT YOU

Answers to the following will vary depending on students’ opinions. (i)

(b)

(c)

(d)

This does not represent the hiding of assets, but rather a choice as to the order of use of assets. This would seem to be ethical. (ii) This does not represent the hiding of assets, but rather is a change in the nature of assets. Since the expenditure was necessary, although perhaps accelerated, it would seem to be ethical. (iii) This represents an intentional attempt to deceive the financial aid office. It would therefore appear to be both unethical and potentially illegal. (iv) This is a difficult issue. By taking the leave, actual net income would be reduced. The form asks the applicant to report actual net income. However, it is potentially deceptive since you do not intend on taking unpaid absences in the future, thus future income would be higher than reported income. Companies might want to overstate net income in order to potentially increase the stock price by improving investors’ perceptions of the company. Also, a higher net income would make it easier to receive debt financing. Finally, managers would want a higher net income to increase the size of their bonuses. Sometimes companies want to report a lower income if they are negotiating with employees. For example, professional sports teams frequently argue that they cannot increase salaries because they aren’t making enough money. This also occurs in negotiations with unions. For tax accounting (as opposed to the financial accounting in this course) companies frequently try to minimize the amount of reported taxable income. Unfortunately many times people who are otherwise very ethical will make unethical decisions regarding financial reporting. They might be driven to do this because of greed. Frequently it is because their superiors have put pressure on them to take an unethical action, and they are afraid to not follow directions because they might lose their job. Also, in some instances top managers will tell subordinates that they should be a team player, and do the action because it would help the company, and therefore would help fellow employees.

LO3 BT: E Difficulty: Hard TOT: 30.0 min. AACSB: Reflective Thinking AICPA FC: Reporting and PC: Problem Solving/Decision Making

CT 1-11

FASB CODIFICATION ACTIVITY

No solution necessary.

CT 1-12

CONSIDERING PEOPLE, PLANET AND PROFIT

(a)

The 5 aspirations relate to the company’s goals related to sustaining its business, its brands, its people, its community and the planet.

(b)

The annual reports discussed in the chapter report on a company’s financial results and financial position. Financial annual reports have a format and content that follows requirements specified by

accounting regulators. The primary contents of a financial annual report is the company’s financial statements, which are audited by independent accountants. The Clif Bar & Company Annual Report describes the company's goals and results related to its 5 aspirations. The report does not follow a prescribed format, but instead can take whatever form, and include any content that the company chooses. The report is not audited by an outside body. LO 3 BT: AN Difficulty: Medium TOT: 15.0 min. AACSB: Analytic and Technology AICPA FC: Reporting

IFRS CONCEPTS AND APPLICATION IFRS1-1 The International Accounting Standards Board, IASB, and the Financial Accounting Standards Board, FASB, are two key players in developing international accounting standards. The IASB releases international standards known as International Financial Reporting Standards (IFRS). The FASB releases US standards, referred to a Generally Accepted Accounting Standards or GAAP. LO4 BT: C Difficulty: Easy TOT: 5.0 min. AACSB: Diversity AICPA FC: Reporting and BB: International/Global

IFRS1-2 A single set of high-quality accounting standards is needed because of increases in multinational corporations, mergers and acquisitions, use of information technology, and international financial markets. LO 4 BT: C Difficulty: Easy TOT: 3.0 min. AACSB: Diversity AICPA FC: Reporting and BB: International/Global

IFRS1-3

(a) (b) (c)

INTERNATIONAL FINANCIAL REPORTING PROBLEM

Ernst & Young et Autres; Deloitte & Associes 22 avenue Montaigne, Paris, France 75008 The company reports in Euros.

LO 4 BT: AN Difficulty: Medium TOT: 5.0 min. AACSB: Technology and Diversity AICPA FC: Reporting and BB: International/Global

CHAPTER 2 A Further Look at Financial Statements Learning Objectives 1. 2. 3.

Identify the sections of a classified balance sheet. Use ratios to evaluate a company’s profitability, liquidity, and solvency. Discuss financial reporting concepts.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

13. 14. 15. 16.

3 3 3 3

K C C C

17. 18. 19. 20.

3 3 3 1

C C C C

7. 8.

3 3

K K

9. 10.

3 3

K K

10. 11.

2 2

AP AP

12. 13.

3 3

K C

7. 8.

2 3

AP E

Questions 1. 2. 3. 4.

1 1 1 1

K K C C

5. 6. 7. 8.

1 2 2 2

K C K C

9. 10. 11. 12.

2 2 2 3

C K C K

1. 2.

1 1

K AP

3. 4.

2 2

AP AP

1a.

1b.

Brief Exercises 5. 2 AP 6. 3 K Do It! Exercises 2. 2 AP

AP AP AP

Exercises AP 7. 2 AP 8. 1, 2 AP 9. 2

AP AN

Problems: Set A 5. 2 AP 6. 2 AP

1. 2. 3. 1. 2.

1 1 1 1 1

AP AP AP AP AP

4. 5. 6. 3. 4.

1 1 1 1 2

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare a classified balance sheet.

Simple

10–20

Prepare financial statements.

Moderate

20–30

Prepare financial statements.

Moderate

20–30

Compute ratios; comment on relative profitability, liquidity, and solvency.

Moderate

20–30

Compute and interpret liquidity, solvency, and profitability ratios.

Simple

10–20

Compute and interpret liquidity, solvency, and profitability ratios.

Moderate

15–25

Compute ratios and compare liquidity, solvency, and profitability for two companies.

Moderate

15–25

Comment on the objectives and qualitative characteristics of financial reporting.

Simple

10–20

ANSWERS TO QUESTIONS 1.

A company’s operating cycle is the average time that is required to go from cash to cash in producing revenue.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement

Current assets are assets that a company expects to convert to cash or use up within one year of the balance sheet date or the company’s operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

Long-term investments are investments in stocks and bonds of other companies where the conversion into cash is not expected within one year or the operating cycle, whichever is longer and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.

LO 1 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting

The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business.

LO 1 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

(a) Geena is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

LO 2 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

(a) Liquidity ratios: Working capital and current ratio. (b) Solvency ratios: Debt to assets and free cash flow. (c)

Profitability ratio: Earnings per share.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

Debt financing is riskier than equity financing because debt must be repaid at specific points in time, whether the company is performing well or not. Thus, the higher the percentage of assets financed by debt, the riskier the company.

LO 2 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

(a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (b) Profitability ratios measure the income or operating success of a company for a given period of time. (c)

Solvency ratios measure the company’s ability to survive over a long period of time.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

10.

(a) The increase in earnings per share is good news because it means that profitability has improved. (b) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (c)

The increase in the debt to assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.”

(d) A decrease in free cash flow is bad news because it means that the company has become less solvent. The higher the free cash flow, the more solvent the company. LO 2 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

11.

(a) The debt to assets ratio and free cash flow indicate the company’s ability to repay the face value of the debt at maturity and make periodic interest payments. (b) The current ratio and working capital indicate a company’s liquidity and short-term debtpaying ability. (c)

Earnings per share indicates the earning power (profitability) of an investment.

LO 2 BT: C Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

12.

(a) Generally accepted accounting principles (GAAP) are a set of rules and practices, having substantial support, that are recognized as a general guide for financial reporting purposes. (b) The body that provides authoritative support for GAAP is the Financial Accounting Standards Board (FASB).

LO 3 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement

13.

(a) The primary objective of financial reporting is to provide information useful for decision making. (b) The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability.

LO 3 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement

14.

Dietz is correct. Consistency means using the same accounting principles and accounting methods from period to period within a company. Without consistency in the application of accounting principles, it is difficult to determine whether a company is better off, worse off, or the same from period to period.

LO 3 BT: AN Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Measurement and Reporting

15.

Comparability results when different companies use the same accounting principles. Consistency means using the same accounting principles and methods from year to year within the same company.

LO 3 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement

16.

The cost constraint allows accounting standard-setters to weigh the cost that companies will incur to provide information against the benefit that financial statement users will gain from having the information available.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement

17.

Accounting standards are not uniform because individual countries have separate standardsetting bodies. Currently many non-U.S. countries are choosing to adopt International Financial Reporting Standards (IFRS). It appears that accounting standards in the United States will move toward compliance with IFRS.

LO 3 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement

18.

Accounting relies primarily on two measurement principles. Fair value is sometimes used when market price information is readily available. However, in many situations reliable market price information is not available. In these instances, accounting relies on historical cost as its basis.

19.

The economic entity assumption states that every economic entity can be separately identified and accounted for. This assumption requires that the activities of the entity be kept separate and distinct from (1) the activities of its owners (the shareholders) and (2) all other economic entities. A shareholder of a company charging personal living costs as expenses of the company is an example of a violation of the economic entity assumption.

20.

At September 27, 2014 Apple’s largest current asset was Cash and cash equivalents of $14,557 million, its largest current liability is Accounts payable of $16,459 million and its largest item under “Assets” was Property and equipment, net of $16,967 million.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 CL Accounts payable CA Accounts receivable PPE Accumulated depreciation PPE Buildings CA Cash IA Goodwill

CL Income taxes payable LTI Investment in long-term bonds PPE Land CA Inventory IA Patent CA Supplies

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 2-2 CHIN COMPANY Partial Balance Sheet Current assets Cash......................................................................................... Debt investments .................................................................... Accounts receivable ............................................................... Supplies................................................................................... Prepaid insurance................................................................... Total current assets ........................................................ LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 2-3 Net income — Preferred dividends Average common shares outstanding $220 million – $0 = = $.66 per share 333 million shares

Earnings per share =

LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

$10,400 8,200 14,000 3,800 2,600 $39,000

BRIEF EXERCISE 2-4 Working capital = Current assets – Current liabilities Current assets Current liabilities Working capital

$102,500,000 201,200,000 ($ 98,700,000)

Current ratio: $102,500,000 Current assets = $201,200,000 Current liabilities = .51:1 LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 2-5 (a) Current ratio æ Current assets ö ÷ çè ø Current liabilities ÷

$262,787 $293,625 = 0.89:1

(b)

$376,002 = 85.5% $439,832

Debt to assets æ ç Total liabilities÷ö÷ çè Total assets ø (c) Free cash flow (Net cash provided operating activities – capital expenditures – dividends paid)

$62,300 – $24,787 – $12,000 = $25,513

LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 2-6 (a) True. (b) False. LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 2-7 (a) (b) (c) (d) (e) (f) (g) (h)

Predictive value. Confirmatory value. Materiality Complete. Free from error. Comparability. Verifiability. Timeliness.

LO 3 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 2-8 (a) Relevant. (b) Faithful representation. (c) Consistency. LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 2-9 (a) (b) (c) (d)

1. 2. 3. 4.

Predictive value. Neutral. Verifiable. Timely.

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 2-10 (c) LO 3 BT: K Difficulty: Easy TOT: 1 min. AACSB: None AICPA FC: Measurement

SOLUTIONS TO DO IT! EXERCISES DO IT! 2-1a MYLAR CORPORATION Balance Sheet (partial) December 31, 2017 Assets Current assets Cash .................................................................. Accounts receivable ........................................ Inventory ........................................................... Supplies ............................................................ Total current assets ............................... Property, plant, and equipment Equipment......................................................... Less: Accumulated depreciation— equipment.............................................. Total assets ..............................................................

$ 13,000 22,000 58,000 7,000 $100,000 180,000 50,000

130,000 $230,000

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 2-1b IA CL NA CL LTI CL

Trademarks Notes payable (current) Interest revenue Income taxes payable Debt investments (long-term) Unearned sales revenue

CA Inventory PPE Accumulated depreciation PPE Land SE Common stock NA Advertising expense LTL Mortgage payable (due in 3 years)

LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 2-2 (a)

2017

2016

($80,000 – $6,000) = $1.29 (40,000 + 75,000)/2

($40,000 – $6,000) = $0.97 (30,000 + 40,000)/2

Nguoi’s profitability, as measured by the amount of income available for each share of common stock, increased by 33 percent (($1.29 – $0.97)/$0.97) during 2017. Earnings per share should not be compared across companies because the number of shares issued by companies varies widely. Thus, we cannot conclude that Nguoi Corporation is more profitable than Matisse Corporation based on its higher EPS in 2017. æ ÷ ç Net Income - Preferred Dividends ö çèAverage Common Shares Outstanding ÷ ø

(b)

2017 $54,000

Current ratio

= 2.45:1

2016 $36,000

= 1.20:1

$22,000

$30,000

$72,000 = 30% $240,000

$100,000 = 49% $205,000

æ ç Current assets ö÷ çèCurrent ø liabilities ÷

Debt to assets ratio æ ÷ ç Total liabilities ö çè Total assets ÷ ø

The company’s liquidity, as measured by the current ratio improved from 1.20:1 to 2.45:1. Its solvency also improved, because the debt to assets ratio declined from 49% to 30%. (c) Free cash flow

2017: $90,000 – $6,000 – $3,000 – $27,000 = $54,000 2016: $56,000 – $6,000 – $1,500 – $12,000 = $36,500

The amount of cash generated by the company above its needs for dividends and capital expenditures increased from $36,500 to $54,000. LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 2-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Monetary unit assumption Faithful representation Economic entity assumption Cost constraint Consistency Historical cost principle Relevance Periodicity assumption Full disclosure principle Materiality Going concern assumption Comparability

LO 2 BT: K Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 2-1 CL CA PPE PPE CA CL IA CL

Accounts payable Accounts receivable Accumulated depreciation—equip. Buildings Cash Interest payable Goodwill Income taxes payable

CA CA PPE LTL CA PPE CA

Inventory Stock investments Land (in use) Mortgage payable Supplies Equipment Prepaid rent

LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 2-2 CA Prepaid advertising PPE Equipment IA Trademarks CL Salaries and wages payable CL Income taxes payable SE Retained earnings CA Accounts receivable LTI Land (held for future use)

IA Patents LTL Bonds payable SE Common stock PPE Accumulated depreciation—equipment CL Unearned sales revenue CA Inventory

LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 2-3 THE BOEING COMPANY Partial Balance Sheet December 31, 2017 (in millions) Assets Current assets Cash....................................................................... Debt investments.................................................. Accounts receivable............................................. Notes receivable ................................................... Inventory ............................................................... Total current assets ...................................... Long-term investments Notes receivable ................................................... Property, plant, and equipment Buildings ............................................................... Less: Accumulated depreciation—buildings.....

$ 9,215 2,008 5,785 368 16,933 $34,309

5,466 21,579 12,795

Intangible assets Patents .................................................................. Total assets .................................................................. LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

8,784 12,528 $61,087

EXERCISE 2-4 H. J. HEINZ COMPANY Partial Balance Sheet April 30, 2017 (in thousands) Assets Current assets Cash .................................................. Accounts receivable ........................ Inventory........................................... Prepaid insurance ............................ Total current assets..................

$ 373,145 1,171,797 1,237,613 125,765 $ 2,908,320

Property, plant, and equipment Land .................................................. 76,193 Buildings........................................... $4,033,369 Less: Accumulated depreciation— Buildings .................................. 2,131,260 1,902,109 Intangible assets Goodwill............................................ Trademarks....................................... Total assets.............................................

3,982,954 757,907

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

1,978,302

4,740,861 $ 9,627,483

EXERCISE 2-5 LONGHORN COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash..................................................... Accounts receivable........................... Prepaid insurance............................... Total current assets ................................... Property, plant, and equipment Land..................................................... Buildings ............................................. Less: Accumulated depreciation— buildings .................................. Equipment ........................................... Less: Accumulated depreciation— equipment ................................ Total assets .................................

$11,840 12,600 3,200 $ 27,640 61,200 $105,800 45,600 82,400

60,200

18,720

63,680

185,080 $212,720

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... Current maturity of note payable ........ Interest payable .................................. Total current liabilities ................ Long-term liabilities Note payable ($93,600 – $13,600) ...... Total liabilities ............................. Stockholders’ equity Common stock.................................... Retained earnings ($40,000 + $6,020*) ............................ Total stockholders’ equity .......... Total liabilities and stockholders’ equity ...........................................

$ 9,500 13,600 3,600 $ 26,700 80,000 106,700 60,000 46,020

*Net income = $14,700 – $780 – $5,300 – $2,600 = $6,020 (Assets = Liabilities + Stockholders’ Equity) LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

106,020 $212,720

EXERCISE 2-6 TEXAS INSTRUMENTS, INC. Balance Sheet December 31, 2017 (in millions) Assets Current assets Cash ......................................................................... Debt investments ..................................................... Accounts receivable ................................................ Inventory .................................................................. Prepaid rent.............................................................. Total current assets ......................................... Long-term investments Stock investments ................................................... Property, plant, and equipment Equipment ............................................................... Less: Accumulated depreciation—equipment...... Intangible assets Patents...................................................................... Total assets......................................................................

$ 1,182 1,743 1,823 1,202 164 $ 6,114 637 6,705 3,547

3,158 2,210 $12,119

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................................... Income taxes payable .............................................. Total current liabilities ..................................... Long-term liabilities Notes payable .......................................................... Total liabilities.......................................................... Stockholders’ equity Common stock ......................................................... Retained earnings.................................................... Total stockholders’ equity ............................... Total liabilities and stockholders’ equity.......................

$1,459 128 $ 1,587 810 2,397 2,826 6,896

(Assets = Liabilities + Stockholders’ Equity) LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

9,722 $12,119

EXERCISE 2-7

(a) Earnings per share =

Net income  Preferred dividends Average common shares outstanding

2017 :

$66,176,000 – 0 = $ 1.01 (66,282,000 + 64,507,000) / 2

2016 :

$54,587,000 – 0 = $ .78 (73,139,000 + 66,282,000) / 2

(b) Using net income (loss) as a basis to evaluate profitability, Callaway Golf’s income improved by 21% [($66,176 – $54,587) ÷ 54,587] between 2016 and 2017. Its earnings per share increased by 29% [($1.01 – $0.78) ÷ $0.78]. (c) To determine earnings per share, dividends on preferred stock are subtracted from net income, but dividends on common stock are not subtracted. LO 2 BT: AP Difficulty: Medium TOT: 7 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 2-8 (a)

FAIRVIEW CORPORATION Income Statement For the Year Ended July 31, 2017 Revenues Service revenue............................................. Rent revenue ................................................. Total revenues ....................................... Expenses Salaries and wages expense ........................ Supplies expense .......................................... Depreciation expense ................................... Total expenses....................................... Net loss..................................................................

$66,100 8,500 $74,600 57,500 15,600 4,000 77,100 $ (2,500)

FAIRVIEW CORPORATION Retained Earnings Statement For the Year Ended July 31, 2017 Retained earnings, August 1, 2013...................... Less: Net loss ..................................................... Dividends .................................................. Retained earnings, July 31, 2014 .........................

$34,000 $2,500 4,000

6,500 $27,500

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings)

(b)

FAIRVIEW CORPORATION Balance Sheet July 31, 2017 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Total current assets............................... Property, plant, and equipment Equipment...................................................... Less: Accumulated depreciation— equipment....................................... Total assets ...........................................................

$29,200 9,780 $38,980 18,500 6,000

12,500 $51,480

EXERCISE 2-8 (Continued) (b)

FAIRVIEW CORPORATION Balance Sheet (Continued) July 31, 2017 Liabilities and Stockholders’ Equity Current liabilities Accounts payable............................................ Salaries and wages payable ........................... Total current liabilities................................. Long-term liabilities Notes payable .................................................. Total liabilities.............................................. Stockholders’ equity Common stock................................................. Retained earnings ........................................... Total stockholders’ equity .......................... Total liabilities and stockholders’ equity ...............

$ 4,100 2,080 $ 6,180 1,800 7,980 16,000 27,500 43,500 $51,480

(Assets = Liabilities + Stockholders’ equity)

$38,980

= 6.3 : 1

$6,180

Debt to assets ratio =

$7,980 = 15.5% $51,480

(Current assets ÷ Current liabilities) and (Total liabilities ÷ Total assets)

(d) The current ratio would not change because equipment is not a current asset and a 5-year note payable is a long-term liability rather than a current liability. The debt to assets ratio would increase from 15.5% to 39.1%*. Looking solely at the debt to assets ratio, I would favor making the sale because Fairview’s debt to assets ratio of 15.5% is very low. Looking at additional financial data, I would note that Fairview reported a significant loss for the current year which would lead me to question its ability to make interest and loan payments (and even remain in business) in the future. I would not make the proposed sale unless Fairview convinced me that it would be capable of earnings in the future rather than losses.

EXERCISE 2-8 (Continued) I would also consider making the sale but requiring a substantial downpayment and smaller note. *($7,980 + $20,000) ÷ ($51,480 + $20,000) LO 1, 2 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 2-9 (a) Working capital

Beginning of Year

End of Year

$3,361 – $1,635 = $1,726

$3,217 – $1,601 = $1,616

$3,361 Current ratio

= 2.06:1

$1,635

$3,217 $1,601

= 2.01:1

(Current assets – Current liabilities) and (Current assets ÷ Current liabilities)

(b) Nordstrom’s liquidity decreased slightly during the year. Its current ratio decreased from 2.06:1 to 2.01:1. Also, Nordstrom’s working capital decreased by $110 million. (c) Nordstrom’s current ratio at both the beginning and the end of the recent year exceeds Best Buy’s current ratio for 2014 (and 2013). Nordstrom’s end-of-year current ratio (2.01) exceeds Best Buy’s 2014 current ratio (1.41*). Nordstrom would be considered much more liquid than Best Buy for the recent year. *(see text, pg. 55) LO 2 BT: AP Difficulty: Medium TOT: 10 min. Difficulty: Analytic AICPA FC: Reporting

EXERCISE 2-10 (a) Current ratio =

$60,000

= 2.0: 1

$30,000 Working capital = $60,000 – $30,000 = $30,000 (Current assets ÷ Current liabilities) and (Current assets – Current liabilities)

EXERCISE 2-10 (Continued) (b) Current ratio =

$40,000*

= 4.0: 1 $10,000** Working capital = $40,000 – $10,000 = $30,000

*$60,000 – $20,000

**$30,000 – $20,000

(Current assets ÷ Current liabilities) and (Current assets – Current liabilities)

(c) Liquidity measures indicate a company’s ability to pay current obligations as they become due. Satisfaction of current obligations usually requires the use of current assets. If a company has more current assets than current liabilities it is more likely that it will meet obligations as they become due. Since working capital and the current ratio compare current assets to current liabilities, both are measures of liquidity. Payment of current obligations frequently requires cash. Neither working capital nor the current ratio indicate the composition of current assets. If a company’s current assets are largely comprised of items such as inventory and prepaid expenses it may have difficulty paying current obligations even though its working capital and current ratio are large enough to indicate favorable liquidity. In Myeneke’s case, payment of $20,000 of accounts payable will leave only $5,000 cash. Since salaries payable will require $10,000, the company may need to borrow in order to make the required payment for salaries. (d) The CFO’s decision to use $20,000 of cash to pay off accounts payable is not in itself unethical. However, doing so just to improve the year-end current ratio could be considered unethical if this action misled creditors. Since the CFO requested preparation of a “preliminary” balance sheet before deciding to pay off the liabilities he seems to be “managing” the company’s financial position, which is usually considered unethical. LO 2 BT: AP Difficulty: Medium TOT: 15 min. Difficulty: Analytic AICPA FC: Reporting

EXERCISE 2-11 2017 $925,359

(a) Current ratio (b) Earnings per share

$401,763 $179,061

2016  2.30 : 1  $0.87

205,169

$554, 645

= 28.2%

$1, 963, 676

(d) Free cash flow

$1,020,834  2.71: 1 $376,178 $400,019  $1.85 216,119 $527, 216 $1, 867, 680

= 28.2%

$302,193 – $265,335 – $82,394 $464,270 – $250,407 – $80,796 = ($45,536) = $133,067

(e) Using the debt to assets ratio and free cash flow as measures of solvency produces deteriorating results for American Eagle Outfitters. Its debt to assets ratio remained constant from 2016 to 2017. However, its free cash flow decreased by 134% indicating a significant decline in solvency. (f) In 2016 American Eagle Outfitters’s cash provided by operating activities was greater than the cash used for capital expenditures. It was generating plenty of cash from operations to cover its investing needs. In 2017, American Eagle Outfitters experienced negative free cash flow. This deficiency could have been covered by issuing stock or debt. LO 2 BT: AP Difficulty: Medium TOT: 15 min. Difficulty: Analytic AICPA FC: Reporting

EXERCISE 2-12 (a) (b) (c) (d) (e) (f)

2 6 3 4 5 1

Going concern assumption Economic entity assumption Monetary unit assumption Periodicity assumption Historical cost principle Full disclosure principle

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

EXERCISE 2-13 (a) This is a violation of the historical cost principle. The inventory was written up to its fair value when it should have remained at cost. (b) This is a violation of the economic entity assumption. The treatment of the transaction treats Victor Lopez and Lopez Co. as one entity when they are two separate entities. The cash used to purchase the truck should have been treated as part of salaries and wages expense. (c) This is a violation of the periodicity assumption. This assumption states that the economic life of a business can be divided into artificial time periods (months, quarters, or a year). By adding two more weeks to the year, Lopez Co. would be misleading financial statement readers. In addition, 2017 results would not be comparable to previous years’ results. The company should use a 52 week year. LO 3 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement

SOLUTIONS TO PROBLEMS PROBLEM 2-1A YAHOO! INC. Balance Sheet December 31, 2017 (Amounts are in millions) Assets Current assets Cash..................................................... Debt investments ................................ Accounts receivable ........................... Prepaid rent......................................... Total current assets .................... Long-term investments Stock investments .............................. Property, plant, and equipment Equipment ........................................... Less: Accumulated depreciation— equipment....................................... Intangible assets Goodwill .............................................. Patents ................................................ Total assets.................................................

$2,292 1,160 1,061 233 $ 4,746 3,247 1,737 201 3,927 234

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... $ 152 Unearned sales revenue .................... 413 Total current liabilities ................ Long-term liabilities Notes payable ..................................... Total liabilities.......................... Stockholders’ equity Common stock .................................... 6,283 Retained earnings............................... 6,108 Total stockholders’ equity .............. Total liabilities and stockholders’ equity ................................................... (Assets = Liabilities + Stockholders’ equity) LO 1 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement

1,536

4,161 $13,690

$ 565 734 1,299

12,391 $13,690

PROBLEM 2-2A

MARTIN CORPORATION Income Statement For the Year Ended December 31, 2017 Revenues Service revenue .................................................... Expenses Salaries and wages expense ............................... Depreciation expense........................................... Insurance expense ............................................... Utilities expense ................................................... Maintenance and repairs expense....................... Total expenses .............................................. Net income....................................................................

$68,000 $37,000 3,600 2,200 2,000 1,800 46,600 $21,400

MARTIN CORPORATION Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1, 2017.............................................. Add: Net income .......................................................................... Less: Dividends............................................................................. Retained earnings, December 31, 2017 ........................................

$31,000 21,400 52,400 12,000 $40,400

PROBLEM 2-2A (Continued) MARTIN CORPORATION Balance Sheet December 31, 2017 Assets Current assets Cash....................................................................... Accounts receivable ............................................. Prepaid insurance................................................. Total current assets ...................................... Property, plant, and equipment Equipment ............................................................. Less: Accumulated depreciation—equipment... Total assets...................................................................

$10,100 11,700 3,500 $25,300 66,000 17,600

48,400 $73,700

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ................................................. Salaries and wages payable................................. Total current liabilities .................................. Stockholders’ equity Common stock ...................................................... Retained earnings................................................. Total stockholders’ equity ............................ Total liabilities and stockholders’ equity....................

$18,300 3,000 $21,300 12,000 40,400 52,400 $73,700

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings) (Assets = Liabilities + Stockholders’ equity) LO 1 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

PROBLEM 2-3A

(a)

LAZURIS ENTERPRISES Income Statement For the Year Ended April 30, 2017 Sales revenue ....................................................... Expenses Cost of goods sold ....................................... Salaries and wages expense ....................... Interest expense ........................................... Depreciation expense................................... Insurance expense ....................................... Income tax expense...................................... Total expenses ....................................... Net income ............................................................

$5,100 $1,060 700 400 335 210 165 2,870 $2,230

LAZURIS ENTERPRISES Retained Earnings Statement For the Year Ended April 30, 2017 Retained earnings, May 1, 2013 ........................... Add: Net income ................................................. Less: Dividends ................................................... Retained earnings, April 30, 2014 ........................

$1,600 2,230 3,830 325 $3,505

[Revenues – Expenses = Net income or (loss)] (Beginning retained earnings ± Changes in retained earnings = Ending retained earnings)

PROBLEM 2-3A (Continued) (b)

LAZURIS ENTERPRISES Balance Sheet April 30, 2017 Assets Current assets Cash ...................................................... Stock investments................................ Accounts receivable............................. Inventory ............................................... Prepaid insurance ................................ Total current assets...................... Property, plant, and equipment Land....................................................... Equipment............................................. $2,420 Less: Accumulated depreciation—equipment.................. 670 Total assets..................................................

$1,270 1,200 810 967 60 $4,307 3,100 1,750

4,850 $9,157

Liabilities and Stockholders’ Equity Current liabilities Notes payable.................................................... Accounts payable ............................................. Salaries and wages payable............................. Income taxes payable ....................................... Total current liabilities .............................. Mortgage payable.............................................. Total liabilities............................................ Stockholders’ equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity ........................ Total liabilities and stockholders’ equity ...............

$ 61 834 222 135 $1,252 3,500 4,752 900 3,505

(Assets = Liabilities + Stockholders’ equity) LO 1 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

4,405 $9,157

PROBLEM 2-4A

(a) Loeb Company’s net income for 2017 is $248,000 ($1,800,000 – $1,175,000 – $283,000 – $9,000 – $85,000). Its earnings per share is $3.10 ($248,000 ÷ 80,000 shares outstanding). Bowsh’s net income for 2017 is $142,200 ($620,000 – $340,000 – $98,000 – $3,800 – $36,000). Its earnings per share is $2.84 ($142,200 ÷ 50,000 shares outstanding). (b) Loeb appears to be more liquid. Loeb’s 2017 working capital of $340,875 ($407,200 – $66,325) is more than twice as high as Bowsh’s working capital of $156,620 ($190,336 – $33,716). In addition, Loeb’s 2017 current ratio of 6.1:1 ($407,200 ÷ $66,325) is higher than Loeb’s current ratio of 5.6:1 ($190,336 ÷ $33,716). (c) Loeb appears to be slightly more solvent. Loeb’s 2017 debt to total assets ratio of 18.6% ($174,825 ÷ $939,200)a is lower than Bowsh’s ratio of 22.5% ($74,400 ÷ $330,064)b. The lower the percentage of debt to assets, the lower the risk is that a company may be unable to pay its debts as they come due. Another measure of solvency, free cash flow, also indicates that Loeb is more solvent. Loeb had $12,000 ($138,000 – $90,000 – $36,000) of free cash flow while Bowsh had only $1,000 ($36,000 – $20,000 – $15,000). a

$174,825 ($66,325 + $108,500) is Loeb’s 2017 total liabilities. $939,200 ($407,200 + $532,000) is Loeb’s 2017 total assets.

$74,400 ($33,716 + $40,684) is Bowsh’s 2017 total liabilities. $330,064 ($190,336 + $139,728) is Bowsh’s 2017 total assets.

LO 2 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 2-5A

(a) (i)

Working capital = $458,900 – $195,500 = $263,400.

(ii) Current ratio =

$458,900 $195,500

= 2.35:1.

(iii) Free cash flow = $190,800 – $92,000 – $31,000 = $67,800 (iv) Debt to assets ratio =

$395,500 $1,034,200

(v) Earnings per share =

= 38.2%.

$153,100

= $3.06.

50,000 shares (b) During 2017, the company’s current ratio increased from 1.65:1 to 2.35:1 and its working capital increased from $160,500 to $263,400. Both measures indicate an improvement in liquidity during 2017. The company’s debt to assets ratio increased from 31.0% in 2016 to 38.2% in 2017 indicating that the company is less solvent in 2017. Another measure of solvency, free cash flow, increased from $48,700 to $67,800. This suggests an improvement in solvency, thus we have conflicting measures of solvency. Earnings per share decreased from $3.15 in 2016 to $3.06 in 2017. This indicates a decline in profitability during 2017. LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 2-6A

2016 (a) Earnings per share. $60,000 = $2.00 30,000 shares

2017 $70,000 = $2.12 33,000 shares

(b) Working capital. ($20,000 + $62,000 + $73,000) – $70,000 = $85,000

($28,000 + $70,000 + $90,000) – $75,000 = $113,000

$188,000 = 2.5:1 $75,000

(d) Debt to assets ratio. $160,000 = 23.4% $685,000 (e) Free cash flow. $56,000 – $38,000 – $15,000 = $3,000 (f)

$155,000 = 20.4% $760,000 $82,000 – $45,000 – $20,000 = $17,000

Net income and earnings per share have increased, indicating that the underlying profitability of the corporation has improved. The liquidity of the corporation as shown by the working capital and the current ratio has improved slightly. Also, the corporation improved its solvency by improving its debt to assets ratio as well as free cash flow.

LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 2-7A

Ratio

Target Wal-Mart (All Dollars are in Millions)

(a)

Working capital

$17,488 – $10,512 = $6,976

$48,949 – $55,390 = ($6,441)

(b)

Current ratio

1.66:1 ($17,488 ÷ $10,512)

.88:1 ($48,949 ÷ $55,390)

(c)

Debt to assets ratio

68.9% ($30,394 ÷ $44,106)

60.0% ($98,144 ÷ $163,429)

(d)

Free cash flow

$4,430 – $3,547 – $465 = $418

$23,147 – $11,499 – $3,746 = $7,902

(e)

Earnings per share

$2.86 =

$2,214 774

(f)

$3.39 =

$13, 400 3, 951

The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.66:1 is much better than WalMart’s .88:1 and Target has significantly higher working capital than Wal-Mart. Solvency—Wal-Mart’s debt to assets ratio is about 13% less than Target’s and its free cash flow is much larger.

LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 2-8A

(a)

Accounting information is the compilation and presentation of financial information for a company. It provides information in the form of financial statements and additional disclosures that is useful for decision making. The accounting rules and practices that have substantial authoritative support and are recognized as a general guide for financial reporting purposes are referred to as generally accepted accounting principles (GAAP). The biotechnology company that employs Saira will follow GAAP to report its assets, liabilities, stockholders’ equity, revenues, and expenses as it prepares financial statements.

(b) Saira is correct in her understanding that the low success rate for new biotech products will be a cause of concern for investors. Her suggestion that detailed scientific findings be reported to prospective investors might offset some of their concerns but it probably won’t conform to the qualitative characteristics of accounting information. These characteristics consist of relevance, faithful representation, comparability, consistency, verifiability, timeliness, and understandability. They apply to accounting information rather than the scientific findings that Saira wants to include. LO 3 BT: E Difficulty: Medium TOT: 15 min. AACSB: Reflective Thinking AICPA FC: Measurement and Reporting

CT 2-1

FINANCIAL REPORTING PROBLEM

(a) Total current assets were $68,531,000 at September 27, 2014, and $73,286,000 at September 28, 2013. (b) Current assets are properly listed in the order of liquidity. As you will learn in a later chapter, inventories are considered to be less liquid than receivables. Thus, they are listed below receivables and before prepaid expenses. (c) The asset classifications are similar to the text: (a) current assets, (b) Long-term marketable securities, (c) property, plant, and equipment, and (d) intangibles. (d) Total current liabilities were $63,448,000 at September 27, 2014, and $43,658,000 at September 28, 2013. LO 1 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

CT 2-2

(a)

($ in thousands)

COMPARATIVE ANALYSIS PROBLEM

Columbia Sports wear

VFC

1. Working capital

$1,266,041 – $373,120 = $892,921

$4,185,854 – $1,620,241 = $2,565,613

2. Current ratio

$1,266,041 ÷ $373,120 = 3.4:1

$4,185,854 ÷ $1,620,241 = 2.6:1

3. Debt to assets ratio 4. Free cash flow

$436,975

$4,349,258 * = 24.4%

= 43.6%

$1,792,209

$9,980,140

$185,783 – $60,283 – $39,836 = *$85,664

$1,697,629 – $234,077 – $478,933 = $984,619

*$1,620,241 + $1,423,581 + $1,305,436

(b) Liquidity VFC Company appears much more liquid since it has about $1,673 million more working capital than Columbia. But, looking at the current ratios, we see that Columbia’s ratio is more than 1.3 times as large as VFC’s. Solvency Based on the debt to assets ratio, Columbia is more solvent. Columbia’s debt to assets ratio is significantly lower than VFC’s and, therefore, Columbia would be considered better able to pay its debts as they come due. Comparing free cash flow, VFC generates much more excess cash than Columbia―$984.6 million versus $85.7 million. LO 2 BT: AN Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

CT 2-3

(a)

COMPARATIVE ANALYSIS PROBLEM

($ in millions)

Amazon

Wal-Mart

Working capital

$31,327 – $28,089 = $3,238

$63,278 – $65,272 = $(1,994)

Current ratio

$31,327 ÷ $28,089 = 1.1:1

$63,278 ÷ $65,272 = .97:1

Debt to assets ratio

$43,764 *

$122,312 = 60.0% $203,706

= 80.3%

$54,505

Free cash flow

$6,842 – $4,893 – $0 = $1,949

$28,564 – $12,174 – $6,785 = $9,605

*$28,089 + $8,265 + $7,410

(b) Liquidity Amazon appears more liquid since it has $5,232 million more working capital than Wal-Mart. Also, Amazon’s current ratio is slightly better than Wal-Mart’s. Solvency Based on the debt to assets ratio, Wal-Mart is more solvent. Wal-Mart’s debt to assets ratio is significantly lower than Amazon’s and, therefore, Wal-Mart would be considered better able to pay its debts as they come due. Comparing free cash flow, Wal-Mart generates much more excess cash than Amazon. LO 2 BT: AN Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

CT 2-4

INTERPRETING FINANCIAL STATEMENTS

(a) The percentage decrease in Gap’s total assets during this period is calculated as: $7,065 – $8,544 = 17.3% $8,544 The average decrease per year can be approximated as: 17.3% = 4.3% per year 4 years (b) Gap’s working capital and current ratio decreased (2014), increased (2015 and 2016) and then decreased (2017) during this period, indicating a decline, an improvement and then another decline in liquidity. The current ratio is a better measure of liquidity because it provides a relative measure; that is, current assets compared to current liabilities. Working capital only tells us the net amount of current assets less current liabilities. It is hard to say whether a given amount of working capital is adequate or inadequate without knowing the size of the company. (c) The debt to assets ratio suggests that Gap’s solvency didn’t change much during the period. Debt to assets was .39 in 2013, rose to .45 in 2014 and then came back down to .42 in 2017. (d) The earnings per share suggests that Gap’s profitability improved significantly from 2013 to 2017, increasing from $0.94 to $1.89. However, based on the years shown, it appears that earnings varied a great deal during this period. LO 2 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

REAL-WORLD FOCUS

CT 2-5 Answers will vary depending on the company chosen and the date. LO 2 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic and Technology AICPA FC: Reporting

CT 2-6 Answers will vary depending on the company chosen and the date. LO 1, 2 BT: E Difficulty: Hard TOT: 25 min. AACSB: Analytic, Technology, and Reflective Thinking AICPA FC: Reporting AICPA BB: Critical Thinking

CT 2-7

RESEARCH CASE

(a) Many large companies, big accounting firms, and accounting standard setters tend to favor a switch to IFRS because they believe that global accounting standards would save companies money by consolidating their bookkeeping. They also believe it would make it easier to raise capital around the world. In addition, investors would have less trouble comparing companies from different countries. They also feel that having international accounting standards would lead to an improvement in the enforcement of securities laws. (b) Many small companies are opposed to switching to IFRS because (1) they say that the switch would be very costly, and (2) because they don't have operations outside of the U.S., so they see any benefit to their company of using international standards. (c) It has been suggested that IFRS lacks standards that are specific to utility companies that U.S. GAAP contains. (d) Condorsement (a word invented by the SEC) represents a combination of convergence and endorsement. Under condorsement, U.S. standard setters would continue to work with international standard setters to try to reduce differences in standards. In addition, as new international standards are issued, U.S. standard setters would review those standards and consider whether to endorse them by absorbing them into U.S. GAAP. LO 3 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 2-8

DECISION MAKING ACROSS THE ORGANIZATION

The current ratio increase is a favorable indication as to liquidity, but alone tells little about the prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The working capital increase is also a favorable indication as to liquidity, but again the amount and direction of the changes in individual current assets and current liabilities cannot be determined from this measure. The increase in free cash flow is a favorable indicator for solvency. An increase in free cash flow means the company can replace assets, pay dividends, and have “free cash” available to pay down debt or expand operations. The decrease in the debt to assets ratio is a favorable indicator for solvency and going-concern prospects. The lower the percentage of debt to assets, the lower the risk that a company may be unable to pay its debts as they come due. A decline in the debt to assets ratio is also a positive sign regarding going-concern potential. The increase in net income is a favorable indicator for both solvency and profitability prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. A significant factor here may be that despite a decline in sales the client’s management has been able to reduce costs to produce this increase. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements. The earnings per share increase is a favorable indicator for profitability. A 109% (from $1.15 to $2.40) increase indicates a significant increase in net income and provides a favorable sign regarding going-concern potential. LO 2 BT: E Difficulty: Hard TOT: 20 min. AACSB: Communication and Reflective Thinking AICPA PC: Interaction, Leadership, and Communication

CT 2-9

COMMUNICATION ACTIVITY

To:

B. P. Palmer

From:

Accounting Major

Subject:

Financial Statement Analysis

(a) Ratios can be classified into three types, which measure three different aspects of a company’s financial health: 1.

Liquidity ratios—These measure a company’s ability to pay its current obligations.

Solvency ratios—These measure a company’s ability to pay its long-term obligations and survive over the long-term.

Profitability ratios—These measure the ability of the company to generate a profit.

(b) 1.

Examples of liquidity measures are: Working capital = Current assets – Current liabilities Current ratio =

Current assets Current liabilities

Examples of solvency measures are: Debt to assets ratio =

Total liabilities Total assets

Free cash flow = Cash provided by operating activities – Capital expenditures – Cash dividends

CT 2-9 (Continued) 3.

Example of profitability measure: Earnings per share =

Net income  Preferred dividends Average common shares outstanding

Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.

Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms).

Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.

LO 2 BT: AP Difficulty: Medium TOT: 18 min. AACSB: Communication AICPA PC: Communication

CT 2-10

ETHICS CASE

(a) The stakeholders in this case are: Boeing’s management; CEO, public relations manager, Boeing’s stockholders, McDonnell Douglas stockholders, other users of the financial statements; especially potential investors of the new combined company. (b) The ethical issues center around full disclosure of financial information. Management attempted to “time” the release of bad news in order to complete a merger that would have been revoked if cost overruns had been disclosed as soon as management became aware of them. (c) The periodicity assumption requires that financial results be reported on specific, pre-determined dates. The full disclosure principle requires that all circumstances and events that make a difference to financial statement users must be disclosed. (d) It is not ethical to “time” the release of bad news. GAAP requires that all significant financial information be released to allow users to make informed decisions. (e) Answers will vary. One possibility: Release the information regarding cost overruns as it became available. Describe the causes of such overruns and explain how Boeing would address them (probably by improving production methods to eliminate the inefficiencies alluded to in the text). (f)

Investors and analysts should be aware that Boeing’s management will probably “manage” information in the future in ways that will interfere with full disclosure.

LO 3 BT: E Difficulty: Hard TOT: 20 min. AACSB: Ethics AICPA FC: Measurement AICPA PC: Personal Demeanor

CT 2-11

ALL ABOUT YOU

Answers will vary. LO - BT: S Difficulty: Hard TOT: 30 min. AACSB: Communication and Reflective Thinking AICPA CC: Critical Thinking AICPA PC: Communication

CT 2-12

FASB CODIFICATION ACTIVITY

(a) 1. Current assets is used to designate cash and other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. 2. Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities. (b) Access FASB Codification 210-20-45 A right of set off exists when all of the following conditions are met: 1.

Each of two parties owes the other determinable amounts.

The reporting party has the right to set off the amount owed with the amount owed by the other party.

The reporting party intends to set off.

The right of set off is enforceable at law. As a result, a company may not offset accounts payable against cash on its balance sheet.

LO 1 BT: C Difficulty: Medium TOT: 15 min. AACSB: Analytic and Technology AICPA FC: Measurement

CT 2-13

PEOPLE, PLANET AND PROFIT

(a)

The existence of three different forms of certification would most likely create confusion for coffee purchasers. It would difficult to know what aspects of the coffee growing process each certification covered. Similarly, if there were multiple groups that certified financial statements, each with different criteria, it would be difficult for financial statement users to know what each certification promised.

(b)

The Starbucks certification appears to be the most common in that area. It has the advantage of having a direct link to the Starbucks coffee market. Although it does not guarantee that Starbucks will buy its coffee, it is a requirement that must be met before Starbucks will buy somebody’s coffee. Note that the article states that the Starbucks certification “incorporates elements of social responsibility and environmental leadership, but quality of coffee is the first criteria.” The Smithsonian Bird Friendly is considered to have the strictest requirements and, as a result, appears to be the least common.

(c)

The certifications have multiple objectives including organic farming as a means to protect bird species, biodiversity and wildlife habitat. Some included requirements are to improve workers’ living conditions, such as providing running water in worker housing, child labor regulations and education requirements. As mentioned above, the Starbucks certification has the potential financial benefit of making Starbucks a potential customer, which can stabilize farmers’ earnings. Certifications can also be financially beneficial because companies can benefit from the positive public relations effects of either producing or buying coffee produced using sustainable practices.

LO - BT: S Difficulty: Hard TOT: 30 min. AACSB: Technology and Reflective Thinking AICPA FC: Measurement and Reporting AICPA BB: Critical Thinking and Resource Management

IFRS CONCEPTS AND APPLICATION

IFRS 2-1 The statement of financial position required under IFRS and the balance sheet prepared under GAAP usually present the same information regarding a company’s assets, liabilities, and stockholders’ equity at a point in time. IFRS does not dictate a specific order but most companies list noncurrent items before current. Differences in ordering are Statement of Financial Position presentation Noncurrent assets Current assets Equity Noncurrent liabilities Current liabilities

Balance Sheet presentation Current assets Noncurrent assets Current liabilities Noncurrent liabilities Stockholders’ equity

Under IFRS, current assets are usually listed in the reverse order of liquidity. LO 4 BT: C Difficulty: Easy TOT: 5 min. AACSB: Diversity AICPA FC: Reporting AICPA BB: International/Global

IFRS 2-2 IFRS uses statement of financial position rather than balance sheet. LO 4 BT: K Difficulty: Easy TOT: 3 min. AACSB: Diversity AICPA FC: Measurement AICPA BB: International/Global

IFRS 2-3 SUNDELL COMPANY Partial Statement of Financial Position Current assets Prepaid insurance................................................................... Supplies................................................................................... Accounts receivable ............................................................... Debt investments .................................................................... Cash......................................................................................... Total ................................................................................. LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: Diversity AICPA FC: Reporting AICPA BB: International/Global

£ 3,600 5,200 12,500 6,700 15,400 £43,400

IFRS 2-4 LESSILA BOWLING ALLEY Statement of Financial Position December 31, 2017 Assets Property, plant, and equipment Land............................................... Buildings ....................................... Less: Acc. depr.—buildings......... Equipment ..................................... Less: Acc. depr.—equipment ...... Current assets Prepaid insurance......................... Accounts receivable..................... Cash............................................... Total assets ..........................................

$64,000 $128,800 42,600 62,400 18,720

86,200 43,680 4,680 14,520 18,040

$193,880

37,240 $231,120

Equity and Liabilities Equity Share capital—ordinary ............................. Retained earnings ($15,000 + $3,440*) ...... Non-current liabilities Notes payable ............................................. Current liabilities Current portion of notes payable .............. Accounts payable ....................................... Interest payable .......................................... Total equity and liabilities .................................

$100,000 18,440

$118,440 83,880

13,900 12,300 2,600

28,800 $231,120

*Net income = $14,180 – $780 – $7,360 – $2,600 = $3,440 (Assets = Equity + Liabilities) LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Diversity AICPA FC: Reporting AICPA BB: International/Global

IFRS 2-5 INTERNATIONAL COMPARATIVE ANALYSIS PROBLEM

Differences in the format of the statement of financial position (balance sheet) used by Vuitton and Apple include the following:

1. 2. 3.

4. 5. 6.

Vuitton Non-current assets listed first Goodwill listed before property, plant and equipment Current assets are shown in reverse order of liquidity with cash being last The equity section is shown before liabilities Long-term liabilities are shown before current liabilities The equity section uses Share capital and Share premium Reporting currency is € (euros)

Apple Current assets listed first Property, plant, and equipment listed before goodwill Current assets are shown in order of liquidity with cash being first Liabilities are shown before the equity section Current liabilities are shown before long-term liabilities The equity section uses Common stock and additional paid-in capital Reporting currency is $ (dollars)

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Diversity AICPA FC: Reporting AICPA BB: International/Global

CHAPTER 3 The Accounting Information System Learning Objectives 1. 2. 3. 4. 5.

Analyze the effect of business transactions on the basic accounting equation. Explain how accounts, debits, and credits are used to record business transactions. Indicate how a journal is used in the recording process. Explain how a ledger and posting help in the recording process. Prepare a trial balance.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

1. 2. 3. 4. 5.

1 1 1 1 2

C C C K K

6. 7. 8. 9. 10.

2 2 2 2 2

C C C K K

1. 2. 3.

1 1 1

C AP AP

4. 5. 6.

2 2 3

K C AP

1. 2. 3. 4. 5.

1 1 1 1 2

C AP AP AP AP

6. 7. 8. 9. 10.

2 2, 3 2 3 3

AP AP C AP AP

1. 2. 3.

1 1, 2 1, 2

AP AP AP

4. 5. 6.

3 AP 3, 4, 5 AP 3, 4, 5 AP

Item

Questions 11. 2 K 12. 2 K 13. 2 K 14. 2 K 15. 3 K Brief Exercises 7. 3 C 8. 3 C Do It! Exercises 3. 3 AP Exercises 11. 3 AP 12. 3 AP 13. 4, 5 AP 14. 1, 3, 4 AP 15. 3, 5 AN Problems: Set A 7. 5 AN 8. 3, 4, 5 AP

Item

16. 17. 18. 19. 20.

3 3 3 4 5

K K AP C C

21. 22.

1 5

K AN

9. 10.

3 4

AP AP

11. 12.

5 5

AP AN

16. 17. 18. 19. 20.

4, 5 3, 5 3, 4, 5 5 5

AP AN AP AN AP

21. 22.

5 5

AP AP

9. 10.

3, 4, 5 AP 3, 4, 5 AP

11.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Analyze transactions and compute net income.

Moderate

40–50

Analyze transactions and prepare financial statements.

Moderate

40–50

Analyze transactions and prepare an income statement, retained earnings statement, and balance sheet.

Moderate

50–60

Journalize a series of transactions.

Simple

20–30

Journalize transactions, post, and prepare a trial balance.

Simple

30–40

Journalize transactions, post, and prepare a trial balance.

Moderate

40–50

Prepare a correct trial balance.

Moderate

30–40

Journalize transactions, post, and prepare a trial balance.

Moderate

40–50

Journalize transactions, post, and prepare a trial balance.

Moderate

40–50

10A

Journalize transactions, post, and prepare trial balance.

Moderate

40–50

11A

Analyze errors and their effects on the trial balance.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

The system of collecting and processing transaction data and communicating financial information to decision makers is known as the accounting information system.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in the equipment account which is offset by a decrease in the cash account is a specific example.

LO 1 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

Accounting transactions are the economic events of the company recorded by accountants because they affect the basic accounting equation. (a) The death of a major stockholder of the company is not an accounting transaction as it does not affect the basic accounting equation. (b) Supplies purchased on account is an accounting transaction because it affects the basic accounting equation. (c) An employee being fired is not an accounting transaction as it does not affect the basic accounting equation. (d) Paying a cash dividend to stockholders is an accounting transaction as it does affect the basic accounting equation.

LO 1 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

(a) (b) (c) (d)

Decrease assets and decrease stockholders’ equity. Increase assets and decrease assets. Increase assets and increase stockholders’ equity. Decrease assets and decrease liabilities.

LO 1 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

An account consists of three parts: (a) the title, (b) the left or debit side, and (c) the right or credit side. Because the alignment of these parts resembles the letter T, it is referred to as a T account.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

Disagree. The terms debit and credit are synonymous with left and right, respectively.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

Barry is incorrect. The double-entry system merely records the dual (two-sided) effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once, and must affect two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must equal credits.

LO 2 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

Misty is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favorable or unfavorable.

LO 2 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

(a) Asset accounts are increased by debits and decreased by credits. (b) Liability accounts are decreased by debits and increased by credits. (c) The common stock account is decreased by debits and increased by credits.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

10.

(a) (b) (c) (d) (e) (f) (g)

Accounts Receivable—debit balance. Cash—debit balance. Dividends—debit balance. Accounts Payable—credit balance. Service Revenue—credit balance. Salaries and Wages Expense—debit balance. Common Stock—credit balance.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

11.

(a) (b) (c) (d) (e)

Accounts Receivable—asset—debit balance. Accounts Payable—liability—credit balance. Equipment—asset—debit balance. Dividends—stockholders’ equity—debit balance. Supplies—asset—debit balance.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

12.

(a) Debit Supplies and credit Accounts Payable. (b) Debit Cash and credit Notes Payable. (c) Debit Salaries and Wages Expense and credit Cash.

LO 2 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

13.

(a) (b) (c) (d) (e) (f)

Cash—both debit and credit entries. Accounts Receivable—both debit and credit entries. Dividends—debit entries only. Accounts Payable—both debit and credit entries. Salaries and Wages Expense—debit entries only. Service Revenue—credit entries only.

LO 2 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

14.

Normal balances for accounts in Apple’s financial statements: Accounts Receivable—debit; Accounts Payable—credit; Sales—credit; Selling, General, and Administrative Expenses—debit.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

15.

The basic steps in the recording process are:

(1) Analyze each transaction in terms of its effect on the accounts. (2) Enter the transaction information in a journal. (3) Transfer the journal information to the appropriate accounts in the ledger. LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

16.

(a) The debit should be entered first. (b) The credit should be indented.

LO 3 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

17.

(a) No, debits and credits should not be recorded directly in the ledger. (b) The advantages of using the journal are: (1) It discloses in one place the complete effect of a transaction. (2) It provides a chronological record of all transactions. (3) It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared.

LO 3 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

18.

(a) Cash ........................................................................................................... 12,000 Common Stock................................................................................. (Issued stock for cash) (b) Prepaid Insurance.................................................................................... Cash ................................................................................................ (Paid one-year insurance policy) (c)

12,000

800 800

Supplies ........................................................................................................ 1,800 Accounts Payable ............................................................................ (Purchased supplies on account)

1,800

(d) Cash ............................................................................................................. 7,500 Service Revenue.............................................................................. (Received cash for services rendered)

7,500

LO 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

19.

(a) The entire group of accounts maintained by a company, including all the asset, liability, and stockholders’ equity accounts, is referred to collectively as the ledger. (b) The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger.

LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

20.

A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after all journalized transactions have been posted. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements.

LO 5 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

21.

The proper sequence is as follows:

(b) (c) (a) (e) (d)

Accounting transaction occurs. Information is entered in the journal. Debits and credits are posted to the ledger. Trial balance is prepared. Financial statements are prepared.

LO 5 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

22.

(a) The trial balance would balance. (b) The trial balance would not balance since the debits would be $720 higher than the credits.

LO 5 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1

(a) (b) (c)

Assets + + –

Liabilities + NE NE

Stockholders’ Equity NE + –

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 3-2

Cash (1)

+$60,000

(2)

–9,000

(3)

+13,000

Assets = Liabilities + Stockholders’ Equity Accounts Accounts Bonds Common Retained + Receivable + Supplies = Payable + Payable + Stock + Earnings +$60,000 –$9,000

Paid div.

–$13,000

(4)

+$3,100

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 3-3 Assets Cash (1)

–$286,176

(2)

+137,590

(3)

+ Inventory +

Equipment

Liabilities

Accounts Payable

Stockholders’ Equity

Common Stock

Retained Earnings

+$286,176 +$137,590 +$68,480

Issued stock

+$68,480

LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 3-4

(a) (b) (c) (d) (e) (f)

Accounts Payable Advertising Expense Service Revenue Accounts Receivable Retained Earnings Dividends

Debit Effect Decrease Increase Decrease Increase Decrease Increase

Credit Effect Increase Decrease Increase Decrease Increase Decrease

Normal Balance Credit Debit Credit Debit Credit Debit

LO 2 BT: K Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 3-5

June 1 2 3 12

Account Debited Cash Equipment Rent Expense Accounts Receivable

Account Credited Common Stock Accounts Payable Cash Service Revenue

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 3-6 June 1 2 3 12

Cash ..................................................................... Common Stock ............................................

5,000

Equipment............................................................ Accounts Payable........................................

1,100

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

740

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

700

5,000 1,100 740 700

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 3-7 The basic steps in the recording process are: 1.

Analyze each transaction. In this step, source documents are examined to determine the effects of the transaction on the accounts.

Enter each transaction in a journal. This step is called journalizing and it results in making a chronological record of the transactions.

Transfer journal information to ledger accounts. This step is called posting. Posting makes it possible to accumulate the effects of journalized transactions on individual accounts.

LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 3-8 (a) Basic Analysis

(b)

Debit-Credit Analysis

Aug. 1

The asset Cash is increased; the stockholders’ equity account Common Stock is increased.

Debits increase assets: debit Cash $10,000. Credits increase stockholders’ equity: credit Common Stock $10,000.

The asset Prepaid Insurance is increased; the asset Cash is decreased.

Debits increase assets: debit Prepaid Insurance $1,500. Credits decrease assets: credit Cash $1,500.

16 The asset Cash is increased; the revenue Service Revenue is increased.

Debits increase assets: debit Cash $900. Credits increase revenues: credit Service Revenue $900.

Debits increase expenses: debit Salaries and Wages Expense $620. Credits decrease assets: credit Cash $620.

The expense Salaries and Wages Expense is increased; the asset Cash is decreased.

LO 3 BT: C Difficulty: Medium TOT: 8 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 3-9 Aug. 1 4 16 27

Cash...................................................................... Common Stock.............................................

10,000

Prepaid Insurance................................................ Cash ..............................................................

1,500

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

900

Salaries and Wages Expense.............................. Cash ..............................................................

620

LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

10,000 1,500 900 620

BRIEF EXERCISE 3-10

5/12 5/15

5/5

Cash 1,600 2,000

Service Revenue 5/5 5/15

3,800 2,000

Accounts Receivable 3,800 5/12 1,600

LO 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 3-11 PEETE COMPANY Trial Balance June 30, 2017 Cash ............................................................................ Accounts Receivable ................................................. Equipment................................................................... Accounts Payable ...................................................... Common Stock ........................................................... Dividends .................................................................... Service Revenue......................................................... Salaries and Wages Expense .................................... Rent Expense .............................................................

Debit $ 5,400 3,000 13,000

Credit

$ 1,000 18,000 1,200 8,600 4,000 1,000 $27,600

(Total of debit account balances = Total of credit account balances) LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

$27,600

BRIEF EXERCISE 3-12 BIRELLIE COMPANY Trial Balance December 31, 2017 Cash ............................................................................ Prepaid Insurance ...................................................... Accounts Payable ...................................................... Unearned Service Revenue ....................................... Common Stock........................................................... Retained Earnings...................................................... Dividends.................................................................... Service Revenue ........................................................ Salaries and Wages Expense .................................... Rent Expense .............................................................

Debit $20,800 3,500

Credit

$ 2,500 1,800 10,000 6,600 5,000 25,600 14,600 2,600 $46,500

(Assets, expenses, and dividends have debit balances) LO 5 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

$46,500

SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 3-1 Assets = Accounts Cash + Receivable = (1) (2)

+$20,000 +$20,000

(3) (4)

Liabilities Accounts Payable

+ +

Common Stock

Stockholders’ Equity Retained Earnings + Revenues – Expenses – Dividends +$20,000

–20,000 –$1,800

+$1,800 –3,000

–$3,000

LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 3-2 Boyd would likely need the following accounts in which to record the transactions necessary to ready his photography studio for opening day: Cash (debit balance) Supplies (debit balance) Notes Payable (credit balance)

Equipment (debit balance) Accounts Payable (credit balance) Common Stock (credit balance)

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

DO IT! 3-3 Each transaction that is recorded is entered in the general journal. The three activities would be recorded as follows: 1. 2.

Cash.......................................................................... Common Stock ................................................. Supplies ................................................................... Accounts Payable ............................................ Cash ..................................................................

8,000

No entry because no transaction has occurred.

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

8,000 950 550 400

DO IT! 3-4 4/1 4/3 4/30

Cash 1,900 4/16 3,400 4/20 4,500

500 300

LO 4 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 3-5 CHILLIN’ COMPANY Trial Balance December 31, 2017 Cash ............................................................................ Accounts Receivable ................................................. Supplies ...................................................................... Equipment................................................................... Notes Payable............................................................. Accounts Payable ...................................................... Salaries and Wages Payable ..................................... Common Stock ........................................................... Dividends.................................................................... Service Revenue ........................................................ Rent Expense ............................................................. Salaries and Wages Expense ....................................

Debit $ 6,000 8,000 5,000 76,000

Credit

$ 20,000 9,000 3,000 25,000 8,000 86,000 2,000 38,000 $143,000

(Liabilities, Common stock, and Revenues have credit balances) LO 5 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

$143,000

SOLUTIONS TO EXERCISES EXERCISE 3-1 1. 2. 3. 4. 5. 6. 7. 8. 9.

Increase in assets and increase in stockholders’ equity. Decrease in assets and decrease in stockholders’ equity. Increase in assets and increase in stockholders’ equity. Increase in assets and increase in stockholders’ equity. Decrease in assets and decrease in stockholders’ equity. Increase in liabilities and decrease in stockholders’ equity. Increase in assets and decrease in assets. Increase in assets and decrease in assets. Increase in assets and increase in liabilities.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

EXERCISE 3-2 Assets

Accounts Cash (1)

Receivable

+ Equipment =

Payable

Stockholders’ Equity Common

+$40,000

Retained Earnings + Revenues –

Stock

Issued Stock

+$30,000

–4,000

–$4,000 +$19,000

(5)

+5,000

(6)

–8,000

(7)

–30,000

Expenses

+$40,000 +$30,000

(4)

Rent Expense

+$19,000

Service Revenue

+5,000

Service Revenue –8,000

Utilities Expense

–1,300

Advertising Expense

–30,000

(8) (9)

Accounts

(2) (3)

Liabilities

+1,300 +12,000

–12,000

$15,000 +

$7,000

$52,000

$30,000

$ 1,300

$40,000 +

$24,000

–

$13,300

$52,000

LO 1 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 3-4 (a)

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Stockholders invested $20,000 cash in the business. Purchased equipment for $5,000, paying $1,000 in cash and the balance of $4,000 on account. Paid $750 cash for supplies. Earned $9,500 in revenue, receiving $4,100 cash and $5,400 on account. Paid $1,500 cash on accounts payable. Paid $2,000 cash dividends to stockholders. Paid $800 cash for rent. Collected $450 cash from customers on account. Paid salaries of $3,000. Incurred $300 of utilities expense on account.

(b) Issued common stock ............................................................ Service revenue ...................................................................... Dividends ................................................................................ Rent expense .......................................................................... Salaries and wages expense.................................................. Utilities expense ..................................................................... Increase in stockholders’ equity............................................

$20,000 9,500 (2,000) (800) (3,000) (300) $23,400

[Revenues – Expenses = Net income or (loss)] (Changes in stockholders’ equity = Additional investment – dividends ± Net income or Loss)

(c) Service revenue ...................................................................... Rent expense .......................................................................... Salaries and wages expense.................................................. Utilities expense ..................................................................... Net income .............................................................................. LO 1 BT: AP Difficulty: Medium TOT. 12 min. AACSB: Analytic AICPA FC: Reporting

$ 9,500 (800) (3,000) (300) $ 5,400

EXERCISE 3-5 WOLFE COMPANY Income Statement For the Month Ended August 31, 2017 Revenues Service revenue ....................................................... Expenses Salaries and wages expense .................................. Rent expense ........................................................... Utilities expense ...................................................... Total expenses ................................................. Net income.......................................................................

$9,500 $3,000 800 300 4,100 $5,400

WOLFE COMPANY Retained Earnings Statement For the Month Ended August 31, 2017 Retained earnings, August 1 ............................................................ Add: Net income ............................................................................. Less: Dividends................................................................................ Retained earnings, August 31 ..........................................................

$ 0 5,400 5,400 2,000 $3,400

WOLFE COMPANY Balance Sheet August 31, 2017 Assets Current assets Cash .......................................................................... Accounts receivable ................................................ Supplies .................................................................... Total current assets.............................................. Equipment..................................................................... Total assets...........................................................

$15,500 4,950 750

Liabilities and Stockholders’ Equity Current liabilities Accounts payable..................................................... Stockholders’ equity Common stock ......................................................... $20,000 Retained earnings .................................................... 3,400 Total liabilities and stockholders’ equity .... (Ending retained earnings = Beginning retained earnings + Net income – Dividends) LO 2 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

$21,200 5,000 $26,200

$ 2,800 23,400 $26,200

EXERCISE 3-6 Account Accounts payable Accounts receivable Common stock Depreciation expense Interest expense Interest income Inventories Prepaid expenses Property and equipment Revenues

(a) Normal Balance Debit or Credit Credit Debit Credit Debit Debit Credit Debit Debit Debit Credit

(b) Balance Sheet or Income Statement Balance sheet Balance sheet Balance sheet Income statement Income statement Income statement Balance sheet Balance sheet Balance sheet Income statement

LO 2 BT: K Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Reporting

EXERCISE 3-7 (Continued) (b) General Journal Trans. 1. 2. 3.

4. 5. 6. 7. 8.

Account Titles Cash .................................................................. Common Stock .........................................

Debit 15,000

Equipment ........................................................ Cash ..........................................................

10,000

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

300

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

3,700

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

200

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

1,100

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

300

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

400

Credit 15,000 10,000 300 3,700 200 1,100 300

LO 2,3 BT: AP Difficulty: Medium TOT: 15 AACSB: Analytic AICPA FC: Reporting

EXERCISE 3-8 Oct. 1

Debits increase assets: debit Cash $30,000. Credits increase stockholders’ equity: credit Common Stock $30,000.

No accounting transaction.

Debits increase assets: debit Equipment $3,800. Credits increase liabilities: credit Accounts Payable $3,800.

400

EXERCISE 3-8 (Continued) Oct. 6

Debits increase assets: debit Accounts Receivable $10,800. Credits increase revenues: credit Service Revenue $10,800.

Debits increase assets: debit Cash $140. Credits increase revenues: credit Service Revenue $140.

Debits decrease liabilities: debit Accounts Payable $700. Credits decrease assets: credit Cash $700.

Debits increase expenses: debit Salaries and Wages Expense $3,000. Credits decrease assets: credit Cash $3,000.

LO 2 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Reporting

EXERCISE 3-9 General Journal Date Oct. 1

Account Titles Cash ................................................................ Common Stock........................................

Debit 30,000

30,000

No entry.

Equipment....................................................... Accounts Payable ...................................

3,800

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

10,800

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

140

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

700

Salaries and Wages Expense ........................ Cash .........................................................

3,000

6 10 27 30

Credit

3,800 10,800 140 700

LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

3,000

EXERCISE 3-10 General Journal Date May 4 7 8 9 17 22 29

Account Titles Accounts Payable........................................... Cash .........................................................

Debit 700

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

6,800

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

850

Equipment ....................................................... Cash .........................................................

1,000

Salaries and Wages Expense......................... Cash .........................................................

530

Maintenance and Repairs Expense ............... Accounts Payable ...................................

900

Prepaid Insurance........................................... Cash .........................................................

1,200

Credit 700 6,800 850 1,000 530 900

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

1,200

EXERCISE 3-11 General Journal Date March

Account Titles Rent Expense.................................................. 1 Cash ......................................................... 3 5 8

12 14 22 24 27 28 30

Debit 1,200

Credit 1,200

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

140

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

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

600

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

140

Salaries and Wages Expense ........................ Cash .........................................................

525

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

Cash ................................................................ Notes Payable .........................................

1,500

Repairs Expense............................................. Cash .........................................................

220

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

520

Prepaid Insurance .......................................... Cash .........................................................

1,800

140 75 80 520 140 525 72 1,500 220 520

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

1,800

EXERCISE 3-12 Trans. 1. 2. 3. 4. 5. 6. 7.

8. 9. 10. 11. 12. 13. 14.

Account Titles Cash .................................................................. Common Stock .........................................

Debit 24,000

Cash .................................................................. Notes Payable...........................................

7,000

Equipment ........................................................ Cash ..........................................................

11,000

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

1,200

Supplies............................................................ Cash ..........................................................

1,450

Advertising Expense........................................ Accounts Payable ....................................

600

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

2,000 16,000

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

400

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

2,000

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

600

Interest Expense .............................................. Cash ..........................................................

Salaries and Wages Expense.......................... Cash ..........................................................

6,400

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

12,000

Income Tax Expense........................................ Cash ..........................................................

1,500

Credit 24,000 7,000 11,000 1,200 1,450 600

18,000 400 2,000 600 40 6,400 12,000

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

1,500

EXERCISE 3-13 (a) Oct. 1 10 Bal.

Cash 30,000 Oct. 27 140 30 26,440

700 3,000

Accounts Payable Oct. 27 700 Oct. 3 Bal.

3,800 3,100

Common Stock Oct. 1 Bal.

30,000 30,000

Accounts Receivable Oct. 6 10,800 Bal. 10,800

Oct. 3 Bal.

Service Revenue Oct. 6 10,800 10 140 Bal. 10,940

Equipment 3,800 3,800

Salaries and Wages Expense Oct. 30 3,000 Bal. 3,000

(b)

MCCALL REAL ESTATE AGENCY Trial Balance October 31, 2017 Cash.................................................................... Accounts Receivable......................................... Equipment .......................................................... Accounts Payable .............................................. Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense............................

Debit $26,440 10,800 3,800

Credit

$ 3,100 30,000 10,940 3,000 $44,040

(Total of debit account balances = Total of credit account balances) LO 4, 5 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

$44,040

EXERCISE 3-14 (a) Assets

Accounts Cash Sept. 1

+$20,000

–3,000

Receivable

Liabilities Accounts

+ Equipment =

Payable

Stockholders’ Equity

+ Common +

Stock

Retained Earnings + Revenues

–4,000

–500

–

Div.

+$9,000

Issued stock

+$ 6,000

+$18,000 –1,200

Exp.

+$20,000

8 14

–

+$18,000

Ser. Rev. –$1,200

Salar. Exp.

–4,000 –$500

$ 11,300 +

$18,000

$9,000

$ 2,000

$20,000

$38,300

$18,000

–

$1,200

–

Dividends

$500

$38,300

(b) General Journal Date Sept. 1 5

8 14 25 30

Account Titles Cash ............................................................... Common Stock ......................................

Debit 20,000

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

9,000

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

18,000

Salaries and Wages Expense ....................... Cash........................................................

1,200

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

4,000

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

500

J1 Credit 20,000 6,000 3,000

18,000 1,200 4,000 500

EXERCISE 3-14 (Continued) (c) 9/1

Bal.

9/8 Bal.

9/5 Bal.

9/25

Cash 20,000 9/5 9/14 9/25 9/30 11,300

3,000 1,200 4,000 500 9/30 Bal.

Accounts Receivable 18,000 18,000

20,000 20,000

Dividends 500 500 Service Revenue 9/8 Bal.

Equipment 9,000 9,000

Accounts Payable 4,000 9/5 Bal.

Common Stock 9/1 Bal.

18,000 18,000

Salaries and Wages Expense 9/14 1,200 Bal. 1,200 6,000 2,000

LO 1, 3, 4 BT: AP Difficulty: Hard TOT:20 min. AACSB: Analytic AICPA FC: Reporting

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

EXERCISE 3-15 (a) General Journal Account Titles and Explanation Cash................................................................. Common Stock........................................ (Issued stock for cash)

Date Apr. 1

Debit 15,000

Credit 15,000

Supplies........................................................... Accounts Payable ................................... (Purchased supplies on account)

5,200

Accounts Receivable...................................... Service Revenue ..................................... (Billed clients for services rendered)

3,400

Cash................................................................. Service Revenue ..................................... (Received cash for revenue earned)

700

Salaries and Wages Expense......................... Cash ......................................................... (Paid salaries)

800

Accounts Payable........................................... Cash ......................................................... (Paid creditors on account)

3,500

Cash................................................................. Accounts Receivable .............................. (Received cash in payment of account)

800

Cash................................................................. Unearned Service Revenue .................... (Received cash for future services)

900

5,200

3,400

700

800

3,500

800

900

EXERCISE 3-15 (Continued) (b)

SALVADOR’s GARDENING COMPANY, INC. Trial Balance April 30, 2017 Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Accounts Payable .............................................. Unearned Service Revenue............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense............................

Debit $13,100 2,600 5,200

Credit

$ 1,700 900 15,000 4,100 800 $21,700

(Assets and Expenses have debit balances) LO 3, 5 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

$21,700

EXERCISE 3-16 (a) Aug. 1 10 31 Bal.

Cash 8,000 Aug. 12 1,700 600 9,100

Accounts Receivable Aug. 25 3,400 Aug. 31 Bal. 2,800

Aug. 12 Bal.

(b)

Notes Payable Aug. 12 Bal.

5,000 5,000

Common Stock Aug. 1 Bal.

8,000 8,000

Service Revenue Aug. 10 25 Bal.

1,700 3,400 5,100

1,200

600

Equipment 6,200 6,200

BAYLEE INC. Trial Balance August 31, 2017 Cash .................................................................... Accounts Receivable ......................................... Equipment .......................................................... Notes Payable .................................................... Common Stock................................................... Service Revenue ................................................

Debit $ 9,100 2,800 6,200

$18,100 (Liabilities, Common stock, and Revenues have credit balances) LO 4, 5 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

Credit

$ 5,000 8,000 5,100 $18,100

EXERCISE 3-17 (a) Oct. 1

Cash ............................................................... Common Stock ...................................... (Issued stock for cash)

7,000

Cash ............................................................... Service Revenue.................................... (Received cash for services provided)

980

Cash ............................................................... Notes Payable........................................ (Issued note payable for cash)

8,000

Cash ............................................................... Accounts Receivable ............................ (Received cash in payment of account)

700

Accounts Receivable .................................... Service Revenue.................................... (Billed clients for services provided)

920

7,000

980

8,000

700

920

EXERCISE 3-17 (Continued) (b)

KRISCOE CO. Trial Balance October 31, 2017 Cash .................................................................... Accounts Receivable ......................................... Supplies.............................................................. Equipment .......................................................... Notes Payable .................................................... Accounts Payable .............................................. Common Stock................................................... Dividends............................................................ Service Revenue ................................................ Salaries and Wages Expense ............................ Supplies Expense .............................................. Rent Expense .....................................................

Debit $15,730 1,020 220 3,000

Credit

$ 8,000 1,500 9,000 300 2,700 500 180 250 $21,200

(Liabilities, Common stock, and Service revenues have credit balances) LO 3, 5 BT: AN Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

$21,200

EXERCISE 3-18 (a) Date Oct.

1 2 4 7

8 10 12 16 21 24 27 31

Account Titles Cash ................................................................ Common Stock........................................

Debit 66,000

Credit 66,000

No entry Rent Expense.................................................. Cash .........................................................

2,000

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

18,000

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

500

Maintenance and Repairs Expense ............... Accounts Payable ...................................

390

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

3,200

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

410

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

14,000

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

148

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

3,200

Salaries and Wages Expense ........................ Cash .........................................................

5,100

2,000 4,000 14,000 500 390 3,200 410 14,000 148 3,200 5,100

EXERCISE 3-18 (Continued) (b) 10/1 10/27

Bal.

Cash 66,000 10/4 3,200 10/7 10/8 10/21 10/24 10/31 43,452

2,000 4,000 500 14,000 148 5,100

Accounts Receivable 10/12 3,200 10/27 3,200

10/16 Bal.

Supplies 410 410

10/7 Bal.

Equipment 18,000 18,000

10/21

10/8 Bal.

3,200 3,200

Advertising Expense 500 500

Salaries and Wages Expense 10/31 5,100 Bal. 5,100 Maintenance & Repairs Expense 10/10 390 Bal. 390

Accounts Payable 14,000 10/7 14,000 10/10 390 10/16 410 Bal. 800

Common Stock 10/1 Bal.

Service Revenue 10/12 Bal.

66,000 66,000

10/4 Bal.

Rent Expense 2,000 2,000

10/24 Bal.

Utilities Expense 148 148

EXERCISE 3-18 (Continued) (c)

BEYERS CORPORATION Trial Balance October 31, 2017 Cash.................................................................... Supplies.............................................................. Equipment .......................................................... Accounts Payable .............................................. Common Stock .................................................. Service Revenue ................................................ Advertising Expense ......................................... Salaries and Wages Expense............................ Maintenance and Repairs Expense .................. Rent Expense ..................................................... Utilities Expense ................................................

Debit $43,452 410 18,000

$ 800 66,000 3,200 500 5,100 390 2,000 148 $70,000

(Total of debit account balances = Total of credit account balances) LO 3-5 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 3-19 Error 1. 2. 3. 4. 5. 6.

(a) In Balance No Yes Yes No Yes No

(b) Difference $400 — — 300 — 36

Credit

LO 5 BT: AN Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

$70,000

EXERCISE 3-20 (a)

RAPID DELIVERY SERVICE Trial Balance July 31, 2017 Debit Cash ($98,370 – Debit total without Cash $85,946) ........................................................... Accounts Receivable.......................................... Prepaid Insurance............................................... Equipment ........................................................... Accounts Payable ............................................... Salaries and Wages Payable.............................. Notes Payable (due 2020)................................... Common Stock ................................................... Retained Earnings .............................................. Dividends ............................................................ Service Revenue ................................................. Salaries and Wages Expense............................. Maintenance and Repairs Expense ................... Insurance Expense .............................................

Credit

$12,424 13,400 2,200 59,360 $ 8,400 820 28,450 40,000 5,200 700 15,500 7,428 1,958 900 $98,370

$98,370

(Liabilities, Common stock, Retained earnings, and Service revenue have credit balances)

EXERCISE 3-20 (Continued) (b)

RAPID DELIVERY SERVICE Income Statement For the Month Ended July 31, 2017 Revenues Service revenue................................................. Expenses Salaries and wages expense ............................ Maintenance and repairs expense ................... Insurance expense ............................................ Total expenses............................................... Net income ............................................................

$15,500 $7,428 1,958 900 10,286 $ 5,214

RAPID DELIVERY SERVICE Retained Earnings Statement For the Month Ended July 31, 2017 Retained earnings, July 1..................................... Add: Net income ................................................. Less: Dividends ................................................... Retained earnings, July 31...................................

$ 5,200 5,214 10,414 700 $ 9,714

EXERCISE 3-20 (Continued) RAPID DELIVERY SERVICE Balance Sheet July 31, 2017 Assets Current assets Cash.................................................................... Accounts receivable.......................................... Prepaid insurance.............................................. Total current assets ....................................... Equipment ............................................................. Total assets ....................................................

$12,424 13,400 2,200 $28,024 59,360 $87,384

Liabilities and Stockholders’ Equity Current liabilities Accounts payable.............................................. Salaries and wages payable ............................. Total current liabilities................................... Notes payable........................................................ Total liabilities ................................................ Stockholders’ equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity............................. Total liabilities and stockholders’ equity .....

$ 8,400 820 $ 9,220 28,450 37,670 40,000 9,714 49,714 $87,384

[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – dividends] LO 5 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 3-21 1. 2. 3. 4. 5. 6. 7. 8. 9.

Financing activity Operating activity Operating activity Non-cash event Financing activity Non-cash event Operating activity Investing activity Non-cash event

LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 3-22 1. 2. 3. 4. 5. 6. 7. 8. 9.

Financing activity Financing activity Investing activity Operating activity Non-cash event Operating activity Non-cash event Operating activity Financing activity

LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 3-1A (Continued) (b) Service Revenue ...................................................... Expenses Salaries and Wages Expense .......................... Rent Expense ................................................... Advertising Expense........................................ Net Income ................................................

$12,000 $1,800 900 200

2,900 $ 9,100

OR Revenues.................................................................. Less: Expenses....................................................... Net Income ............................................................... [Revenues – Expenses = Net Income or (Loss)] LO 1 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting

$12,000 2,900 $ 9,100

PROBLEM 3-2A (Continued) (b)

CURRY CONSULTING INC. Income Statement For the Month Ended May 31, 2017 Revenues Service revenue ($1,400 + $4,200)................ Expenses Salaries and wages expense ........................ Rent expense................................................. Utilities expense............................................ Advertising expense ..................................... Total expenses....................................... Net income ............................................................

$5,600 $2,500 600 180 150 3,430 $2,170

[Revenues – Expenses = Net Income or (Loss)]

(c)

CURRY CONSULTING INC. Balance Sheet May 31, 2017 Assets Current assets Cash............................................................... Accounts receivable ..................................... Supplies......................................................... Total current assets .............................. Equipment ..................................................... Total assets............................................

$18,270 3,000 500

Liabilities and Stockholders’ Equity Current liabilities Notes payable ............................................... $ 5,000 Accounts payable ......................................... 1,800 Total current liabilities .......................... Stockholders’ equity Common stock.............................................. 15,000 Retained earnings ($0 + $2,170 – $200)....... 1,970 Total liabilities and stockholders’ equity.................................................. (Assets = Liabilities + Stockholders’ equity) LO 1, 2 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting

$21,770 2,000 $23,770

$ 6,800 16,970 $23,770

PROBLEM 3-3A (Continued) (b)

BINDY CRAWFORD INC. Income Statement For the Month Ended August 31, 2017 Revenues Service revenue................................................ Expenses Salaries and wages expense ........................... Rent expense.................................................... Utilities expense............................................... Advertising expense ........................................ Total expenses.......................................... Net income ...............................................................

$5,400 $1,400 700 380 350 2,830 $2,570

BINDY CRAWFORD INC. Retained Earnings Statement For the Month Ended August 31, 2017 Retained earnings, August 1 .................................................... Add: Net income...................................................................... Less: Dividends ........................................................................ Retained earnings, August 31...................................................

$1,600 2,570 4,170 700 $3,470

PROBLEM 3-3A (Continued) BINDY CRAWFORD INC. Balance Sheet August 31, 2017 Assets Current assets Cash ................................................................ Accounts receivable ...................................... Supplies .......................................................... Total current assets................................ Equipment....................................................... Total assets.............................................

$7,150 3,200 500 $10,850 9,000 $19,850

Liabilities and Stockholders’ Equity Current liabilities Notes payable................................................. Accounts payable........................................... Total current liabilities............................ Stockholders’ equity Common stock ............................................... Retained earnings .......................................... Total liabilities and stockholders’ equity ...................................................

$5,000 5,180 $10,180 6,200 3,470

9,670 $19,850

[Ending retained earnings = Beginning retained earnings ± Net income or (loss) – Dividends] LO 1, 2 BT: AP Difficulty: Hard TOT: 55 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 3-4A

Date Mar. 1

Account Titles and Explanation Cash ................................................................ Common Stock........................................ (Issued stock for cash)

Debit 50,000

Land................................................................. Buildings ......................................................... Equipment....................................................... Cash ......................................................... (Purchased Snead’s Golf Land)

23,000 9,000 6,000

Advertising Expense ...................................... Cash ......................................................... (Paid for advertising)

1,200

Prepaid Insurance .......................................... Cash ......................................................... (Paid for one-year insurance policy)

2,400

Equipment....................................................... Accounts Payable ................................... (Purchased equipment on account)

5,500

Cash ................................................................ Service Revenue ..................................... (Received cash for revenue earned)

1,600

Cash (100 X $25) ............................................. Unearned Service Revenue .................... (Received cash for coupon books sold)

2,500

Dividends ........................................................ Cash ......................................................... (Payment of cash dividend)

500

Credit 50,000

38,000

1,200

2,400

5,500

1,600

2,500

500

PROBLEM 3-4A (Continued) Date Mar. 30

Account Titles and Explanation Salaries and Wages Expense......................... Cash ......................................................... (Paid salaries expense)

Debit 800

Accounts Payable........................................... Cash ......................................................... (Paid creditor on account)

5,500

Cash................................................................. Service Revenue ..................................... (Received cash for revenue earned)

900

Credit 800

5,500

LO 3 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

900

PROBLEM 3-5A (a) Date Apr. 1

Account Titles and Explanation Cash ................................................................. Common Stock ........................................ (Issued shares of stock for cash)

Debit 18,000

Credit 18,000

No entry—not a transaction. 2

Rent Expense .................................................. Cash.......................................................... (Paid monthly office rent)

900

Supplies ........................................................... Accounts Payable.................................... (Purchased supplies on account from Burmingham Company)

1,300

Accounts Receivable ...................................... Service Revenue ...................................... (Billed clients for services rendered)

1,900

Cash ................................................................. Unearned Service Revenue..................... (Received cash advance for future service)

700

Cash ................................................................. Service Revenue ...................................... (Received cash for service performed)

2,800

Salaries and Wages Expense ......................... Cash.......................................................... (Paid monthly salary)

1,500

Accounts Payable ........................................... Cash.......................................................... (Paid Burmingham Company on account)

300

900

1,300

1,900

700

2,800

1,500

300

PROBLEM 3-5A (Continued) (b) 4/1 4/11 4/20 Bal.

Cash 18,000 4/2 700 4/30 2,800 4/30 18,800

4/10 Bal.

Accounts Receivable 1,900 1,900

4/3 Bal.

Supplies 1,300 1,300

4/30

Accounts Payable 300 4/3 Bal.

900 1,500 300

Salaries and Wages Expense 4/30 1,500 Bal. 1,500

4/2 Bal.

1,300 1,000

Unearned Service Revenue 4/11 700 Bal. 700 Common Stock 4/1 Bal.

18,000 18,000

Service Revenue 4/10 4/20 Bal.

1,900 2,800 4,700

Rent Expense 900 900

PROBLEM 3-5A (Continued) (c)

AYALA ARCHITECTS INC. Trial Balance April 30, 2017 Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Accounts Payable .............................................. Unearned Service Revenue............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense............................ Rent Expense .....................................................

Debit $18,800 1,900 1,300

Credit

$ 1,000 700 18,000 4,700 1,500 900 $24,400

(Assets and Expenses have debit balances) LO 3-5 BT: AP Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting

$24,400

PROBLEM 3-6A

(a) & (c) Cash 10/1 Bal. 19,200 10/15 10/5 1,300 10/20 10/17 600 10/29 10/31 Bal. 17,300

1,200 1,900 300 400

Retained Earnings 10/1 Bal. 11,000 Bal. 11,000

Accounts Receivable 10/1 Bal. 2,600 10/5 1,300 10/10 5,100 Bal. 6,400

10/1 Bal. Bal.

Supplies 2,100 2,100

10/1 Bal. Bal.

Equipment 8,000 8,000

10/20

Accounts Payable 1,900 10/1 Bal. Bal.

Common Stock 10/1 Bal. 15,000 Bal. 15,000

10/29 Bal.

Dividends 300 300 Service Revenue 10/10 10/17 Bal.

5,100 600 5,700

Salaries and Wages Expense 10/15 1,200 Bal. 1,200 4,800 2,900 10/31 Bal.

Unearned Service Revenue 10/1 Bal. 1,100 Bal. 1,100

Utilities Expense 400 400

PROBLEM 3-6A (Continued) (b) Date Oct. 5

Account Titles and Explanation Cash ................................................................ Accounts Receivable .............................. (Received collections from customers on account)

Debit 1,300

Accounts Receivable ..................................... Service Revenue ..................................... (Billed customers for services performed)

5,100

Salaries and Wages Expense ........................ Cash ......................................................... (Paid employee salaries)

1,200

Cash ................................................................ Service Revenue ..................................... (Performed services for customers)

600

Accounts Payable........................................... Cash ......................................................... (Paid creditors on account)

1,900

Dividends ........................................................ Cash ......................................................... (Payment of cash dividend)

300

Utilities Expense............................................. Cash ......................................................... (Paid utilities)

400

Credit 1,300

5,100

1,200

600

1,900

300

400

PROBLEM 3-6A (Continued) (d)

LACEY COMPANY Trial Balance October 31, 2017 Cash .................................................................... Accounts Receivable ......................................... Supplies.............................................................. Equipment .......................................................... Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock................................................... Retained Earnings.............................................. Dividends............................................................ Service Revenue ................................................ Salaries and Wages Expense ............................ Utilities Expense ................................................

Debit $ 17,300 6,400 2,100 8,000

Credit

$ 2,900 1,100 15,000 11,000 300 5,700 1,200 400 $35,700

$35,700

(Liabilities, Common stock, Retained earnings, and Service revenue have credit balances) LO 3-5 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 3-7A

WASHBURN CO. Trial Balance June 30, 2017 Cash ($3,090 – $780 + $870) .............................. Accounts Receivable* ....................................... Supplies ($800 – $340)....................................... Equipment ($3,000 + $340) ................................ Accounts Payable ($3,686 – $206 – $260) ........ Unearned Service Revenue............................... Common Stock .................................................. Dividends ($800 + $600) .................................... Service Revenue ................................................ Salaries and Wages Expense ($3,600 + $700 – $600)..................................... Utilities Expense ................................................

Debit $ 3,180 3,910 460 3,340

Credit

$ 3,220 1,200 9,000 1,400 3,480 3,700 910 $16,900

*$3,190 + $780 – $870 – $90 + $900 (Each journal entry must balance and reflect the actual amount of the transaction) LO 5 BT: AN Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting

$16,900

PROBLEM 3-8A

(a) & (c) 3/1 Bal. 3/9 3/20 3/31 3/31 Bal.

3/31 Bal.

2,000 10,900 500 5,000 3,800

Accounts Receivable 750 750

3/1 Bal. Bal.

3/10

Cash 16,000 3/2 9,900 3/10 8,300 3/12 750 3/20 20,000 3/31 32,750

Land 38,000 38,000

Buildings 22,000 22,000

Equipment 16,000 16,000

Accounts Payable 10,900 3/1 Bal. 12,000 3/2 8,000 Bal. 9,100

Common Stock 3/1 Bal. Bal.

80,000 80,000

Service Revenue 3/9 3/20 3/31 Bal.

9,900 8,300 20,000 38,200

Sales Revenue 3/31 Bal.

1,500 1,500

3/12 Bal.

Advertising Expense 500 500

3/2 3/20 Bal.

Rent Expense 10,000 5,000 15,000

Salaries and Wages Expense 3/31 3,800 Bal. 3,800

PROBLEM 3-8A (Continued) (b) Date Mar. 2

Account Titles and Explanation Rent Expense ................................................. Accounts Payable................................... Cash ........................................................ (Rented films for cash and on account)

Debit 10,000

8,000 2,000

No entry—not a transaction.

Cash ................................................................ Service Revenue..................................... (Received cash for admissions)

9,900

Accounts Payable ($8,000 + $2,900) ............. Cash ........................................................ (Paid creditors on account)

10,900

9,900

10,900

No entry—not a transaction.

Advertising Expense...................................... Cash ........................................................ (Paid advertising expenses)

500

Cash ................................................................ Service Revenue..................................... (Received cash for admissions)

8,300

Rent Expense ................................................. Cash ........................................................ (Paid film rental)

5,000

Salaries and Wages Expense ........................ Cash ........................................................ (Paid salaries expense)

3,800

Credit

500

8,300

5,000

3,800

PROBLEM 3-8A (Continued) Date Mar. 31

(d)

Account Titles and Explanation Cash ................................................................ Accounts Receivable ..................................... Sales Revenue (15% X $10,000) ............... (Received cash and balance on account for concessions)

Debit 750 750

Cash ................................................................ Service Revenue ..................................... (Received cash for admissions)

20,000

Credit

1,500

20,000

TRIQUEL THEATER INC. Trial Balance March 31, 2017 Cash ................................................................. Accounts Receivable ...................................... Land ................................................................. Buildings ......................................................... Equipment ....................................................... Accounts Payable ........................................... Common Stock................................................ Service Revenue ............................................. Sales Revenue ................................................. Advertising Expense....................................... Rent Expense .................................................. Salaries and Wages Expense .........................

Debit $ 32,750 750 38,000 22,000 16,000

Credit

500 15,000 3,800 $128,800

(Assets and Expenses have debit balances) LO 3-5 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting

9,100 80,000 38,200 1,500

$128,800

PROBLEM 3-9A (a) & (c) 7/31 8/3 8/5 8/7 8/18 8/26 Bal. 7/31 8/7 8/24 Bal.

Cash 4,000 8/6 1,200 8/12 1,300 8/14 3,000 8/20 3,500 8/31 2,000 6,225

2,700 400 4,675 500 500

Retained Earnings 7/31 Bal.

8/20 Bal.

Accounts Receivable 1,500 8/3 1,200 3,500 8/18 3,500 1,000 1,300

3,400 3,400

Dividends 500 500 Service Revenue 8/7 8/24 Bal.

6,500 1,000 7,500

7/31 Bal.

Supplies 500 500

Salaries and Wages Expense 8/14 3,500 Bal. 3,500

7/31 8/12 Bal.

Equipment 5,000 1,200 6,200

8/14 Bal.

Rent Expense 900 900

8/14 Bal.

Advertising Expense 275 275

8/28 Bal.

Utilities Expense 275 275

8/31 Bal.

Income Tax Expense 500 500

8/6

Accounts Payable 2,700 7/31 8/12 8/28 Bal. Notes Payable 8/26 Bal. Common Stock 7/31 8/5 Bal.

4,100 800 275 2,475

2,000 2,000

3,500 1,300 4,800

PROBLEM 3-9A (Continued) (b) Date Aug. 3 5 6 7

18 20 24 26

Account Titles Cash ................................................................ Accounts Receivable .............................

Debit 1,200

Cash ................................................................ Common Stock .......................................

1,300

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

2,700

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

3,000 3,500

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

1,200

Salaries and Wages Expense ........................ Rent Expense ................................................. Advertising Expense...................................... Cash ........................................................

3,500 900 275

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

3,500

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

500

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

1,000

Cash ................................................................ Notes Payable.........................................

2,000

1,200 1,300 2,700

6,500 400 800

4,675 3,500 500 1,000 2,000

No entry

Utilities Expense ............................................ Accounts Payable...................................

275

Income Tax Expense...................................... Cash ........................................................

500

Credit

275 500

PROBLEM 3-9A (Continued) (d)

HILLS LEGAL SERVICES INC. Trial Balance August 31, 2017 Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Equipment .......................................................... Accounts Payable .............................................. Notes Payable .................................................... Common Stock .................................................. Retained Earnings ............................................. Dividends ........................................................... Service Revenue ................................................ Advertising Expense ......................................... Salaries and Wages Expense............................ Rent Expense ..................................................... Utilities Expense ................................................ Income Tax Expense .........................................

Debit $ 6,225 1,300 500 6,200

Credit

$ 2,475 2,000 4,800 3,400 500 7,500 275 3,500 900 275 500 $20,175

(Assets, Dividends, and Expenses have debit balances) LO 3-5 BT: AP Difficulty: Hard TOT: 55 min. AACSB: Analytic AICPA FC: Reporting

$20,175

PROBLEM 3-10A (a) & (c) Apr. 30 May 7 8 15 22 29

Bal.

Cash 5,000 1,500 May 1 1,200 4 800 14 1,000 21 1,700 25 31 31 31 5,100

Apr. 30 Bal.

Supplies 500 500

Apr. 30 Bal.

Equipment 24,000 24,000

Accounts Payable Apr. 30 May 4 1,100 May 22 May 21 1,000 25 Bal. Notes Payable Apr. 30 Bal.

Common Stock Apr. 30 1,000 1,100 1,200 1,000 400 50 1,200 150

Bal.

10,000

Bal.

11,400

1,200 800 700 1,000 1,700 600 6,000

Salaries and Wages Expense May 14 1,200 31 1,200 Bal. 2,400

May 1 Bal.

Rent Expense 1,000 1,000

10,000

Unearned Service Revenue Apr. 30 1,000 May 15 700 May 7 1,500 29 600 Bal. 1,200

5,000

Retained Earnings Apr. 30 11,400

Service Revenue May 8 15 15 22 29 29 Bal.

2,100 700 500 1,200

5,000

Supplies Expense May 22 700 Bal. 700 Advertising Expense May 25 500 Bal. 500

PROBLEM 3-10A (Continued) Utilities Expense May 25 400 Bal. 400 Interest Expense May 31 50 Bal. 50

Income Tax Expense May 31 150 Bal. 150

PROBLEM 3-10A (Continued) (b) Date May 1 4 7 8 14 15 15 21 22 22

Account Titles Rent Expense ................................................. Cash ........................................................

Debit 1,000

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

1,100

Cash ................................................................ Unearned Service Revenue ...................

1,500

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

1,200

Salaries and Wages Expense ........................ Cash ........................................................

1,200

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

800

Unearned Service Revenue ........................... Service Revenue.....................................

700

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

1,000

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

1,000

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

700

Credit 1,000 1,100 1,500 1,200 1,200 800 700 1,000 1,000 700

PROBLEM 3-10A (Continued) May 25 25 29 29 31 31 31

Advertising Expense ..................................... Accounts Payable ..................................

500

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

400

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

1,700

Unearned Service Revenue........................... Service Revenue.....................................

600

Interest Expense ............................................ Cash ........................................................

Salaries and Wages Expense........................ Cash ........................................................

1,200

Income Tax Expense ..................................... Cash ........................................................

150

500 400 1,700 600 50 1,200 150

PROBLEM 3-10A (Continued) (d)

PAMPER ME SALON INC. Trial Balance May 31, 2017 Cash .................................................................... Supplies.............................................................. Equipment .......................................................... Accounts payable .............................................. Notes payable..................................................... Unearned service revenue................................. Common stock ................................................... Retained earnings .............................................. Service revenue ................................................. Salaries and wages expense............................. Rent expense...................................................... Supplies expense............................................... Advertising expense .......................................... Utilities expense................................................. Interest expense................................................. Income tax expense ........................................... Totals ..............................................................

Debit $ 5,100 500 24,000

Credit

$ 1,200 10,000 1,200 5,000 11,400 6,000 2,400 1,000 700 500 400 50 150 $34,800

(Assets and Expenses have debit balances) LO 3-5 BT: AP Difficulty: Hard TOT: 55 min. AACSB: Analytic AICPA FC: Reporting

$34,800

PROBLEM 3-11A

Error 1.

(a) In Balance No

(b) Difference $600

Yes

None

N/A

Yes

None

N/A

$680

Credit

Yes

None

N/A

Yes

None

N/A

$900

Debit

Yes

None

N/A

LO 5 BT: AN Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting

CT 3-1

FINANCIAL REPORTING PROBLEM

(a) Account Common Stock Accounts Payable Accounts Receivable Selling, General, and Administrative Expenses Inventories Net Property, Plant, and Equipment Net Sales

Increase Side Right/Credit Right/Credit Left/Debit

Decrease Side Left/Debit Left/Debit Right/Credit

Normal Balance Credit Credit Debit

Left/Debit Left/Debit

Right/Credit Right/Credit

Debit Debit

Left/Debit Right/Credit

Right/Credit Left/Debit

Debit Credit

(b)

1. 2. 3.

Cash is increased. Cash is decreased. Cash is decreased.

(c)

1. 2.

Cash is decreased or Interest Payable is increased. Cash is decreased or Notes (or Mortgage) Payable is increased.

LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

CT 3-2

(a) 1. 2. 3. 4. 5.

COMPARATIVE ANALYSIS PROBLEM

Columbia Sportswear Accounts Receivable debit Net Property, Plant, and Equipment debit credit Accounts Payable Retained Earnings credit Net Sales credit

1. 2. 3. 4. 5.

VF Corporation Inventories Income Taxes Accrued Liabilities Common Stock Interest Expense

debit debit credit credit debit

(b) The following other accounts are ordinarily involved: 1.

Increase in Accounts Receivable: Service Revenue or Sales Revenue is increased (credited).

Decrease in Notes Payable: Cash is decreased (credited).

Increase in Equipment: Notes Payable is increased (credited) or Cash is decreased (credited).

Increase in Interest Revenue: Cash or Interest Receivable is increased (debited).

LO 2 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

CT 3-3

(a) 1. 2. 3.

COMPARATIVE ANALYSIS PROBLEM

Amazon Interest Expense: Cash and Cash Equivalents: Accounts Payable:

debit debit

1. 2.

Wal-Mart Product Revenues: Inventories:

credit

Cost of Sales:

credit debit debit

(b) The following other accounts are ordinarily involved: 1.

Increase in Accounts Receivable: Service Revenue or Sales Revenue is increased (credited).

Increase in Interest Expense: Cash is decreased (credited).

Decrease in Salaries and Wages Payable: Cash is decreased (credited).

Increase in Service Revenue: Cash or Accounts Receivable is increased (debited).

LO 2 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

CT 3-4

INTERPRETING FINANCIAL STATEMENTS

CHIEFTAIN INTERNATIONAL, INC. (a) One of the primary advantages to Chieftain of having no long-term debt is that there is room for growth through the use of debt and the company’s financial risk is greatly reduced. Another advantage is that profitability is enhanced when there is no interest expense. A possible disadvantage is that the company could expand more and earn a greater return if the growth had been financed with long-term debt. (b) An advantage to Chieftain from having a large cash balance is that cash is available to finance such things as the drilling of new wells and the investment in new technology. New opportunities may be seized and expansions may be undertaken at the time most advantageous for the business. A disadvantage is that cash earns little or no interest. A higher rate of return might be generated on excess cash by some other type of investment. (c) Accounts payable, as purchases on credit, represent interest-free loans. Business enterprises don’t pay cash unless the supplier requires immediate payment. Nearly all exchange transactions are conducted on 30-day or more credit. LO 2 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Reflective Thinking AICPA FC: Reporting

CT 3-5

REAL-WORLD FOCUS

(a) CPAs work in public accounting, business and industry, government, and education. (b) A CPA needs: strong leadership, communication skills, tech know-how, business savvy. (c) Salary ranges are: $51,500 – $74,250 during the first three years for a CPA at a large firm; $189,750 – $411,000 for Chief Financial Officer at a large corporation. LO 2 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic and Technology AICPA PC: Communication

CT 3-6

RESEARCH CASE

(a) The reason the Green Bay Packers’ issue an annual report is because they are a publicly owned, nonprofit company. They issue the report to the more than 100,000 shareholders who hold shares. None of the other teams are publicly owned, so they have no obligation to make their financial information available except to their small group of owners. (b) At the time that the article was written the owners of the NFL teams and the players’ labor union were negotiating a new contract. Knowing how profitable the NFL teams are would be useful information for the players to know so that they would have a better sense of how much the teams could afford to pay. The Packers are obviously a “small market” team, they are not necessarily representative of teams in general. However, the Packers’ annual report does give the players some sense of the profitability of other teams. (c) Since some of the cost of the stadium that the Packers play in is covered by taxpayers, the county and state government has an interest in the team’s finances. (d) The Packers’ revenues increased during recent years. However, because the cost of players’ salaries increased at a faster rate than revenues, the Packers’ operating profit actually declined. LO 2 BT: E Difficulty: Hard TOT: 25 min. AACSB: Analytic, Technology and Reflective Thinking AICPA FC: Reporting AICPA BB: Critical Thinking

CT 3-7

DECISION MAKING ACROSS THE ORGANIZATION

(a)

Cash ............................................................... Common Stock ......................................

May 1 5 7 9 14 15 20 31

15,000 15,000

Correct. Cash ............................................................... Unearned Service Revenue ..................

500

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

1,500

Equipment ..................................................... Cash .......................................................

800

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

400

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

154

Maintenance and Repairs Expense ............. Accounts Payable..................................

500 1,500 800 400 154 75

(b) The error in the entries of May 14 and May 20 would prevent the trial balance from balancing. (c) Net income as reported ......................................... Add: 5/9, Supplies expense................................. $1,500 5/15, Salaries and wages expense (dividends 400 paid) ......................................................... Less: 5/7, Unearned service revenue .................. Correct net income ................................................ (d) Cash as reported.................................................... Add: 5/9, Purchase on account........................... 5/20, Transposition error ............................

$ 4,500 1,900 6,400 500 $ 5,900 $12,475

$1,500 9

1,509 $13,984

LO 3, 5 BT: AN Difficulty: Hard TOT: 30 min. AACSB: Reflective Thinking and Communication AICPA PC: Interaction, Leadership and Communication

CT 3-8

COMMUNICATION ACTIVITY

To:

Accounting Instructor

From:

Accounting Student

Re:

Steps in Recording Process

In the first transaction, bills totaling $6,000 were sent to customers for services provided. Therefore, the asset Accounts Receivable is increased $6,000 and the revenue Service Revenue is increased $6,000. Debits increase assets and credits increase revenues, so the journal entry is: Accounts Receivable ............................................................ Service Revenue ............................................................ (Billed customers for services provided)

6,000 6,000

The $6,000 amount is then posted to the debit side of the general ledger account Accounts Receivable and to the credit side of the general ledger account Service Revenue. In the second transaction, $2,000 was paid in salaries to employees. Therefore, the expense Salaries and Wages Expense is increased $2,000 and the asset Cash is decreased $2,000. Debits increase expenses and credits decrease assets, so the journal entry is: Salaries and Wages Expense ............................................... Cash................................................................................ (Salaries paid)

2,000 2,000

The $2,000 amount is then posted to the debit side of the general ledger account Salaries and Wages Expense and to the credit side of the general ledger account Cash. LO 3 BT: S Difficulty: Hard TOT: 25 min. AACSB: Communication AICPA PC: Communication

CT 3-9

ETHICS CASE

(a) The stakeholders in this situation are:   

Vanessa Jones, assistant chief accountant. Users of the company’s financial statements. IBT Company.

(b) By adding $1,000 to the Equipment account, that account total is intentionally misstated. By not locating the error causing the imbalance, some other account may also be misstated by $1,000. If the amount of $1,000 is determined to be immaterial, and the intent is not to commit fraud (cover up an embezzlement or other misappropriation of assets), Vanessa’s action might not be considered unethical in the preparation of interim financial statements. However, if Vanessa is violating a company accounting policy by her action, then she is acting unethically. (c) Vanessa’s alternatives are: 1.

Miss the deadline but find the error causing the imbalance.

Tell her supervisor of the imbalance and suffer the consequences.

Do as she did and locate the error later, making the adjustment in the next quarter.

LO 5 BT: E Difficulty: Hard TOT: 20 min. AACSB: Etics AICPA PC: Personal Demeanor

CT 3-10

ETHICS CASE

(a) Employees in the rail unit accelerated revenue in each of the fourth quarters from 2000 to 2003. That is, revenue that should have been reported in the first quarter of a year was instead reported in the fourth quarter of the previous year. (b) One possible motivation for engaging in this activity is that bonuses are frequently based on annual results. If it appeared that the rail unit was not going to meet the performance level required for bonuses, the employees may have shifted the revenue recognition forward on these sales in order to boost annual results to meet performance targets. (c) The employees were fired. In addition, the matter was being investigated by the Securities and Exchange Commission (SEC). (d) To restate financial statements means to actually issue new financial statements to replace those that were previously issued. We are told that, for example, 2002 revenue was overstated by $158 million, and net income was overstated by $22 million. While these numbers seem large, to GE they are immaterial. $22 million was less than 0.2% of the company’s net income. As a percentage of GE’s total results the errors are not large enough to change investors’ evaluation of the company. LO 3, 4 BT: E Difficulty: Hard TOT: 20 min. AACSB: Ethics AICPA PC: Personal Demeanor

CT 3-11

ALL ABOUT YOU

We address the issue of contingent liabilities in greater detail in Chapter 10. Our primary interest in this exercise is to engage students in a discussion regarding the general nature of the financial statement elements (assets, liabilities, equity, revenues and expenses). (a)

By taking out the bank loan your friend has incurred a liability. You do not have a liability unless your friend defaults, or unless it becomes clear that he will default. The loan application may, however, require you to disclose any guarantees that you have signed, since they represent potential liabilities.

(b) Accounting standards have specific requirements regarding accounting for situations where there is uncertainty regarding whether a liability has been incurred. Those standards require an evaluation of the probability of an amount being owed. Without going into detail regarding those standards, the basic idea is that if it is probable that you will owe money, then you should accrue a liability. If it is not probable, but it is possible that you will owe money, then you should disclose facts regarding the situation. The most important point is that this event has the potential to materially impact your finances, and therefore you have a responsibility to disclose it to the bank in some form. (c)

Losing your job would not create a financial liability, although it would most certainly reduce your revenues. You are obviously concerned that you might lose your job, but you don’t have specific information that would suggest that it will happen. Therefore, you probably don’t have an obligation to disclose this information to the bank. However, unless you are relatively certain that you would be able to find suitable employment relatively quickly, you might want to wait until your job situation has stabilized before pursuing a loan of this size.

LO N/A BT: S Difficulty: Hard TOT: 30 min. AACSB: Communication and Reflective Thinking AICPA CC: Critical Thinking AICPA PC: Communication

IFRS 3-1

Account Other operating income and expense Cash and cash equivalents Trade accounts payable Cost of net financial debt

CONCEPTS AND APPLICATION

Financial Statement Position in Financial Statement Consolidated Income After gross profit and before Statement operating profit Consolidated Current assets Balance Sheet Consolidated Current liabilities Balance Sheet Consolidated Income After operating profit and before Statement profit from continuing operations before taxes.

LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Diversity and Communication AICPA FC: Reporting AICPA PC: Communication

CHAPTER 4 Accrual Accounting Concepts Learning Objectives 1. 2. 3. 4. *5.

Explain the accrual basis of accounting and the reasons for adjusting entries. Prepare adjusting entries for deferrals. Prepare adjusting entries for accruals. Prepare an adjusted trial balance and closing entries. Describe the purpose and the basic form of a worksheet.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item

LO BT Questions

16.

Item

23.

30.

10.

17.

24.

31.

11.

18.

25.

32.

12.

19.

2, 3

26.

33.

13.

20.

2, 3

27.

34.

14.

21.

28.

35.

15.

22.

29.

36.

10.

13.

Brief Exercises 1.

2. 3.

11.

14.

12.

15.

4a.

4b.

Do It! Exercises 1.

Exercises 1.

1, 2, 3

11.

2,3

16.

2, 3

21.

2 ,3 , 4

1, 2, 3

12.

2,3

17.

2, 3

22.

1, 2, 3

13.

1, 2, 3

18.

2, 3

23.

1, 2, 3

2,3

14.

2,3

19.

10.

2,3

15.

1, 2, 3

20.

2, 3, 4

Problems: Set A 1.

1, 2, 3

2, 3, 4

2, 3

2, 3, 4

2, 3

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Record transactions on accrual basis; convert revenue to cash receipts.

Simple

20–30

Prepare adjusting entries, post to ledger accounts, and prepare adjusted trial balance.

Simple

40–50

Prepare adjusting entries, adjusted trial balance, and financial statements.

Simple

50–60

Prepare adjusting entries and financial statements; identify accounts to be closed.

Moderate

40–50

Prepare adjusting entries.

Moderate

30–40

Prepare adjusting entries and a corrected income statement.

Moderate

30–40

Journalize transactions and follow through accounting cycle to preparation of financial statements.

Moderate

60–70

ANSWERS TO QUESTIONS 1.

(a) Under the periodicity assumption, an accountant is required to determine the effect of each accounting transaction on a specific accounting period. (b) An accounting time period that is one year in length is referred to as a fiscal year.

LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement and Reporting

The two generally accepted accounting principles that pertain to adjusting the accounts are: The revenue recognition principle, which states that revenue should be recognized in the time period in which the performance obligation is satisfied. The expense recognition principle, which states that expenses be matched with revenues in the period when the company makes efforts to generate those revenues.

LO 1 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement

The law firm should recognize the revenue in April. The revenue recognition principle states that revenue should be recognized in the accounting period in which the performance obligation is satisfied.

LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement

Expenses of $4,700 should be deducted from the revenues in April. Under the expense recognition principle efforts (expenses) should be matched with results (revenues).

LO 1 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Measurement

No, adjusting entries are required by the revenue and expense recognition principles.

LO 1 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement

The financial information in a trial balance may not be up-to-date because: (1) Some events are not journalized daily because it is not useful or efficient to do so. (2) The expiration of some costs occurs with the passage of time rather than as a result of recurring daily transactions. (3) Some items may be unrecorded because the transaction data are not known.

LO 1 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting

The two categories of adjusting entries are deferrals and accruals. Deferrals consist of revenues collected before services are provided and expenses paid before they are incurred. Accruals consist of revenues for services performed prior to collection and expenses incurred prior to payment.

LO 1 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting

In a prepaid expense adjusting entry, expenses are debited and assets are credited.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

No. Depreciation is the process of allocating the cost of an asset to expense over its useful life. Depreciation results in the presentation of the book value of the asset, not its fair value.

LO 2 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Measurement and Reporting

10.

Depreciation expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognized from the date of acquisition to the balance sheet date.

LO 2 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

11.

Equipment ............................................................................... Less: Accumulated depreciation—equipment .........................

$15,000 7,000

$8,000

LO 2 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

12.

In an unearned revenue adjusting entry, liabilities are debited and revenues are credited.

LO 2 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

13.

The sale of a three-year maintenance contract on December 29, 2016 will have no effect on the 2016 income statement but receipt of $100,000 on December 29, 2016, 2017, and 2018 will increase an asset, Cash, and a liability, Unearned Service Revenue. As Abe Technologies provides service to its customer during 2017, 2018, and 2019, the liability will decrease and revenue will be recognized. Accrual accounting rules require that revenue be recognized as the performance obligation is satisfied rather than when cash is received.

LO 2 BT: AN Diff: H TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

Questions Chapter 4 (Continued) 14.

This promotion plan sounds like a bad idea for two reasons: (1) GAAP requires that the sale of a gift card be recorded as Unearned Sales Revenue (a liability) rather than Sales Revenue. Revenue recognition is delayed until the gift card is used or expires. Ed’s plan will not help the company meet its target revenue unless customers use the cards by year-end. (2) Selling a $50 card for $45 will probably not help the company meet its target net income. Although this promotion may result in additional sales revenue as the cards are used, the income resulting from the cards will be much less than usual since they eliminate $5 of normal gross profit.

LO 2 BT: AN Diff: H TOT: 5 min. AACSB: None AICPA FC: Reporting

15.

An asset is debited and a revenue is credited.

LO 3 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting

16.

An expense is debited and a liability is credited.

LO 3 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting

17.

Net income was understated $270 because prior to adjustment revenues are understated by $780 and expenses are understated by $510. The difference in this case is $270 ($780 – $510).

LO 3 BT: AN Diff: H TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

18.

The entry is: Jan. 9 Salaries and Wages Expense ....................................... Salaries and Wages Payable ........................................ Cash ....................................................................

5,100 1,100 6,200

LO 3 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

19.

(a) Accrued revenues. (b) Unearned revenues. (c) Accrued expenses.

(d) Accrued expenses or prepaid expenses. (e) Prepaid expenses. (f) Accrued revenues or unearned revenues.

LO 2 & 3 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

20.

(a) Salaries and Wages Payable. (b) Accumulated Depreciation. (c) Interest Expense.

(d) Supplies Expense. (e) Service Revenue. (f) Service Revenue.

LO 2 & 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

21.

Disagree. An adjusting entry affects only one balance sheet account and one income statement account.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

22.

Apple reports Accounts Receivable. This suggests that it records revenue when it has delivered goods, even though it hasn’t received payment. If it used a cash basis it wouldn’t record revenue until cash was received, and it would therefore not establish receivables.

LO 1 & 3 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

23.

Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period.

LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

24.

(a) Information presented on an accrual basis is useful because it reveals important information about the relationship between efforts and results. This information is useful in predicting future results. Trends in revenues and expenses are thus more meaningful. (b) Information presented on a cash basis is useful for predicting the future availability of cash. Cash basis financial statements provide useful information about a company’s sources and uses of cash.

LO 1 & 4 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

25.

The amount shown in the adjusted trial balance column for an account equals the account balance in the ledger after adjusting entries have been journalized and posted.

LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

Questions Chapter 4 (Continued) 26. (1) (Dr) Individual revenue accounts and (Cr) Income Summary. (2) (Dr) Income Summary and (Cr) Individual expense accounts. (3) (Dr) Income Summary and (Cr) Retained Earnings (for net income). (4) (Dr) Retained Earnings and (Cr) Dividends. LO 4 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

27. Financial information is used by managers to direct and evaluate a company’s performance. The sooner such information is made available; the sooner changes can be made to get a company “back on track”. A “virtual close” speeds up the reporting process and allows managers to react much faster to changing economic conditions. LO 4 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

28. Income Summary is a temporary account that is used in the closing process. The account is debited for expenses and credited for revenues. The difference, either net income or net loss, is then closed to Retained Earnings. LO 4 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

29. The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the equality of the permanent account balances that the company carries forward into the next accounting period. LO 4 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

30. The accounts that will not appear in the post-closing trial balance are: Depreciation Expense; Dividends; and Service Revenue. LO 4 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

31. The steps that involve journalizing are (1) journalize the transactions, (2) journalize the adjusting entries, and (3) journalize the closing entries. LO 4 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

32. The three trial balances are the (1) trial balance, (2) adjusted trial balance, and (3) post-closing trial balance. LO 4 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

33. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. Such action is undertaken to help a company meet target financial numbers. Quality of earnings indicates the level of full and transparent information that a company provides to users of financial statements. LO 4 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

34. Examples of ways a company can manage earnings include the following.

Use of “one-time” items to prop up earnings numbers. A company may decide to sell property that has appreciated in value in order to record a gain on the sale. Such a gain will increase the current year’s net income but future income will probably not include a similar increase. Inflating revenue in the short-run to the detriment of the long-run. A company may implement changes in its promotion activities near the end of an accounting period to boost year-end revenues. Offering a special rebate or a two–for–one package is likely to increase sales for the time the promotion runs but usually results in lower sales in subsequent periods. Savvy customers may even postpone purchases until special deals are available. Recording improper adjusting entries. Some adjusting entries require estimates and judgment to properly recognize revenue and match expenses. By recognizing revenue “sooner” and delaying the recognition of expenses, earnings can be overstated in early periods and understated in subsequent periods. This type of management is most prevalent with multi-year contracts and prepaid expenses. LO 4 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

*35.

The worksheet is a working paper designed to make it easier to prepare adjusting entries and financial statements.

LO 5 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

*36.

The columns of the worksheet from left to right are two columns each for the trial balance, adjustments, adjusted trial balance, income statement, and balance sheet.

LO 5 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1

(a) (b) (c) (d) (e) (f)

Cash $–100 0 0 +800 –2,500 0

Net Income $0 –20 +1,300 0 0 –600

LO 1 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 4-2 (a) Prepaid Insurance—to recognize insurance expired during the period. (b) Depreciation Expense—to allocate the cost of an asset to expense during the current period. (c) Unearned Service Revenue—to account for unearned revenue for which services were provided during the period. (d) Interest Payable—to recognize interest accrued but unpaid on notes payable during the current period. LO 1 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 4-3 Item

(1) Type of Adjustment

(2) Accounts Before Adjustment

(a)

Prepaid Expenses

Assets Overstated Expenses Understated

(b)

Accrued Revenues

Assets Understated Revenues Understated

(c)

Accrued Expenses

Expenses Understated Liabilities Understated

(d)

Unearned Revenues

Liabilities Overstated Revenues Understated

LO 1 BT: AN Difficulty: Hard TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 4-4 Dec. 31

Supplies Expense ........................................... Supplies ...................................................

Supplies 8,800 12/31 12/31 Bal. 1,100

7,700

12/31

7,700

Supplies Expense 7,700

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

7,700

BRIEF EXERCISE 4-5 Dec. 31

Depreciation Expense ..................................... Accumulated Depreciation— Equipment.............................................

2,750 2,750

Accumulated Depreciation— Equipment 12/31 2,750

Depreciation Expense 12/31 2,750

Balance Sheet: Equipment ..................................................................... $22,000 Less: Accumulated depreciation—equipment ...... 2,750

$19,250

LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 4-6 July 1

Dec. 31

Prepaid Insurance............................................ Cash ..........................................................

12,400

Insurance Expense ($12,400 X 6/24)............... Prepaid Insurance ....................................

3,100

Prepaid Insurance 7/1 12,400 12/31 12/31 Bal. 9,300

3,100

12/31

12,400

Insurance Expense 3,100

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

3,100

BRIEF EXERCISE 4-7 July 1 Dec. 31

Cash ................................................................. Unearned Service Revenue ....................

12,400

Unearned Service Revenue ............................ Service Revenue ($12,400 X 6/24) ..........

3,100

Unearned Service Revenue 12/31 3,100 7/1 12,400 12/31 Bal. 9,300

12,400 3,100

Service Revenue 12/31

3,100

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 4-8 (a) Dec. 31 (b) (c)

31 31

Interest Expense...................................... Interest Payable ...............................

300

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

1,700

Salaries and Wages Expense ................. Salaries and Wages Payable ...........

780

300

LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

1,700 780

BRIEF EXERCISE 4-9 Account

(1) Type of Adjustment

(2) Related Account

(a)

Accounts Receivable

Accrued Revenues

Service Revenue

(b)

Prepaid Insurance

Prepaid Expenses

Insurance Expense

(c)

Equipment

Not required

(d)

Accum. Depreciation— Equipment

Prepaid Expenses

(e)

Notes Payable

Not required

(f)

Interest Payable

Accrued Expenses

Interest Expense

(g)

Unearned Service Revenue

Unearned Revenues

Service Revenue

Depreciation Expense

LO 4 BT: AN Difficulty: Hard TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 4-10 LEVIN CORPORATION Income Statement For the Year Ended December 31, 2017 Revenues Service revenue .................................................... Expenses Salaries and wages expense ............................... Rent expense ........................................................ Insurance expense ............................................... Supplies expense ................................................. Depreciation expense........................................... Total expenses .............................................. Net income....................................................................

$32,000 $14,000 3,900 1,800 1,500 1,000

[Revenues – Expenses = Net income or (loss)] LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

22,200 $ 9,800

BRIEF EXERCISE 4-11 LEVIN CORPORATION Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1 ......................................................... Add: Net income ............................................................................ Less: Dividends.............................................................................. Retained earnings, December 31 ...................................................

$17,200 10,400 27,600 6,000 $21,600

(Beginning retained earnings ± Changes to retained earnings = Ending retained earnings) LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 4-12 Account (a) (b) (c) (d) (e) (f) (g)

Accumulated Depreciation Depreciation Expense Retained Earnings (beginning) Dividends Service Revenue Supplies Accounts Payable

Balance Sheet Income Statement Retained Earnings Statement Retained Earnings Statement Income Statement Balance Sheet Balance Sheet

LO 4 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 4-13 The accounts that will appear in the post-closing trial balance are: Accumulated Depreciation Retained Earnings (ending) Supplies Accounts Payable LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 4-14 (a) July 31

Closing Entries Service Revenue ..................................... Income Summary ............................. (To close revenue account)

16,000 16,000

Income Summary .................................... Salaries and Wages Expense .......... Maintenance and Repairs Expense ......................................... Income Tax Expense ........................ (To close expense accounts)

11,900

Income Summary .................................... Retained Earnings ............................ (To close net income to retained earnings)

4,100

Retained Earnings................................... Dividends .......................................... (To close dividends to retained earnings)

1,300

8,400 2,500 1,000

4,100

(Income statement accounts are closed to the Income Summary account)

(b) Retained Earnings 1,300 7/1 Bal. 20,000 4,100 7/31 Bal. 22,800 LO 4 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

1,300

BRIEF EXERCISE 4-15 The proper sequencing of the required steps in the accounting cycle is as follows: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Analyze business transactions. Journalize the transactions. Post to ledger accounts. Prepare a trial balance. Journalize and post adjusting entries. Prepare an adjusted trial balance. Prepare financial statements. Journalize and post closing entries. Prepare a post-closing trial balance.

LO 4 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 4-1 1. (d)

2. (e)

3. (h)

4. (c)

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

DO IT! 4-2 1.

Insurance Expense ....................................................... Prepaid Insurance .................................................. (To record insurance expired)

300

Supplies Expense ......................................................... Supplies .................................................................. (To record supplies used)

1,600

Depreciation Expense .................................................. Accumulated Depreciation—Equipment.............. (To record monthly depreciation)

200

Unearned Service Revenue.......................................... Service Revenue..................................................... (To record revenue for services provided)

4,000

300

1,600

200

4,000

LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 4-3 1.

Salaries and Wages Expense....................................... Salaries and Wages Payable ................................. (To record accrued salaries)

1,100

Interest Expense ($20,000 X .09 X 1/12) ...................... Interest Payable ...................................................... (To record accrued interest)

150

Accounts Receivable ................................................... Service Revenue..................................................... (To record revenue for service provided)

1,600

LO 3 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

1,100

150

1,600

DO IT! 4-4a Income statement: Service Revenue, Utilities Expense Balance sheet: Accounts Receivable, Accumulated Depreciation, Notes Payable, Common Stock. LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

DO IT! 4-4b Dec. 31

Service Revenue ...................................................... 108,000 Income Summary .............................................. 108,000 (To close revenue to income summary)

Dec. 31

Income Summary..................................................... 72,000 Salaries and Wages Expense........................... Rent Expense .................................................... Utilities Expense ............................................... Supplies Expense ............................................. (To close expenses to income summary)

40,000 18,000 8,000 6,000

Income Summary..................................................... 36,000 Retained Earnings ............................................ (To close net income to retained earnings)

36,000

Retained Earnings ................................................... 22,000 Dividends .......................................................... (To close dividends to retained earnings)

22,000

Dec. 31

LO 4 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 4-1 The revenue recognition principle requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied. (a) Since the sales effort is not complete until the flight actually occurs, revenue should not be recognized until December. Southwest Airlines should recognize the revenue in December when the customer has been provided with the flight. (b) Sales revenue should be recognized at the time of delivery. (c) Revenue should be recognized on a per game basis over the season from April through October. (d) Interest revenue should be accrued and recognized by RBC evenly over the term of the loan. (e) Revenue should be recognized when the sweater is shipped to the customer in September. LO 1 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement

EXERCISE 4-2 (a) (b) (c) (d) (e) (f) (g) (h)

8. 1. 7. 3. 6. 4. 2. 5.

Going concern assumption. Economic entity assumption. Full disclosure principle. Monetary unit assumption. Materiality. Periodicity assumption. Expense recognition principle. Historical cost principle.

LO 1 BT: K Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Reporting

EXERCISE 4-3 (a) (b) (c) (d) (e) (f)

Revenue recognition principle. Periodicity assumption. No violation. Going concern assumption. Historical cost principle. Economic entity assumption.

LO 1 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Reporting

EXERCISE 4-4 $ 33,640 + 3,400 – 2,800 + 1,300 – 1,460 – 2,000 + 2,400 – 1,400 + 1,100 $ 34,180

Cash basis earnings. Accounts receivable arise from sales that have been made, thus revenue must be recognized for balance outstanding at the end of the current year. Accounts receivable collected in current year, for sales made in previous year must be deducted from earnings. Supplies on hand at year end should be set up as an asset rather than expensed, this increases earnings. Supplies on hand at the end of the previous year should be expensed this year, this decreases earnings. Wages owing at the end of the current year should be accrued, thus reducing earnings. Wages owed at the end of the previous year should not be deducted from the current year’s earnings, thus increasing earnings. Other unpaid amounts owed at the end of the current year should be accrued, thus reducing earnings. Other unpaid amounts owed at the end of the previous year should not be deducted from the current year’s earnings, thus increasing earnings. Accrual basis earnings.

LO 1-3 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-5 (a) Service Revenue – Operating Expenses – Insurance Expense Net Income

Cash Basis $22,000 12,000 2,400 $ 7,600

Accrual Basis $28,000 15,800 — $12,200

(b) The accrual basis of accounting provides more useful information for decision makers because it recognizes revenues when the performance obligation is satisfied and expenses when incurred. LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-6 (a)

FRANKEN COMPANY Income Statement For the Six Months Ended April 30, 2017 Revenues Service revenue ($32,150 + $540) ................... Expenses Income tax expense......................................... Salaries and wages expense ($2,600 + $420). Depreciation expense [($9,200 ÷ 4) X 6/12] .... Rent expense ($1,225 – $175) ......................... Utilities expense .............................................. Advertising expense........................................ Total expenses .......................................... Net income...............................................................

[Revenues – Expenses = Net income or (loss)]

$32,690 $10,000 3,020 1,150 1,050 970 375 16,565 $16,125

EXERCISE 4-6 (Continued) (b)

FRANKEN COMPANY Balance Sheet April 30, 2017 Assets Current Assets Cash ............................................................... Accounts receivable ..................................... Prepaid rent ................................................... Total current assets ............................... Property, plant, and equipment Equipment...................................................... Less: Accumulated depreciation—equipment .......................... Total assets ............................................

$27,780 540 175 $28,495 9,200 1,150

Liabilities and Stockholders’ Equity Current Liabilities Salaries and wages payable........................ Stockholders’ equity Common stock ............................................. $20,000 Retained earnings ........................................ 16,125 Total stockholders’ equity.............. Total liabilities and stockholders’ equity................................................... (Assets = Liabilities + Stockholders’ equity) LO 1-3 BT: AP Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

8,050 $36,545

420

36,125 $36,545

EXERCISE 4-7 (a) Event 180-day financing for customers

Cash Accounting Revenue is recorded as cash is received.

Accrual Accounting Revenue is recorded when the performance obligation is satisfied. BizCon records revenue (and a receivable) as soon as services are provided but may wait up to 180 days to receive cash.

Payment to Equipment expense is equipment recorded as an suppliers upon expense as soon as delivery of goods equipment is received and paid for.

Equipment is recorded as an asset and depreciated.

Prepayment for 2 years of insurance coverage

Insurance expense is recorded as soon as payment is made.

Prepayment is recorded as an asset and recognized as an expense as time passes.

One month’s salaries owed at year-end

No salary expense is recorded until salaries are paid.

Salary expense is recorded as employees perform work. Amounts owed at year-end would be recorded as a liability.

Proper accrual accounting would require adjusting depreciation, prepaid insurance, and accrued salaries.

entries for

EXERCISE 4-7 (Continued) (b) Accrual accounting rules require that revenue be recognized as a company performs services and expenses be matched with the revenue they help produce. Receipt or payment of cash does not influence the calculation of net income. BizCon has provided many services during the year and thus has positive net income. Since BizCon allowed its largest customers to take up to 180 days to pay, but was forced to pay cash for all purchases, it is likely that the company has very little cash at year-end. New companies frequently experience cash shortages because they extend credit to attract customers but are unable to receive credit from their suppliers. As time passes, the cash supply should increase as payments on accounts receivable come in and offset current purchases. LO 1-3 BT: C Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement AICPA FC: Reporting

EXERCISE 4-8 Item

(1) Type of Adjustment

(2) Accounts Before Adjustment

(a)

Accrued Revenues

Assets Understated Revenues Understated

(b)

Prepaid Expenses

Assets Overstated Expenses Understated

(c)

Accrued Expenses

Expenses Understated Liabilities Understated

(d)

Unearned Revenues

Liabilities Overstated Revenues Understated

(e)

Accrued Expenses

Expenses Understated Liabilities Understated

(f)

Prepaid Expenses

Assets Overstated Expenses Understated

LO 1-3 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-9 1.

2. 3. 4.

Mar. 31

31 31 31

Depreciation Expense ($280 X 3)................. Accumulated Depreciation— Equipment .........................................

840

Unearned Rent Revenue .............................. Rent Revenue ($12,400 X 1/2)...............

6,200

Interest Expense........................................... Interest Payable ....................................

400

Supplies Expense......................................... Supplies ($3,000 – $850).......................

2,150

Insurance Expense ($400 X 3) ..................... Prepaid Insurance.................................

1,200

840 6,200 400 2,150 1,200

LO 2, 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-10 1. 2. 3.

Jan. 31 31 31

31 4. 5.

31 31

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

760

Utilities Expense........................................... Accounts Payable .................................

450

Depreciation Expense .................................. Accumulated Depreciation— Equipment .........................................

400

Interest Expense........................................... Interest Payable ....................................

500

Insurance Expense ($24,000 ÷ 12)............... Prepaid Insurance.................................

2,000

Supplies Expense ($1,750 – $550)............... Supplies.................................................

1,200

760

450

400

500 2,000

LO 2, 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

1,200

EXERCISE 4-11 1.

2. 3.

4. 5. 6. 7.

Oct. 31

31 31

31 31 31 31

Supplies Expense ......................................... Supplies ($2,500 – $500)...................................

2,000

Insurance Expense ....................................... Prepaid Insurance .................................

100

Depreciation Expense .................................. Accumulated Depreciation— Equipment .........................................

Unearned Service Revenue.......................... Service Revenue ...................................

800

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

280

Interest Expense ........................................... Interest Payable.....................................

Salaries and Wages Expense ...................... Salaries and Wages Payable ................

1,400

2,000

100

800 280 70

LO 2, 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

1,400

EXERCISE 4-12 Date July 31 31

31 31

31 31 31

Account Titles Debit Interest Receivable ($20,000  .06  1/12) ....... 100 Interest Revenue.......................................

Credit 100

Supplies Expense ($24,000 – $18,600)............ 5,400 Supplies.....................................................

5,400

Rent Expense ($3,600  4) ............................... Prepaid Rent .............................................

900

Salaries and Wages Expense .......................... 3,100 Salaries and Wages Payable.................... Depreciation Expense ($6,000  12) ................ Accumulated Depreciation—Buildings ...

3,100

500 500

Unearned Service Revenue ............................. 4,700 Service Revenue .......................................

4,700

Maintenance and Repairs Expense................. 2,300 Accounts Payable.....................................

2,300

LO 2, 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-13 NORSKI CO. Income Statement For the Month Ended July 31, 2017 Revenues Service revenue ($5,500 + $700) ............................. Expenses Salaries and wages expense ($2,100 + $360)......... Supplies expense ($900 – $200).............................. Utilities expense ...................................................... Insurance expense................................................... Depreciation expense .............................................. Total expenses ................................................. Net income .......................................................................

$6,200 $2,460 700 500 350 150 4,160 $2,040

[Revenues – Expenses = Net income or (loss)] LO 1-3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-14 (a)

July 10 14 15 20

Supplies ........................................................ Cash .......................................................

200

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

3,800

Salaries and Wages Expense ...................... Cash .......................................................

1,000

Cash............................................................... Unearned Service Revenue ..................

600

200 3,800 1,000 600

EXERCISE 4-14 (Continued) (b) July 31

31 31 31

Supplies Expense......................................... Supplies.................................................

750

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

500

Salaries and Wages Expense ...................... Salaries and Wages Payable ................

1,000

Unearned Service Revenue ......................... Service Revenue ...................................

900

750 500 1,000 900

LO 2, 3 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-15 Answer

Computation

(a) Supplies balance = $1,350

Supplies expense Add: Supplies (1/31) Less: Supplies purchased Supplies (1/1)

(b) Total premium = $6,240

Total premium = Monthly premium X 12; $520 X 12 = $6,240

Purchase date = May 1, 2016

$ 950 700 (300) $1,350

Purchase date: On Jan. 31, there are 3 months coverage remaining ($520 X 3). Thus, the purchase date was 9 months earlier on May 1, 2016.

EXERCISE 4-15 (Continued) (c) Salaries and wages payable = $1,760

Cash paid Salaries and wages payable (1/31/17) Less: Salaries and wages expense Salaries and wages payable (12/31/16)

(d) Unearned service revenue = $2,950

Service revenue Unearned revenue (1/31/17) Cash received in Jan. Unearned revenue (12/31/16)

LO 1-3 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

$2,500 1,060 3,560 1,800 $1,760

$4,000 750 4,750 1,800 $2,950

EXERCISE 4-16

Item Incorrect balances Effects of: Salaries and Wages

Net Income $70,000

Rent Revenue Depreciation Correct balances

4,000 (9,000) $55,000

Total Total Stockholders’ Assets Liabilities Equity $150,000 $70,000 $80,000

(10,000)

10,000 (4,000) (9,000) $141,000

$76,000

(10,000) 4,000 (9,000) $65,000

(Revenues increase Net income and Stockholders’ equity and expenses do the opposite) LO 2, 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-17 (a) 2017 June

Aug. Sept. Nov. Dec.

31 4 30 5

Prepaid Insurance ...................................... Cash .....................................................

1,800

Prepaid Rent............................................... Cash .....................................................

6,500

Cash ............................................................ Unearned Service Revenue ................

3,600

Prepaid Cleaning........................................ Cash .....................................................

2,000

Cash ............................................................ Unearned Service Revenue ................

1,500

1,800 6,500 3,600 2,000 1,500

EXERCISE 4-17 (Continued) (b) 2017 Dec.

31 31

Insurance Expense .................................... Prepaid Insurance ............................. ($1,800 × 7/12 months = $1,050)

1,050

Rent Expense ............................................. Prepaid Rent...................................... ($6,500 × 4/5 months = $5,200)

5,200

Unearned Service Revenue ....................... Service Revenue ............................... ($3,600 × 4/9 months = $1,600)

1,600

Maintenance and Repairs Expense........... Prepaid Cleaning...............................

1,000

Unearned Service Revenue ....................... Service Revenue ............................... ($1,500 – $475 not played = $1,025 played)

1,025

1,050

5,200

1,600

1,000 1,025

EXERCISE 4-17 (Continued) (c)

June 1

Prepaid Insurance 1,800 Dec. 31 Adj. 1,050

Dec. 31 Bal.

750

Dec. 31 Adj. 1,050

Rent Expense Dec. 31 Adj. 5,200

Prepaid Rent Aug. 31

Insurance Expense

6,500 Dec. 31 Adj. 5,200

Service Revenue

Dec. 31 Bal. 1,300

Dec. 31 Adj. 1,600 Dec. 31 Adj. 1,025

Unearned Service Revenue Dec. 31 Adj. 1,600 Sept. 4 Dec. 31 Adj. 1,025 Dec. 5

Dec. 31 Bal. 2,625

3,600 1,500

Maintenance and Repairs Expense Dec. 31 Bal. 2,475

Dec. 31 Adj. 1,000

Prepaid Cleaning Nov. 30

2,000 Dec. 31 Adj. 1,000

Dec. 31 Bal. 1,000 Note: The Cash account has not been included in this solution, as per the instructions. LO 2, 3 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-18 (a) 2017 Dec.

31 31

31 31 (b) 2018 Jan.

1 4 2

Utilities Expense ........................................ Accounts Payable .............................

425

Salaries and Wages Expense .................... Salaries and Wages Payable ............ ($3,500 × 4/7 days = $2,000)

2,000

425 2,000

Interest Expense ........................................ 375 Interest Payable ................................ ($45,000 × 5% × 2/12 months = $375 (rounded)) Accounts Receivable ................................. Service Revenue ...............................

300

Accounts Receivable ................................. Rent Revenue ....................................

6,000

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

425

Salaries and Wages Payable ..................... Salaries and Wages Expense .................... Cash .....................................................

2,000 1,500

Interest Payable.......................................... Cash .....................................................

375

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

300

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

6,000

375

300 6,000

425

3,500 375 300

LO 2, 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

6,000

EXERCISE 4-19 Jan. 31 31

Service Revenue.................................................. Income Summary .........................................

4,000

Income Summary................................................. Salaries and Wages Expense...................... Supplies Expense ........................................ Insurance Expense ......................................

3,270

Income Summary................................................. Retained Earnings........................................

730

4,000 1,800 950 520 730

LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-20 (a) Date Dec. 31

31 31

Account Titles Service Revenue........................................ Rent Revenue ............................................ Income Summary...............................

Debit 183,800 6,200

Income Summary ...................................... Salaries and Wages Expense............ Depreciation Expense ....................... Rent Expense ..................................... Supplies Expense ..............................

109,300

Income Summary ...................................... Retained Earnings .............................

80,700

Retained Earnings ..................................... Dividends ...........................................

26,300

Credit

190,000 91,100 13,200 3,600 1,400

80,700 26,300

EXERCISE 4-20 (Continued) (b) Retained Earnings Jan. 1 61,800 Dec. 31 26,300 Dec. 31 80,700 Bal. 116,200 LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-21 Aug. 31 31 31 31 31 31

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

600

Supplies Expense ................................................ Supplies ........................................................

2,000

Insurance Expense .............................................. Prepaid Insurance ........................................

1,500

Depreciation Expense ......................................... Accumulated Depreciation—Equipment ....

1,200

Salaries and Wages Expense.............................. Salaries and Wages Payable .......................

1,100

Unearned Rent Revenue ..................................... Rent Revenue ...............................................

1,000

600 2,000 1,500 1,200 1,100

LO 2-4 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

1,000

EXERCISE 4-22 RYAN COMPANY Income Statement For the Year Ended August 31, 2017 Revenues Service revenue .................................................... Rent revenue......................................................... Total revenues............................................... Expenses Salaries and wages expense ............................... Rent expense ........................................................ Supplies expense ................................................. Insurance expense ............................................... Depreciation expense........................................... Total expenses .............................................. Net income....................................................................

$34,600 13,100 $47,700 18,100 10,800 2,000 1,500 1,200 33,600 $14,100

EXERCISE 4-22 (Continued) RYAN COMPANY Retained Earnings Statement For the Year Ended August 31, 2017 Retained earnings, September 1, 2016 .......................................... Add: Net income ............................................................................ Less: Dividends.............................................................................. Retained earnings, August 31, 2017 ..............................................

$ 5,500 14,100 19,600 2,800 $16,800

RYAN COMPANY Balance Sheet August 31, 2017 Assets Current Assets Cash........................................................................ Accounts receivable .............................................. Supplies.................................................................. Prepaid insurance.................................................. Total current assets ....................................... Equipment .............................................................. Less: Accum. depreciation—equipment............... Total assets ....................................................

$10,900 9,400 500 2,500 $23,300 16,000 4,800

11,200 $34,500

Liabilities and Stockholders’ Equity Current Liabilities Accounts payable .................................................. Salaries and wages payable.................................. Unearned rent revenue .......................................... Total current liabilities ................................... Stockholders’ equity Common stock ....................................................... Retained earnings.................................................. Total stockholders’ equity ......................... Total liabilities and stockholders’ equity......

$ 5,800 1,100 800 $ 7,700 10,000 16,800 26,800 $34,500

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings) LO 4 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 4-23 Aug. 31

31 31

Service Revenue.............................................. Rent Revenue................................................... Income Summary .....................................

34,600 13,100

Income Summary............................................. Salaries and Wages Expense.................. Rent Expense ........................................... Supplies Expense .................................... Insurance Expense .................................. Depreciation Expense..............................

33,600

Income Summary............................................. Retained Earnings....................................

14,100

Retained Earnings ........................................... Dividends..................................................

2,800

47,700 18,100 10,800 2,000 1,500 1,200 14,100

LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

2,800

SOLUTIONS TO PROBLEMS PROBLEM 4-1A (a)

(b)

1. Cash ..................................................................... 19,000 Accounts Receivable .................................... 19,000 2. Unearned Sales Revenue.................................... 23,000 23,000 Sales Revenue ............................................... 3. Cash ..................................................................... 44,000 44,000 Unearned Sales Revenue.............................. Unearned Sales Revenue ($44,000 – $20,000) ........................................... 24,000 Sales Revenue ............................................... 24,000 4. Accounts Receivable .......................................... 151,000 151,000 Service Revenue............................................ 5. Cash ..................................................................... 136,000 136,000 Accounts Receivable ($151,000 – $15,000).... Cash received with respect to fees and dues 1. Collection of 2016 dues $ 19,000 3. Sale of tickets 44,000 5. Collection of 2017 dues 136,000 $199,000

Cash 1. 19,000 3. 44,000 5. 136,000 2017 Bal. 199,000 Accounts Receivable 2016 Bal. 19,000 4. 151,000 1. 19,000 5. 136,000 2017 Bal. 15,000

2. 3.

Unearned Sales Revenue 2016 Bal. 23,000 44,000 23,000 3. 24,000 2017 Bal. 20,000

Service Revenue 4. 151,000 2017 Bal.151,000 Sales Revenue 2. 23,000 3. 24,000 2017 Bal. 47,000

LO 1-3 BT: AP Difficulty: Medium TOT: 30 min. AACSB Analytic AICPA FC: Reporting

PROBLEM 4-2A (a)

Date 2017

Account Titles

Debit

June 30

Supplies Expense .................................... Supplies ($2,000 – $720) ..................

1,280

Utilities Expense ...................................... Accounts Payable ............................

180

Insurance Expense .................................. Prepaid Insurance ($2,880 ÷ 12 months) ....................

240

Unearned Service Revenue..................... Service Revenue ..............................

4,100

Salaries and Wages Expense ................. Salaries and Wages Payable ...........

1,250

Depreciation Expense ............................. Accumulated Depreciation— Equipment ....................................

250

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

3,900

2. 3.

4. 5. 6.

30 30

30 30 30

Credit

1,280 180

240

4,100 1,250

250 3,900

(b)

6/30 Bal.

Cash 6,850

Accounts Receivable 6/30 Bal. 7,000 6/30 3,900 6/30 Bal. 10,900

6/30 Bal. 6/30 Bal.

Supplies 2,000 6/30 720

Prepaid Insurance 6/30 Bal. 2,880 6/30 6/30 Bal. 2,640

1,280

240

PROBLEM 4-2A (Continued) Equipment 6/30 Bal. 15,000 Accumulated Depreciation— Equipment 6/30 250 6/30 Bal. 250 Accounts Payable 6/30 Bal. 6/30 6/30

4,230 180 4,410

Salaries and Wages Payable 6/30 1,250 6/30 Bal. 1,250 Unearned Service Revenue 6/30 4,100 6/30 Bal. 5,200 6/30 Bal. 1,100 Common Stock 6/30 Bal. 22,000 Service Revenue 6/30 Bal. 8,300 6/30 4,100 6/30 3,900 6/30 Bal. 16,300

Salaries and Wages Expense 6/30 Bal. 4,000 6/30 1,250 6/30 Bal. 5,250 Rent Expense 6/30 Bal. 2,000 Depreciation Expense 6/30 250 6/30 Bal. 250 Insurance Expense 6/30 240 6/30 Bal. 240 Utilities Expense 6/30 180 6/30 Bal. 180 Supplies Expense 6/30 1,280 6/30 Bal. 1,280

PROBLEM 4-2A (Continued) (c)

KUMAR CONSULTING Adjusted Trial Balance June 30, 2017 Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Prepaid Insurance.............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Salaries and Wages Payable ............................. Unearned Service Revenue............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense............................ Rent Expense ..................................................... Depreciation Expense ....................................... Insurance Expense ............................................ Utilities Expense ................................................ Supplies Expense ..............................................

Debit $ 6,850 10,900 720 2,640 15,000

Credit

250 4,410 1,250 1,100 22,000 16,300

5,250 2,000 250 240 180 1,280 $45,310

(Total debits = Total credits) LO 2-4 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

$45,310

PROBLEM 4-3A

(a) 1. May 31 2. 3.

31 31

5. 6.

31 31

Insurance Expense ................................. Prepaid Insurance ...........................

450

Supplies Expense ................................... Supplies ($2,600 – $1,050) ..............

1,550

Depreciation Expense ($3,600 X 1/12) ..................................... Accumulated Depreciation— Building........................................ Depreciation Expense ($3,000 X 1/12) ..................................... Accumulated Depreciation— Equipment....................................

450 1,550 300 300

250 250

Interest Expense ..................................... Interest Payable [($36,000 X 6%) X 1/12]................

180

Unearned Rent Revenue......................... Rent Revenue ..................................

2,500

Salaries and Wages Expense................. Salaries and Wages Payable ..........

900

180 2,500 900

(b)

5/31 Bal.

Cash 2,500

Prepaid Insurance 5/31 Bal. 1,800 5/31 5/31 Bal. 1,350

5/31 Bal. 5/31 Bal.

Supplies 2,600 5/31 1,050

Land 5/31 Bal. 15,000

1,550

450

PROBLEM 4-3A (Continued) Building 5/31 Bal. 70,000

Mortgage Payable 5/31 Bal. 36,000

Accumulated Depreciation— Building 5/31 300 5/31 Bal. 300

Rent Revenue 5/31 Bal. 9,000 5/31 2,500 5/31 Bal. 11,500

Equipment 5/31 Bal. 16,800 Accumulated Depreciation— Equipment 5/31 250 5/31 Bal. 250

Accounts Payable 5/31 Bal.

4,700

Unearned Rent Revenue 5/31 2,500 5/31 Bal. 3,300 5/31 Bal. 800

Salaries and Wages Payable 5/31 900 5/31 Bal. 900

Interest Payable 5/31 5/31 Bal.

Common Stock 5/31 Bal. 60,000

180 180

Salaries and Wages Expense 5/31 Bal. 3,000 5/31 900 5/31 Bal. 3,900

Utilities Expense 5/31 Bal. 800 Advertising Expense 5/31 Bal. 500 Interest Expense 5/31 180 5/31 Bal. 180

Insurance Expense 5/31 450 5/31 Bal. 450

PROBLEM 4-3A (Continued) Supplies Expense 5/31 1,550 5/31 Bal. 1,550 Depreciation Expense 5/31 300 5/31 250 5/31 Bal. 550 MOTO HOTEL Adjusted Trial Balance May 31, 2017

(c)

Cash ................................................................. Supplies........................................................... Prepaid Insurance ........................................... Land ................................................................. Building ........................................................... Accumulated Depreciation—Building ........... Equipment ....................................................... Accumulated Depreciation—Equipment ....... Accounts Payable ........................................... Unearned Rent Revenue................................. Salaries and Wages Payable .......................... Interest Payable .............................................. Mortgage Payable ........................................... Common Stock................................................ Rent Revenue .................................................. Salaries and Wages Expense ......................... Utilities Expense ............................................. Advertising Expense....................................... Interest Expense ............................................. Insurance Expense ......................................... Supplies Expense ........................................... Depreciation Expense..................................... (Total debits = Total credits)

Debit $ 2,500 1,050 1,350 15,000 70,000

Credit

300

16,800 250 4,700 800 900 180 36,000 60,000 11,500 3,900 800 500 180 450 1,550 550 $114,630

$114,630

PROBLEM 4-3A (Continued) (d)

MOTO HOTEL Income Statement For the Month Ended May 31, 2017 Revenues Rent revenue ................................................... Expenses Salaries and wages expense .......................... Supplies expense............................................ Utilities expense.............................................. Depreciation expense ..................................... Advertising expense ....................................... Insurance expense.......................................... Interest expense.............................................. Total expenses......................................... Net income ..............................................................

$11,500 $3,900 1,550 800 550 500 450 180 7,930 $ 3,570

MOTO HOTEL Retained Earnings Statement For the Month Ended May 31, 2017 Retained earnings, May 1...................................... Add: Net income .................................................. Retained earnings, May 31....................................

0 3,570 $3,570

PROBLEM 4-3A (Continued) MOTO HOTEL Balance Sheet May 31, 2017 Assets Current Assets Cash................................................... Supplies............................................. Prepaid insurance............................. Total current assets.................. Property, plant, and equipment Land ................................................... Building ............................................. Less: Accumulated deprec.—Building .......................... Equipment ......................................... Less: Accumulated deprec.—equipment ...................... Total assets ...............................

$ 2,500 1,050 1,350 $

4,900

15,000 $70,000 300 16,800

69,700

250

16,550

Liabilities and Stockholders’ Equity Current Liabilities Accounts payable........................................... $ 4,700 Salaries and wages payable .......................... 900 Unearned rent revenue .................................. 800 Interest payable .............................................. 180 Total current liabilities ............................ Long-term Liabilities Mortgage payable ........................................... Total liabilities ......................................... Stockholders’ equity Common stock ............................................... 60,000 Retained earnings .......................................... 3,570 Total stockholders’ equity ............... Total liabilities and stockholders’ equity ...................................................

101,250 $106,150

6,580 36,000 42,580

63,570 $106,150

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

PROBLEM 4-3A (Continued) (e) The following accounts would be closed: Rent Revenue, Salaries and Wages Expense, Utilities Expense, Advertising Expense, Interest Expense, Insurance Expense, Supplies Expense, Depreciation Expense. LO 2-4 BT: AP Difficulty: Hard TOT: 60 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 4-4A (a)

Sept. 30 30 30 30 30 30 30

(b)

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

600

Rent Expense ................................................ Prepaid Rent ..........................................

900

Supplies Expense ......................................... Supplies .................................................

1,020

Depreciation Expense................................... Accum. Depreciation—Equipment .......

350

Interest Expense ........................................... Interest Payable .....................................

Unearned Rent Revenue............................... Rent Revenue.........................................

200

Salaries and Wages Expense ....................... Salaries and Wages Payable.................

600

600 900 1,020 350 50 200 600

SALT CREEK GOLF INC. Income Statement For the Quarter Ended September 30, 2017 Revenues Service revenue.............................................. Rent revenue .................................................. Total revenues ........................................ Expenses Salaries and wages expense ......................... Rent expense.................................................. Supplies expense ........................................... Utilities expense ............................................. Depreciation expense .................................... Interest expense ............................................. Total expenses........................................ Net income .............................................................

$14,700 900 $15,600 9,400 1,800 1,020 470 350 50 13,090 $ 2,510

PROBLEM 4-4A (Continued) SALT CREEK GOLF INC. Retained Earnings Statement For the Quarter Ended September 30, 2017 Retained earnings, July 1, 2017................................................ Add: Net income ...................................................................... Less: Dividends ........................................................................ Retained earnings, September 30, 2017...................................

0 2,510 2,510 600 $1,910

SALT CREEK GOLF INC. Balance Sheet September 30, 2017 Assets Current Assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Prepaid rent ................................................... Total current assets .............................. Property, Plant and Equipment Equipment ..................................................... Less: Accumulated depreciation— equipment .......................................... Total assets............................................

$ 6,700 1,000 180 900 $ 8,780 15,000 350

Liabilities and Stockholders’ Equity Current Liabilities Notes payable................................................ $ 5,000 Accounts payable ......................................... 1,070 Unearned rent revenue ................................. 800 Salaries and wages payable......................... 600 Interest payable............................................. 50 Total current liabilities .......................... Stockholders’ equity Common stock .............................................. 14,000 Retained earnings ......................................... 1,910 Total stockholders’ equity................. Total liabilities and stockholders’ equity..................................................

14,650 $23,430

$ 7,520

15,910 $23,430

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

PROBLEM 4-4A (Continued) (c) The following accounts would be closed: Service Revenue, Rent Revenue, Salaries and Wages Expense, Rent Expense, Utilities Expense, Depreciation Expense, Supplies Expense, Interest Expense, Dividends. (d) Interest of 12% per year equals a monthly rate of 1%; monthly interest is $50 ($5,000 X 1%). Since total interest payable is $50, the note has been outstanding one month. LO 2-4 BT: AP Diffciulty: Hard TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 4-5A

Dec. 31

Insurance Expense....................................... Prepaid Insurance................................. [($9,600 ÷ 3) = $3,200 ($7,200 X 12/18) = 4,800 $8,000]

8,000 8,000

Dec. 31

Unearned Rent Revenue .................................. 84,000 Rent Revenue ........................................ 84,000 [ Nov. 5 X $5,000 X 2 = 50,000 Dec. 4 X $8,500 X 1 = 34,000 $84,000]

Dec. 31

Interest Expense........................................... Interest Payable ($40,000 X 7% X 3/12).........................

700

Salaries and Wages Expense ...................... Salaries and Wages Payable ................ [5 X $600 X 3/5 = $1,800 3 X $700 X 3/5 = 1,260 $3,060]

3,060

Dec. 31

700

LO 2, 3 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

3,060

PROBLEM 4-6A

(a) 1. June 2. 3.

30 30 30

Rent Revenue .................................. Unearned Rent Revenue........

57,000

Supplies Expense............................ Supplies ($8,200 – $1,800).....

6,400

57,000 6,400

Insurance Expense ($14,400 X 3/12)............................. Prepaid Insurance..................

3,600

Maintenance and Repairs Expense........................... Utilities Expense.............................. Advertising Expense ....................... Accounts Payable ..................

4,450 215 110

Salaries and Wages Expense ($300 X 4)....................................... Salaries and Wages Payable ................................ Interest Expense ($14,000 X 6% X 2/12) ................... Interest Payable .................... Income Tax Expense ....................... Income Taxes Payable...........

3,600

4,775 1,200 1,200 140 140 13,400 13,400

PROBLEM 4-6A (Continued) (b)

ROADSIDE TRAVEL COURT Income Statement For the Quarter Ended June 30, 2017 Revenues Rent revenue ($212,000 – $57,000) ....................... $155,000 Expenses Salaries and wages expense ($80,500 + $1,200) ............................................... $ 81,700 Income tax expense ............................................... 13,400 Maintenance and repairs expense ($4,300 + $4,450) ................................................. 8,750 Supplies expense................................................... 6,400 Advertising expense ($3,800 + $110) .................... 3,910 Insurance expense................................................. 3,600 Depreciation expense ............................................ 2,700 Utilities expense ($900 + $215) ............................. 1,115 Interest expense..................................................... 140 Total expenses ....................................................... 121,715 Net income ............................................................. $ 33,285

(Revenues are recognized when a service has been provided and expenses are recognized when an asset has been used up or a service incurred.)

PROBLEM 4-6A (Continued) (c)

The generally accepted accounting principles pertaining to the income statement not recognized by Betty were the revenue recognition principle and the expense recognition principle. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. The cash payments of $57,000 for summer rentals have not been earned and, therefore, should not be reported as income for the quarter ended June 30. The expense recognition principle dictates that efforts (expenses) be matched with accomplishments (revenue) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in June but not paid until July, and any other costs related to the operations of the business during the period April–June. The difference in reported expenses was $29,515 ($121,715 – $92,200). The overstatement of revenues ($57,000) plus the understatement of expenses ($29,515) equals the difference in reported income of $86,515 ($119,800 – $33,285).

LO 2, 3 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement AICPA FC: Reporting

PROBLEM 4-7A

(a) , (c) & (e)

Cash 11/1 Bal. 2,790 11/8 11/10 1,800 11/20 11/12 3,700 11/22 11/29 750 11/25 11/30 Bal. 3,840

1,220 2,500 480 1,000

Accounts Receivable 11/1 Bal. 2,910 11/10 1,800 11/27 900 11/30 Bal. 2,010

Supplies 11/1 Bal. 1,120 11/30 11/17 1,300 11/30 Bal. 1,100

1,320

Equipment 11/1 Bal. 10,000 11/15 3,600 11/30 Bal. 13,600

Accumulated Depreciation— Equipment 11/1 Bal. 500 11/30 250 11/30 Bal. 750

11/20

11/30

Accounts Payable 2,500 11/1 Bal. 2,300 11/15 3,600 11/17 1,300 11/30 Bal. 4,700

Unearned Service Revenue 500 11/1 Bal. 11/29 11/30 Bal.

400 750 650

Salaries and Wages Payable 620 11/8 620 11/1 Bal. 11/30 480 11/30 Bal. 480

Common Stock 11/1 Bal. 10,000 11/30 Bal.10,000

Retained Earnings 11/1 Bal. 3,000 11/30 Bal. 3,000

PROBLEM 4-7A (Continued) Service Revenue 11/12 3,700 11/27 900 11/30 500 11/30 Bal. 5,100

Depreciation Expense 11/30 250 11/30 Bal. 250

Supplies Expense 11/30 1,320 11/30 Bal. 1,320

Salaries and Wages Expense 11/8 600 11/25 1,000 11/30 480 11/30 Bal. 2,080

Rent Expense 11/22 480 11/30 Bal. 480

PROBLEM 4-7A (Continued) (b) General Journal Date Nov. 8

10 12 15 17 20 22 25 27 29

Account Titles Salaries and Wages Payable ......................... Salaries and Wages Expense ........................ Cash ........................................................

Debit 620 600

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

1,800

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

3,700

Equipment ...................................................... Accounts Payable...................................

3,600

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

1,300

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

2,500

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

480

Salaries and Wages Expense ........................ Cash ........................................................

1,000

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

900

Cash ................................................................ Unearned Service Revenue ...................

750

Credit

1,220

1,800 3,700 3,600 1,300 2,500 480 1,000 900 750

PROBLEM 4-7A (Continued) (d) & (f)

SOHO EQUIPMENT REPAIR Trial Balances November 30, 2017

Cash ............................................ Accounts Receivable ................. Supplies...................................... Equipment .................................. Accumulated Depreciation— Equipment Accounts Payable ...................... Unearned Service Revenue ....... Salaries and Wages Payable ..... Common Stock........................... Retained Earnings ..................... Service Revenue ........................ Depreciation Expense................ Supplies Expense ..................... Salaries and Wages Expense ... Rent Expense .............................

Before Adjustment Dr. Cr. $ 3,840 2,010 2,420 13,600 $

500 4,700 1,150

After Adjustment Dr. Cr. $ 3,840 2,010 1,100 13,600 $

10,000 3,000 4,600

750 4,700 650 480 10,000 3,000 5,100

1,600 480 $23,950 $23,950

250 1,320 2,080 480 $24,680 $24,680

PROBLEM 4-7A (Continued) (e) Nov. 30

(g)

1. Supplies Expense ...............................................1,320 Supplies ($2,420 – $1,100)...................... 2. Salaries and Wages Expense ........................ Salaries and Wages Payable..................

480

3. Depreciation Expense .................................... Accumulated Depreciation-Equipment .

250

4. Unearned Service Revenue ........................... Service Revenue .....................................

500

1,320

480

250

500

SOHO EQUIPMENT REPAIR Income Statement For the Month Ended November 30, 2017 Revenues Service revenue............................................... Expenses Salaries and wages expense .......................... Supplies expense............................................ Rent expense................................................... Depreciation expense ..................................... Total expenses......................................... Net income ..............................................................

$5,100 $2,080 1,320 480 250 4,130 $ 970

SOHO EQUIPMENT REPAIR Retained Earnings Statement For the Month Ended November 30, 2017 Retained earnings, November 1 ........................... Add: Net income .................................................... Retained earnings, November 30 .........................

$3,000 970 $3,970

PROBLEM 4-7A (Continued)

SOHO EQUIPMENT REPAIR Balance Sheet November 30, 2017 Assets Current assets Cash ................................................................... $ 3,840 Accounts receivable ......................................... 2,010 Supplies ................................................................. 1,100 Total current assets................................... Property, plant and equipment Equipment.......................................................... 13,600 Less: Accumulated depreciation— equipment .............................................. 750 Total assets................................................

$ 6,950

12,850 $19,800

Liabilities and Stockholders’ Equity Current liabilities Accounts payable.............................................. $ 4,700 Unearned service revenue................................ 650 Salaries and wages payable ................................. 480 Total current liabilities............................... Stockholders’ equity Common stock .................................................. 10,000 Retained earnings ................................................. 3,970 Total stockholders’ equity .................... Total liabilities and stockholders’ equity .......................................................

$ 5,830

13,970 $19,800

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings) LO 2-4 BT: AP Difficulty: Hard TOT: 70 min. AACSB: Analytic AICPA FC: Reporting

ACCOUNTING CYCLE REVIEW 4-1

(a)

General Journal Date July 1

3 5 12 18 20 21 25 31 31

Account Titles Cash ................................................................ Common Stock........................................

Debit 12,000

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

8,000

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

900

Prepaid Insurance .......................................... Cash .........................................................

1,800

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

3,700

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

1,500

Salaries and Wages Expense ........................ Cash .........................................................

2,000

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

1,600

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

2,500

Maintenance and Repairs Expense ............... Cash .........................................................

290

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

600

Credit 12,000 6,000 2,000 900 1,800 3,700 1,500 2,000 1,600 2,500 290 600

ACR 4-1 (Continued) (b) , (e) & (h)

Cash 7/1 12,000 7/1 7/21 1,600 7/5 7/18 7/20 7/31 7/31 7/31 Bal. 5,410

2,000 1,800 1,500 2,000 290 600

7/18

Accounts Payable 1,500 7/1 7/3 7/31 Bal.

Salaries and Wages Payable 7/31 400 7/31 Bal. 400

Accounts Receivable 7/12 3,700 7/21 1,600 7/25 2,500 7/31 1,700 7/31 Bal. 6,300

7/3 7/31 Bal.

Supplies 900 7/31 320

Prepaid Insurance 7/5 1,800 7/31 7/31 Bal. 1,650

7/1 7/31 Bal.

Common Stock 7/1 12,000 7/31 Bal. 12,000

580

Retained Earnings 600 7/31 7/31 Bal.

150

Dividends 600 7/31 0

7/31

Equipment 8,000 8,000

Accumulated Depreciation— Equipment 7/31 180 7/31 Bal. 180

6,000 900 5,400

7/31 7/31 Bal.

7/31 7/31

7/31

Income Summary 3,600 7/31 4,300 7/31 Bal. Service Revenue 7,900 7/12 7/25 7/31 7/31 Bal.

4,300 3,700

600

7,900 0

3,700 2,500 1,700 0

ACR 4-1 (Continued) Maintenance and Repairs Expense 7/31 290 7/31 290 7/31 Bal. 0 Supplies Expense 7/31 580 7/31 7/31 Bal. 0

580

Depreciation Expense 7/31 180 7/31 7/31 Bal. 0

180

Insurance Expense 7/31 150 7/31 7/31 Bal. 0

150

Salaries and Wages Expense 7/20 2,000 7/31 2,400 7/31 400 7/31 Bal. 0

ACR 4-1 (Continued) (c) & (f)

KLEENE WINDOW WASHING INC. Trial Balance July 31, 2017

Cash ................................................... Accounts Receivable ........................ Supplies ............................................. Prepaid Insurance ............................. Equipment.......................................... Accumulated Depreciation— Equipment...................................... Accounts Payable ............................. Salaries and Wages Payable ............ Common Stock .................................. Dividends ........................................... Service Revenue................................ Maintenance and Repairs Expense.. Supplies Expense.............................. Depreciation Expense ....................... Insurance Expense............................ Salaries and Wages Expense ...........

Total debits = Total credits

Before Adjustment Debit Credit $ 5,410 4,600 900 1,800 8,000

After Adjustment Debit Credit $ 5,410 6,300 320 1,650 8,000 $

180 5,400 400 12,000

$ 5,400 12,000 600

600 6,200

7,900

2,000 $23,600 $23,600

290 580 180 150 2,400 $25,880 $25,880

290

ACR 4-1 (Continued) (d)

General Journal Date 1. July 31 2. 3. 4. 5.

(g)

31 31 31 31

Account Titles Accounts Receivable....................................... Service Revenue ........................................

Debit 1,700

Depreciation Expense ..................................... Accumulated Depreciation—Equipment ....

180

Insurance Expense ($1,800 X 1/12)................. Prepaid Insurance......................................

150

Supplies Expense ($900 – $320) ..................... Supplies......................................................

580

Salaries and Wages Expense.......................... Salaries and Wages Payable.....................

400

Credit 1,700 180 150 580 400

KLEENE WINDOW WASHING INC. Income Statement For the Month Ended July 31, 2017 Revenues Service revenue................................................ Expenses Salaries and wages expense ........................... Supplies expense............................................. Maintenance and repairs expense .................. Depreciation expense ...................................... Insurance expense........................................... Total expenses.......................................... Net income ...............................................................

$7,900 $2,400 580 290 180 150 3,600 $4,300

ACR 4-1 (Continued) (g)

KLEENE WINDOW WASHING INC. Retained Earnings Statement For the Month Ended July 31, 2017 Retained earnings, July 1...................................... Add: Net income ..................................................

0 4,300 4,300 600 $3,700

Less: Dividends ................................................... Retained earnings, July 31...................................

KLEENE WINDOW WASHING INC. Balance Sheet July 31, 2017 Assets Current assets Cash ................................................................ $ Accounts receivable ...................................... Supplies .......................................................... Prepaid insurance .......................................... Total current assets................................ Property, plant, and equipment Equipment....................................................... Less: Accumulated depreciation ................. Total assets.............................................

5,410 6,300 320 1,650 $13,680 8,000 180

7,820 $21,500

Liabilities and Stockholders’ Equity Current liabilities Accounts payable........................................... Salaries and wages payable .......................... Total current liabilities............................ Stockholders’ equity Common stock ............................................... Retained earnings .......................................... Total stockholders’ equity................. Total liabilities and stockholders’ equity ...................................................

$ 5,400 400 $ 5,800 12,000 3,700 15,700 $21,500

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

ACR 4-1 (Continued) (h) Date July 31 31

31 31

(i)

General Journal Account Titles and Explanation Service Revenue............................................. Income Summary ....................................

Debit 7,900

Credit 7,900

Income Summary............................................ Salaries and Wages Expense................. Supplies Expense ................................... Maintenance and Repairs Expense ....... Depreciation Expense............................. Insurance Expense .................................

3,600

Income Summary............................................ Retained Earnings ..................................

4,300

Retained Earnings .......................................... Dividends.................................................

600

2,400 580 290 180 150 4,300 600

KLEENE WINDOW WASHING INC. Post-Closing Trial Balance July 31, 2017 Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Prepaid Insurance.............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Salaries and Wages Payable ............................. Common Stock .................................................. Retained Earnings .............................................

Debit $ 5,410 6,300 320 1,650 8,000

Credit

$21,680 (Total debits for permanent accounts = Total credits for permanent accounts) LO 2-4 BT: AP Difficulty: Hard TOT: 80 min. AACSB: Analytic AICPA FC: Reporting

180 5,400 400 12,000 3,700 $21,680

ACCOUNTING CYCLE REVIEW 4-2 (a)

General Journal Date Mar. 1 1 1 2 3 6 14 18 20 21 28 31 31

Account Titles Cash................................................................ Common Stock.......................................

Debit 15,000

Cash................................................................ Notes Payable.........................................

6,000

Equipment ...................................................... Cash ........................................................

8,000

Prepaid Rent .................................................. Cash ........................................................

1,500

Prepaid Insurance.......................................... Cash ........................................................

2,400

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

2,000

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

3,700

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

500

Salaries and Wages Expense........................ Cash ........................................................

1,750

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

1,600

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

4,200

Maintenance and Repairs Expense .............. Cash ........................................................

350

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

Credit 15,000 6,000 8,000 1,500 2,400 2,000 3,700 500 1,750 1,600 4,200 350

900

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

900

ACR 4-2 (Continued) (b) , (e) & (h)

Cash 3/1 15,000 3/1 3/1 6,000 3/2 3/21 1,600 3/3 3/18 3/20 3/31 3/31 3/31 Bal. 7,200

8,000 1,500 2,400 500 1,750 350 900

Accounts Receivable 3/14 3,700 3/21 1,600 3/28 4,200 3/31 200 3/31 Bal. 6,500

3/6 3/31 Bal.

Supplies 2,000 3/31 280

1,720

3/2 3/31 Bal.

Prepaid Rent 1,500 3/31 1,000

500

Prepaid Insurance 3/3 2,400 3/31 3/31 Bal. 2,000

3/1 3/31 Bal.

Equipment 8,000 8,000

Accumulated Depreciation— Equipment 3/31 250 3/31 Bal. 250

3/18

Notes Payable 3/1 3/31 Bal.

6,000 6,000

Accounts Payable 500 3/6 3/31 Bal.

2,000 1,500

Salaries and Wages Payable 3/31 1,080 3/31 Bal. 1,080 Interest Payable 3/31 3/31 Bal.

30 30

Common Stock 3/1 15,000 3/31 Bal. 15,000

400 3/31

Retained Earnings 900 3/31 3/31 Bal.

3/31 3/31 Bal.

Dividends 900 3/31 0

2,020 1,120

900

ACR 4-2 (Continued) 3/31 3/31

3/31

Income Summary 6,080 3/31 2,020 3/31 Bal. Service Revenue 8,100 3/14 3/28 3/31 3/31 Bal.

8,100 0

3,700 4,200 200 0

Depreciation Expense 3/31 250 3/31 3/31 Bal. 0

250

Insurance Expense 3/31 400 3/31 3/31 Bal. 0

400

Salaries and Wages Expense 3/20 1,750 3/31 2,830 3/31 1,080 3/31 Bal. 0

Maintenance and Repairs Expense 3/31 350 3/31 350 3/31 Bal. 0

Rent Expense 3/31 500 3/31 3/31 Bal. 0

500

Supplies Expense 3/31 1,720 3/31 3/31 Bal. 0

Interest Expense 3/31 30 3/31 3/31 Bal. 0

1,720

ACR 4-2 (Continued) (c) & (f)

LARS CLEANERS Trial Balance March 31, 2017

Cash ..................................................... Accounts Receivable .......................... Supplies ............................................... Prepaid Rent ........................................ Prepaid Insurance ............................... Equipment............................................ Accumulated Depreciation— Equipment......................................... Notes Payable...................................... Accounts Payable ............................... Salaries and Wages Payable .............. Interest Payable................................... Common Stock .................................... Dividends ............................................. Service Revenue.................................. Maintenance and Repairs Expense.... Salaries and Wages Expense ............. Depreciation Expense ......................... Insurance Expense.............................. Supplies Expense................................ Rent Expense ...................................... Interest Expense..................................

(Total debits = Total credits)

Before Adjustment Debit Credit $ 7,200 6,300 2,000 1,500 2,400 8,000

After Adjustment Debit Credit $ 7,200 6,500 280 1,000 2,000 8,000 $

250 6,000 1,500 1,080 30 15,000

$ 6,000 1,500 15,000 900

900 7,900

8,100

$30,400 $30,400

350 2,830 250 400 1,720 500 30 $31,960 $31,960

350 1,750

ACR 4-2 (Continued) (d)

1. 2.

4. 5. 6. 7.

Date March 31 31

31 31 31 31

General Journal Account Titles Accounts Receivable............................. Service Revenue ............................

Debit 200

Credit 200

Depreciation Expense ........................... Accumulated Depreciation— Equipment ...................................

250

Insurance Expense ................................ Prepaid Insurance ($2,400 ÷ 6)......................................

400

Supplies Expense .................................. Supplies ($2,000 – $280) ................

1,720

Salaries and Wages Expense ............... Salaries and Wages Payable .........

1,080

Rent Expense......................................... Prepaid Rent ($1,500 ÷ 3)...............

500

Interest Expense .................................... Interest Payable ($6,000 × .06 × 1/12).....................

250

400 1,720 1,080 500 30

ACR 4-2 (Continued) (g)

LARS CLEANERS Income Statement For the Month Ended March 31, 2017 Revenues Service revenue................................................ Expenses Salaries and wages expense ........................... Supplies expense ............................................. Rent expense.................................................... Insurance expense ........................................... Maintenance and repairs expense .................. Depreciation expense ...................................... Interest expense ............................................... Total expenses.......................................... Net income ...............................................................

$8,100 $2,830 1,720 500 400 350 250 30 6,080 $2,020

LARS CLEANERS Retained Earnings Statement For the Month Ended March 31, 2017 Retained earnings, March 1 .................................. Add: Net income .................................................. Less: Dividends .................................................... Retained earnings, March 31 ................................

0 2,020 2,020 900 $1,120

ACR 4-2 (Continued) LARS CLEANERS Balance Sheet March 31, 2017 Assets Current assets Cash ................................................................. $7,200 Accounts receivable ....................................... 6,500 Supplies ........................................................... 280 Prepaid rent ..................................................... 1,000 Prepaid insurance ........................................... 2,000 Total current assets ................................ Property, plant, and equipment Equipment ....................................................... 8,000 Less: Accumulated depreciation— equipment ........................................ 250 Total assets..............................................

$16,980

7,750 $24,730

Liabilities and Stockholders’ Equity Current liabilities Notes payable.................................................. $ 6,000 Accounts payable ........................................... 1,500 Salaries and wages payable........................... 1,080 Interest payable ................................................... 30 Total current liabilities ............................ Stockholders’ equity Common stock ................................................ 15,000 Retained earnings ........................................... 1,120 Total stockholders’ equity................... Total liabilities and stockholders’ equity .......................................................

$ 8,610

16,120 $24,730

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

ACR 4-2 (Continued) (h) Date Mar. 31 31

31 31

General Journal Account Titles and Explanation Service Revenue ............................................ Income Summary ...................................

Debit 8,100

Credit 8,100

Income Summary........................................... Salaries and Wages Expense ................ Supplies Expense .................................. Rent Expense ......................................... Insurance Expense ................................ Maintenance and Repairs Expense....... Depreciation Expense............................ Interest Expense ....................................

6,080

Income Summary........................................... Retained Earnings..................................

2,020

Retained Earnings ......................................... Dividends................................................

900

2,830 1,720 500 400 350 250 30 2,020 900

ACR 4-2 (Continued) (i)

LARS CLEANERS Post-Closing Trial Balance March 31, 2017 Cash .................................................................... Accounts Receivable.......................................... Supplies .............................................................. Prepaid Rent ....................................................... Prepaid Insurance .............................................. Equipment........................................................... Accumulated Depreciation—Equipment........... Notes Payable ..................................................... Accounts Payable............................................... Salaries and Wages Payable.............................. Interest Payable .................................................. Common Stock ................................................... Retained Earnings ..............................................

Debit $ 7,200 6,500 280 1,000 2,000 8,000

Credit

$24,980 (Permanent accounts with debit balances = Permanent accounts with credit balances) LO 2-4 BT: AP Difficulty: Hard TOT: 90 min. AACSB: Analytic AICPA FC: Reporting

250 6,000 1,500 1,080 30 15,000 1,120 $24,980

ACCOUNTING CYCLE REVIEW 4-3

(a), (c) & (e) 8/1 Bal. 8/5 8/12 8/29 8/31 Bal.

Cash 6,040 8/1 1,200 8/3 2,800 8/10 780 8/20 8/25 2,020

400 380 3,120 2,000 2,900

Accounts Receivable 8/1 Bal. 2,910 8/5 1,200 8/27 3,760 8/31 Bal. 5,470

Notes Receivable 8/1 Bal. 4,000 8/31 Bal. 4,000

Equipment 8/1 Bal. 10,000 8/15 2,000 8/31 Bal. 12,000

Accumulated Depreciation— Equipment 8/1 Bal. 600 8/31 320 8/31 Bal. 920

8/20

Interest Receivable 8/31 20 8/31 Bal. 20 8/31

8/1 Bal. 8/22 8/31 Bal.

Supplies 1,030 8/31 800 960

Prepaid Advertising 8/1 400 8/31 8/31 Bal. 200

Accounts Payable 2,000 8/1 Bal. 8/15 8/22 8/31 Bal.

2,300 2,000 800 3,100

Unearned Service Revenue 800 8/1 Bal. 8/29 8/31 Bal.

1,260 780 1,240

870 Salaries and Wages Payable 1,420 8/10 1,420 8/1 Bal. 8/31 1,540 8/31 Bal. 1,540 200 Common Stock

8/1 Bal.

12,000

8/31 Bal. 12,000

ACR 4-3 (Continued) 8/31

8/31

Retained Earnings 530 8/1 Bal. 8/31 Bal.

Income Summary 7,910 8/31 8/31 8/31 Bal.

Service Revenue 7,360 8/12 8/27 8/31 8/31 Bal.

Interest Revenue 20 8/31 8/31 Bal.

6,400 5,870

7,380 530 0

2,800 3,760 800 0

20 0

Depreciation Expense 8/31 320 8/31 8/31 Bal. 0

320

Supplies Expense 8/31 870 8/31 8/31 Bal. 0

870

Salaries and Wages Expense 8/10 1,700 8/31 6,140 8/25 2,900 8/31 1,540 8/31 Bal. 0

Rent Expense 8/3 380 8/31 8/31 Bal. 0

380

Advertising Expense 8/31 200 8/31 8/31 Bal. 0

200

ACR 4-3 (Continued) (b)

General Journal

Date Aug. 1 3 5 10

12 15 20 22 25 27 29

Account Titles Prepaid Advertising ....................................... Cash ........................................................

Debit 400

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

380

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

1,200

Salaries and Wages Payable ......................... Salaries and Wages Expense........................ Cash ........................................................

1,420 1,700

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

2,800

Equipment ...................................................... Accounts Payable ..................................

2,000

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

2,000

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

800

Salaries and Wages Expense........................ Cash ........................................................

2,900

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

3,760

Cash ................................................................ Unearned Service Revenue ...................

780

Credit 400 380 1,200

3,120

2,800 2,000 2,000 800 2,900 3,760 780

ACR 4-3 (Continued) (d) & (f)

B & B REPAIR SERVICES Trial Balances August 31, 2017

Cash............................................ Accounts Receivable................. Notes Receivable ....................... Interest Receivable .................... Supplies...................................... Prepaid Advertising ................... Equipment .................................. Accumulated Depr.— Equipment ............................... Accounts Payable ...................... Unearned Service Revenue....... Salaries and Wages Payable ..... Common Stock .......................... Retained Earnings ..................... Service Revenue ........................ Interest Revenue ........................ Salaries and Wages Expense.... Rent Expense ............................. Supplies Expense ...................... Depreciation Expense ............... Advertising Expense .................

Before Adjustment Dr. Cr. $ 2,020 5,470 4,000 1,830 400 12,000 $

600 3,100 2,040

12,000 6,400 6,560 4,600 380

$30,700 $30,700 (Total debits = Total credits)

After Adjustment Dr. Cr. $ 2,020 5,470 4,000 20 960 200 12,000 $

920 3,100 1,240 1,540 12,000 6,400 7,360 20

6,140 380 870 320 200 $32,580 $32,580

ACR 4-3 (Continued) (e) Aug. 31

1. Supplies Expense........................................... Supplies ($1,830 – $960).........................

870

2. Salaries and Wages Expense ........................ Salaries and Wages Payable..................

1,540

3. Depreciation Expense .................................... Accumulated Depreciation-Equipment .

320

4. Unearned Service Revenue ........................... Service Revenue .....................................

800

5. Advertising Expense...................................... Prepaid Advertising................................

200

6. Interest Receivable......................................... Interest Revenue ($4,000 × .06 × 1/12)...

870

1,540

320

800

200

ACR 4-3 (Continued) (g)

B & B REPAIR SERVICES Income Statement For the Month Ended August 31, 2017 Revenues Service revenue.............................................. Interest revenue.............................................. Total expenses........................................ Expenses Salaries and wages expense ......................... Supplies expense ........................................... Rent expense.................................................. Depreciation expense .................................... Advertising expense ...................................... Total expenses........................................ Net loss...................................................................

$7,360 20 $7,380 6,140 870 380 320 200 7,910 ($530)

B & B REPAIR SERVICES Retained Earnings Statement For the Month Ended August 31, 2017 Retained earnings, August 1................................. Less: Net loss ....................................................... Retained earnings, August 31...............................

$6,400 530 $5,870

ACR 4-3 (Continued)

B & B REPAIR SERVICES Balance Sheet August 31, 2017 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Notes receivable............................................ Interest receivable......................................... Supplies ......................................................... Prepaid Advertising ...................................... Total current assets .............................. Property, plant and equipment Equipment ..................................................... Less: Accumulated depreciation— equipment .......................................... Total assets............................................

$ 2,020 5,470 4,000 20 960 200 $12,670 12,000 920

11,080 $23,750

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................... $ 3,100 Unearned service revenue.................................. 1,240 Salaries and wages payable ................................. 1,540 Total current liabilities ................................ Stockholders’ equity Common stock .................................................... 12,000 Retained earnings ............................................... 5,870 Total stockholders’ equity .......................... Total liabilities and stockholders’ equity.........................................................

$ 5,880

17,870 $23,750

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

ACR 4-3 (Continued) (h) Date Aug.

General Journal Account Titles and Explanation 31 Service Revenue........................................... Interest Revenue........................................... Income Summary ..................................

Debit 7,360 20

Income Summary.......................................... Salaries and Wages Expense............... Supplies Expense ................................. Rent Expense ........................................ Depreciation Expense .......................... Advertising Expense ............................

7,910

Retained Earnings ........................................ Income Summary ..................................

530

(i)

Credit

7,380 6,140 870 380 320 200 530

B & B REPAIR SERVICES Post-Closing Trial Balance March 31, 2017 Cash..................................................................... Accounts Receivable.......................................... Notes Receivable ................................................ Interest Receivable ............................................. Supplies............................................................... Prepaid Advertising ............................................ Equipment ........................................................... Accumulated Depreciation—Equipment........... Accounts Payable............................................... Unearned Service Revenue................................ Salaries and Wages Payable.............................. Common Stock ................................................... Retained Earnings ..............................................

Debit $ 2,020 5,470 4,000 20 960 200 12,000

Credit

$24,670 (Permanent accounts with debit balances = Permanent accounts with credit balances)

920 3,100 1,240 1,540 12,000 5,870 $24,670

LO 2-4 BT: AP Difficulty: Hard TOT: 90 min. AACSB: Analytic AICPA FC: Reporting

ACCOUNTING CYCLE REVIEW 4-4 (b) Date July

Account Titles

Debit

Equipment ............................................................... Cash ................................................................ Notes Payable ................................................

24,000

Cash ........................................................................ Common Stock...............................................

50,000

Prepaid Insurance................................................... Cash ................................................................

3,600

Prepaid Rent............................................................ Cash ................................................................

8,000

Supplies................................................................... Cash ................................................................

3,800

4,000 20,000

50,000

3,600

8,000

3,800

No entry required (consulting agreement)

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

1,200

Unearned Service Revenue.................................... Service Revenue ............................................

1,120

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

400

Cash ......................................................................... Unearned Service Revenue...........................

12,000

Salaries and Wages Expense ................................ Cash ................................................................

11,000

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

28,000

Credit

1,200

1,120

400

12,000

11,000 28,000

ACR 4-4 (Continued) (b) (Continued) Date July 20 23 27

Account Titles

Debit

Advertising Expense ............................................... Accounts Payable...........................................

2,200

Unearned Service Revenue .................................... Service Revenue.............................................

10,000

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

15,000

Credit

2,200 10,000 15,000

Adjusting Entries 31

31 31

31 31 31

Insurance Expense.................................................. Prepaid Insurance .......................................... ($3,600 × 1/12)

300

Rent Expense........................................................... Prepaid Rent ...................................................

4,000

Supplies Expense.................................................... Supplies ..........................................................

1,250

Depreciation Expense ............................................. Accumulated Depreciation—Equipment ...... ($24,000 ÷ 4 × 1/12)

500

Interest Expense...................................................... Interest Payable .............................................. ($20,000 × 6% × 1/12)

100

Salaries and Wages Expense ................................. Salaries and Wages Payable .........................

11,000

Utilities Expense...................................................... Accounts Payable...........................................

800

Income Tax Expense ............................................... Income Taxes Payable ...................................

1,200

300

4,000 1,250

500

100

11,000 800 1,200

ACR 4-4 (Continued) (a), (c), (e), and (h) Cash July

July

1 Bal.

5,230 July

4,000

50,000

3,600

1,200

8,000

12,000

3,800

15,000

14 18

400 11,000

31 Bal.

52,630 Accounts Receivable

July

1 Bal. 20

1,200 28,000

July

31 Bal.

13,000

July

31 Bal.

July

Prepaid Insurance 3,600 July

10 27

1,200 15,000

300

1,250

4,000

3,300 Supplies

July

1 Bal. 6

690 July 3,800

July

31 Bal.

3,240 Prepaid Rent

July

8,000 July

July

31 Bal.

4,000

ACR 4-4 (Continued) (a), (c), (e), and (h) (Continued) Equipment July

24,000

July 31 Bal.

24,000 Accumulated Depreciation—Equipment July 31

500

July 31 Bal

500

Accounts Payable July 14

400 July 1 Bal. 20 31 July

400 2,200 800

31 Bal.

Interest Payable July 31 July 31 Bal.

3,000

100 100

Salaries and Wages Payable July 31

11,000

July 31 Bal.

11,000

Income Taxes Payable July 31 July 31 Bal.

1,200 1,200

ACR 4-4 (Continued) (a), (c), (e), and (h) (Continued) Unearned Service Revenue July 13 23

1,120 10,000

July 1 Bal. 16

1,120 12,000

July 31 Bal.

2,000

Notes Payable July 1

20,000

July 31 Bal.

20,000

Common Stock July 1 Bal. 2

3,600 50,000

July 31 Bal.

53,600

Retained Earnings July 1 Bal. July 31

2,000 6,770

July 31 Bal.

8,770

Service Revenue

July 31

July 13

1,120

28,000

10,000

39,120 July 31 Bal.

ACR 4-4 (Continued) (a), (c), (e), and (h) (Continued)

Salaries and Wages Expense July 18

11,000

July 31

11,000 July 31

July 31 Bal.

22,000

Rent Expense July 31

4,000 July 31

July 31 Bal.

4,000

0 Advertising Expense

July 20

2,200 July 31

July 31 Bal.

2,200

0 Supplies Expense

July 31

1,250 July 31

July 31 Bal.

1,250

ACR 4-4 (Continued) (a), (c), (e), and (h) (Continued)

Utilities Expense July 31

800 July 31

July 31 Bal.

800

0 Depreciation Expense

July

500 July 31

July 31 Bal.

500

0 Insurance Expense

July

300 July 31

July 31 Bal.

300

0 Interest Expense

July

100 July 31

July 31 Bal.

100

0 Income Tax Expense

July 31

1,200 July 31

July 31 Bal.

1,200

0 Income Summary

July

31 31

32,350 6,770 July 31 July 31 B al.

39,120 0

ACR 4-4 (Continued) (d) and (f) (Continued) GREEN RIVER COMPUTER CONSULTANTS Trial Balances July 31, 2017

Cash ............................................................... Accounts receivable ..................................... Prepaid insurance ......................................... Supplies ......................................................... Prepaid rent.................................................... Equipment ..................................................... Accumulated depreciation—equipment ...... Accounts payable ......................................... Interest payable ............................................. Salaries and wages payable ......................... Income taxes payable ................................... Unearned service revenue ........................... Notes payable................................................. Common stock .............................................. Retained earnings ......................................... Service revenue ............................................ Salaries and wages expense ........................ Rent expense ................................................. Advertising expense ..................................... Supplies expense .......................................... Utilities expense ............................................ Depreciation expense ................................... Insurance expense ........................................ Interest expense ............................................ Income tax expense ......................................

Before Adjustment

After Adjustment

Debit $ 52,630 13,000 3,600 4,490 8,000 24,000

Debit $ 52,630 13,000 3,300 3,240 4,000 24,000

Credit

$ $

2,200

2,000 20,000 53,600 2,000 39,120 11,000 2,200

$118,920 (Total debits = Total credits)

Credit

$118,920

22,000 4,000 2,200 1,250 800 500 300 100 1,200 $132,520

500 3,000 100 11,000 1,200 2,000 20,000 53,600 2,000 39,120

$132,520

ACR 4-4 (Continued) (g)

(1) GREEN RIVER COMPUTER CONSULTANTS Income Statement For the Month Ended July 31, 2017

Revenues Service revenue ............................................. Expenses Salaries and wages expense ........................ Rent expense ................................................. Advertising expense ..................................... Supplies expense .......................................... Utilities expense ............................................ Depreciation expense ................................... Insurance expense ........................................ Interest expense ............................................ Income tax expense ...................................... Total expenses...................................... Net income ..............................................................

$39,120 $22,000 4,000 2,200 1,250 800 500 300 100 1,200 32,350 $ 6,770

(2) GREEN RIVER COMPUTER CONSULTANTS Retained Earnings Statement For the Month Ended July 31, 2017 Retained earnings, July 1 ..................................... Add: Net income .................................................... Retained earnings, July 31 ...................................

$2,000 6,770 $8,770

ACR 4-4 (Continued) (g) (Continued) (3) GREEN RIVER COMPUTER CONSULTANTS Balance Sheet July 31, 2017 Assets Current assets Cash .......................................................... Accounts receivable ................................ Prepaid rent .............................................. Prepaid insurance .................................... Supplies .................................................... Total current assets ........................ Property, plant, and equipment Equipment ................................................ Less: Accumulated depreciation ............ Total assets .......................................................

$52,630 13,000 4,000 3,300 3,240 76,170 $24,000 500

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................... $ 3,000 Salaries and wages payable.................... 11,000 Interest payable........................................ 100 Income tax payable .................................. 1,200 Unearned service revenue ...................... 2,000 Total current liabilities........................ Long-term liabilities Notes payable........................................... Total liabilities ................................. Stockholders’ equity Common stock ......................................... $53,600 Retained earnings .................................... 8,770 Total stockholders’ equity.............. Total liabilities and stockholders’ equity ........

23,500 $99,670

$17,300 20,000 37,300

62,370 $99,670

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

ACR 4-4 (Continued) (h) Date July 31 31

Debit

Account Titles Service Revenue ..................................................... Income Summary ...........................................

39,120

Income Summary .................................................... Salaries and Wages Expense ....................... Rent Expense ................................................. Advertising Expense ..................................... Supplies Expense .......................................... Utilities Expense ............................................ Depreciation Expense ................................... Insurance Expense ........................................ Interest Expense ............................................ Income Tax Expense .....................................

32,350

Income Summary .................................................... Retained Earnings .........................................

6,770

Credit

39,120 22,000 4,000 2,200 1,250 800 500 300 100 1,200 6,770

(i) GREEN RIVER COMPUTER CONSULTANTS Post-Closing Trial Balance July 31, 2017 Cash .............................................................. Accounts receivable .................................... Prepaid insurance ........................................ Supplies ........................................................ Prepaid rent ................................................... Equipment ..................................................... Accumulated depreciation—equipment...... Accounts payable ........................................ Interest payable ............................................ Salaries and wages payable ........................ Income taxes payable .................................. Unearned service revenue ........................... Notes payable................................................ Common stock ............................................. Retained earnings ........................................

Debit $ 52,630 13,000 3,300 3,240 4,000 24,000

Credit

$100,170

500 3,000 100 11,000 1,200 2,000 20,000 53,600 8,770 $100,170

(Permanent accounts with debit balances = Permanent accounts with credit balances) LO 2-4 BT: AP Difficulty: Hard TOT: 180 min. AACSB: Analytic AICPA FC: Reporting

CT 4-1

FINANCIAL REPORTING PROBLEM

(a) Items that may result in adjusting entries for deferrals are: 1. 2. 3. 4. (b) 1. 2.

Deferred tax assets. Other current assets (prepaid expenses). Plant and equipment accumulated depreciation. Deferred revenue. Accrued expenses (interest expense, provision for income taxes, and other expense) Accrued revenues (other income)

(c) Depreciation and amortization expense was $7,946 (millions) in 2014 and $6,757 (millions) in 2013. Accumulated depreciation was reported in Note 3 to the consolidated financial statements. (d) The statement of cash flows (at the bottom) reports income taxes paid in 2014 of $10,026 (millions). The income statement reports income tax expense of $13,973 (millions). LO 2-4 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Communication and Analytic AICPA FC: Reporting AICPA PC: Communication

CT 4-2

COMPARATIVE ANALYSIS PROBLEM

Accounts that provide evidence of the use of accrual accounting are: Balance Sheet

Income Statement

(a) Columbia Company 1. Accounts receivable, net 2. Prepaid expenses 3. Income taxes payable 4. Accrued liabilities

1. 2. 3. 4.

Sales Insurance (or supplies) expense Income tax expense Miscellaneous expense

(b) VFC 1. Other current assets 2. Accounts receivable, less allowance for doubtful accounts 3. Accrued liabilities 4. Deferred income taxes

1. Insurance (or supplies) expense 2. Sales 3. Miscellaneous expense 4. Income tax expense

LO 1 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 4-3

COMPARATIVE ANALYSIS PROBLEM

Accounts that provide evidence of the use of accrual accounting are: Balance Sheet

Income Statement

(a) Amazon Company 1. Accounts receivable, net and other 2. Accrued expenses and other 3. Unearned revenue

1. Product or Service Sales 2. Interest expense 3. Product or Service revenue

(b) Wal-Mart 1. Prepaid expenses 2. Accumulated depreciation 3. Accounts receivable, net 4. Accrued liabilities 5. Accrued income taxes

1. 2. 3. 4. 5.

Insurance (or supplies) expense Depreciation expense Sales Miscellaneous expense Income tax expense

LO 1 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 4-4

INTERPRETING FINANCIAL STATEMENTS

LASER RECORDING SYSTEMS (a)

Laser Recording is handling legal expense via an accrued expense adjustment. This is explained by the fact that accrued professional services increased during the year.

(b)

Each of the three adjustments is an accrued expense adjustment. Since this type of adjustment increases expenses, net income is decreased by each adjustment.

(c)

In recording accrued interest, Laser Recording debited Interest Expense and credited Interest Payable.

LO 3 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 4-5

REAL-WORLD FOCUS

(a) The SEC was created by Congress after the stock market crash of 1929. The SEC was created to restore investor confidence in our capital markets by providing more structure and government oversight. (b) Division of Corporation Finance. The Division of Corporation Finance oversees corporate disclosure of important information to the investing public. Corporations are required to comply with regulations pertaining to disclosure that must be made when stock is initially sold and then on a continuing and periodic basis. The Division’s staff routinely reviews the disclosure documents filed by companies. The staff also provides companies with assistance interpreting the Commission’s rules and recommends to the Commission new rules for adoption. Division of Trading and Markets. The Division of Trading and Markets establishes and maintains standards for fair, orderly, and efficient markets. It does this primarily by regulating the major securities market participants: broker-dealer firms; self-regulatory organizations (SROs), which include the stock exchanges and the National Association of Securities Dealers (NASD), Municipal Securities Rulemaking Board (MSRB), and clearing agencies (SROs that help facilitate trade settlement); transfer agents (parties that maintain records of stock and bond owners); and securities information processors. (A self-regulatory organization is a member organization that creates and enforces rules for its members based on the federal securities laws. SROs, which are overseen by the SEC, are the front line in regulating broker-dealers.) Division of Investment Management. The Division of Investment Management oversees and regulates the $15 trillion investment management industry and administers the securities laws affecting investment companies (including mutual funds) and investment advisers. In applying the federal securities laws to this industry, the Division works to improve disclosure and minimize risk for investors without imposing undue costs on regulated entities.

CT 4-5 (Continued) Division of Enforcement. The Division of Enforcement investigates possible violations of securities laws, recommends Commission action when appropriate, either in a federal court or before an administrative law judge, and negotiates settlements on behalf of the Commission. While the SEC has civil enforcement authority only, it works closely with various criminal law enforcement agencies throughout the country to develop and bring criminal cases when the misconduct warrants more severe action. Division of Economic and Risk Analysis The Division of Economic and Risk Analysis assists the Commission in executing its mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation by integrating robust economic analysis and rigorous data analytics into the work of the SEC. The Division has a broad role in Commission activities, interacting with nearly every Division and Office, providing sophisticated and data-driven economic and risk analyses to help inform the agency's policymaking, rulemaking, enforcement, and examinations. There are two main functions for the Division. First, DERA staff provide vital support in the form of economic analyses in support of Commission rulemaking and policy development. Second, the Division also provides economic analysis and research, risk assessment, and data analytics to critically support the agency's resources on matters presenting the greatest perceived risks in litigation, examinations, and registrant reviews, as well as providing economic support for enforcement matters. ( c ) Office of the Chief Accountant The Chief Accountant is appointed by the Chairman to be the principal adviser to the Commission on accounting and auditing matters. The Office of the Chief Accountant assists the Commission in executing its responsibility under the securities laws to establish accounting principles, and for overseeing the private sector standards-setting process. The Office works closely with the Financial Accounting Standards Board, whose accounting standards the Commission has recognized as generally accepted for purposes of the federal securities laws, as well as the International Accounting Standards Board and the American Institute of Certified Public Accountants.

CT 4-5 (Continued) In addition to its responsibility for accounting standards, the Commission is responsible for the approval or disapproval of auditing rules put forward by the Public Company Accounting Oversight Board, a private-sector regulator established by the Sarbanes-Oxley Act to oversee the auditing profession. The Commission also has thorough-going oversight responsibility for all of the activities of the PCAOB, including approval of its annual budget. To assist the Commission in the execution of these responsibilities, the Office of the Chief Accountant is the principal liaison with the PCAOB. The Office also consults with registrants and auditors on a regular basis regarding the application of accounting and auditing standards and financial disclosure requirements. Because of its expertise and ongoing involvement with questions concerning the financial books and records of public companies registered with the SEC, the Office of the Chief Accountant is often called upon to assist in addressing issues that arise in the context of Commission enforcement actions. LO None BT: S Difficulty: Hard TOT: 60 min. AACSB: Communication, Technology and Reflective Thinking AICPA PC: Communication

CT 4-6

(a)

GROUP DECISION CASE

ABBEY PARK Income Statement For the Quarter Ended March 31, 2017 Revenues Rent revenue ($83,000 – $21,000) ................ Expenses Salaries and wages expense [$27,600 + ($290 X 3)] ............................ Advertising expense ($4,200 + $110) ........... Supplies expense ($4,500 – $600)................ Maintenance and repairs expense ($2,800 + $1,040) .................................... Insurance expense ($7,200 X 3/12) .............. Utilities expense ($1,500 + $240).................. Depreciation expense ................................... Interest expense ($20,000 X 7% X 3/12) ....... Total expenses....................................... Net income ............................................................

$62,000 $28,470 4,310 3,900 3,840 1,800 1,740 800 350 45,210 $16,790

(Revenues are recognized when a service has been provided and expenses are recognized when an asset is used up or a service is used)

(b) The generally accepted accounting principles pertaining to the income statement that were not recognized by Trudy were the revenue recognition principle and the expense recognition principle. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. The revenue of $21,000 for summer rentals has not been recognized and, therefore, should not be reported in income for the quarter ended March 31. The expense recognition principle dictates that efforts (expenses) be matched with results (revenues) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in March but not paid until April. The difference in expenses was $8,310 ($45,210 – $36,900). The overstatement of revenues ($21,000) plus the understatement of expenses ($8,310) equals the difference in reported income of $29,310 ($46,100 – $16,790). LO 2-4 BT: AN Difficulty: Hard Tot: 60 min. AACSB: Communication and Reflective Thinking AICPA PC: Interaction, Leadership and Communication

CT 4-7

COMMUNICATION ACTIVITY

(a) Accrual-basis accounting records the events that change an entity’s financial statements in the periods in which the events occur, rather than in the periods in which the entity receives or pays cash. Information presented on an accrual-basis is useful because it reveals relationships that are likely to be important in predicting future results. Conversely, under cash-basis accounting, revenue is recorded only when cash is received, and an expense is recognized only when cash is paid. As a result, the cash-basis of accounting often results in misleading financial statements. (b) Politicians might desire a cash-basis accounting system over an accrualbasis system because if an accrual accounting system is used, it could mean that billions in government liabilities presently unrecorded would have to be reported in the federal budget immediately. Currently, the federal government is facing a huge budget deficit. The recognition of these additional liabilities would make the deficit even worse. This is not what politicians would like to see and be held responsible for. (c) Dear Senator, It is my understanding, after having taken a beginning course in accounting principles, that the federal government uses a cash-basis accounting system rather than an accrual-basis accounting system. I am shocked at such a practice! There must be billions of dollars of liabilities hidden in many contracts that have not been recorded because they haven’t been paid yet. I realize that the deficit would dramatically increase if we were to implement an accrual system, but in all fairness, we citizens should be given a more accurate picture of what our government is up to. Sincerely, CONCERNED STUDENT LO 1 BT: S Difficulty: Hard TOT: 45 min. AACSB: Communication and Reflective Thinking AICPA PC: Communication AICPA BB: Critical Thinking

CT 4-8

ETHICS CASE

(a) The stakeholders in this situation are:    (b) 1.

Tim Allen, controller. The president of Wells Company. Company stockholders and potential stockholders. It is unethical for the president to place pressure on Tim to misstate net income by requesting him to prepare incorrect adjusting entries.

2. It is customary for adjusting entries to be dated as of the balance sheet date although the entries are prepared at a later date. Tim did nothing unethical by dating the adjusting entries December 31. (c) Tim can accrue revenues and defer expenses through the preparation of adjusting entries and be ethical so long as the entries reflect economic reality. Intentionally misrepresenting the company’s financial condition and its results of operations is unethical (it is also illegal). LO 2, 3 BT: E Difficulty: Hard TOT: 30 min. AACSB: Ethics AICPA PC: Personal Demeanor

CT 4-9

ALL ABOUT YOU ACTIVITY

The following is a personal balance sheet using the classified presentation. Note that the earnings from the part-time job as well as the tuition costs are not listed since neither of those items is an asset, liability, or equity item. Assets Current assets Cash ................................................................. Money market account ................................... Certificate of deposit....................................... Accounts receivable from brother .................. Total current assets.................................

$1,200 1,800 3,000 300

Property, plant, and equipment Automobile ...................................................... Video and stereo equipment .......................... Home computer ............................................... Total assets..............................................

7,000 1,250 800

$ 6,300

9,050 $15,350

Liabilities and Owner’s Equity Current liabilities Current portion of automobile loan ............... Current portion of credit card payable .......... Total current liabilities............................. Long-term liabilities Student loan .................................................... Automobile loan .............................................. Credit card payable ......................................... Total long-term liabilities ........................ Total liabilities....................................

$1,500 150 $ 1,650 5,000 4,000 1,650 10,650 12,300

Equity M. Y. Own, Capital ($15,350 – $12,300) ..........

3,050

Total liabilities and equity ...................

$15,350

LO None BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 4-10

FASB CODIFICATION ACTIVITY

(a) Revenues are “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.” (b) Compensation is reciprocal transfers of cash or other assets in exchange for services performed. LO 1 BT: C Difficulty: Medium TOT: 20 min. AACSB: Communication and Technology AICPA FC: Reporting AICPA PC: Communication

IFRS 4-1

INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) Note 1.25 states that revenue includes shipment and transportation costs re-billed to customers only when these costs are included in products’ selling prices as a lump sum. Revenue is presented net of all forms of discount. In particular, payments made in order to have products referenced or, in accordance with agreements, to participate in advertising campaigns with the distributors, are deducted from related revenue. (b) Note 1.25 state that revenue and the corresponding trade receivables are reduced by the estimated amount of such returns, and a corresponding entry is made to inventories. The estimated rate of returns is based on statistics of historical return. (c) Louis Vuitton could have adjustments for prepayments such as: Depreciation expense, Amortisation of intangible assets, Deferred tax assets. (d) Louis Vuitton could have adjustments for accruals such as: Finance costs (interest expense), Tax liabilities, and Trade and other payables. LO 2, 3 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Communication, Technology and Diversity AICPA FC: Reporting AICPA PC: Communication AICPA BB: International/Global Perspective

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

CHAPTER 5 Merchandising Operations and the Multiple-Step Income Statement Learning Objectives 1. 2. 3. 4. 5. 6. *7.

Describe merchandising operations and inventory systems. Record purchases under a perpetual inventory system. Record sales under a perpetual inventory system. Prepare a multiple-step income statement and a comprehensive income statement. Determine cost of goods sold under a periodic inventory system. Compute and analyze gross profit rate and profit margin. Record purchases and sales of inventory under a periodic inventory system.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item 1. 2. 3. 4. 5. 6.

LO 1 1 1 1 1 3

BT C C C C AP C

Item 7. 8. 9. 10. 11.

LO 3 3 3 3 2

Item

K AP C C AP

Questions 12. 4 AP 13. 3 C 14. 4 C 15. 4 K 16. 1 K

17. 18. 19. 20. 21.

4 2 2 5 5

K K K K K

22. 23. 24. 25. 26.

6 6 6 6 7*

K C AN C AP

10. 11. 12.

5 6 6

AP AP AP

13. 14.

6 7

C AP

1. 2. 3.

1, 4 2, 3 3

AP AP AP

4. 5. 6.

2 4 4

AP AP AP

1. 2.

1 2

C AP

3. 4.

3 4

AP AP

Brief Exercises 7. 4 AP 8. 5 AP 9. 5 AP Do It! Exercises 4. 5 AP 5. 5 AP

AP AP AP

Exercises 7. 4, 6 AP 8. 4, 6 AP 9. 4, 6 AP

10. 11. 12.

4 4 5

AP AP AP

13. 14. 15.

5 6 7

AP C AP

Problems: Set A 5. 4 AP

4, 5

5, 7*

4, 5, 6

1. 2. 3. 1. 2.

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

AP AP AP

4. 5. 6. 3.

AP AP

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

AP AP

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Journalize, post, prepare partial income statement, and calculate ratios.

Simple

30–40

Journalize purchase and sale transactions under a perpetual system.

Moderate

20–30

Journalize, post, and prepare trial balance and partial income statement.

Simple

30–40

Prepare financial statements and calculate profitability ratios.

Moderate

40–50

Prepare a correct multiple-step income statement.

Complex

20–30

Journalize, post, and prepare adjusted trial balance and financial statements.

Moderate

40–50

Determine cost of goods sold and gross profit under a periodic system.

Moderate

40–50

Calculate missing amounts and assess profitability.

Moderate

20–30

*9A

Journalize, post, and prepare trial balance and partial income statement under a periodic system.

Simple

30–40

ANSWERS TO QUESTIONS 1.

(a) Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service company. (b) The measurement of income is conceptually the same. In both types of companies, net income (or loss) results from the matching of expenses with revenues.

LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting 2.

The components of revenues and expenses differ as follows:

Revenues Expenses

Merchandising Sales revenue Cost of Goods Sold and Operating

Service Fees, Rents, etc. Operating (only)

LO 1 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting 3.

Under a periodic inventory system the company does not keep track of how many units are on hand. Instead it takes a physical count at the end of the period to determine ending inventory and cost of goods sold. Under a perpetual system the company adjusts its inventory account each time it purchases or sells inventory. Thus it always has a record of its available inventory. Having knowledge of inventory balances helps a company avoid lost sales due to “stock-outs” as well as carrying too much inventory on hand (which results in additional storage and handling costs). The purchasing department can make better decisions with the aid of perpetual inventory records.

LO 1 BT: C Diff: M TOT: 4 min. AACSB: None AICPA FC: Reporting 4.

(a) The income measurement process is as follows: Sales Revenue

Less

Cost of Goods Sold

Equals

Gross Profit

Less

Operating Expenses

Equals

Net Income (Loss)

(b) Income measurement in a merchandising company differs from a service company as follows: (a) sales are the primary source of revenue and (b) expenses are divided into two main categories: cost of goods sold and operating expenses. LO 1 BT: C Diff: M TOT: 4 min. AACSB: None AICPA FC: Reporting 5.

Sales revenue.......................................................................................................... Cost of goods sold ................................................................................................... Gross profit..............................................................................................................

$100,000 70,000 $ 30,000

LO 1 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 6.

Agree. In accordance with the revenue recognition principle, sales revenues are generally considered to be recognized when the goods are transferred from the seller to the buyer; that is, when the performance obligation is satisfied. The recognition of revenue is not dependent on the collection of credit sales.

LO 3 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement & Reporting

(a)

The primary source documents are (1) cash sales—cash register tapes and (2) credit sales— sales invoice.

(b) The entries are: Debit Cash sales—

Credit sales—

Cash ................................................................... Sales Revenue............................................

Credit

XX XX

Cost of Goods Sold ............................................. Inventory .....................................................

Accounts Receivable........................................... Sales Revenue............................................

Cost of Goods Sold ............................................. Inventory .....................................................

LO 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 8.

July 19

Cash ($800 – $8) .......................................................................... Sales Discounts ($800 X 1%)........................................................ Accounts Receivable ($900 – $100) ......................................

792 8 800

LO 3 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 9.

Shipping unwanted goods to customers is generally considered unethical behavior. In addition, if proper accounting is applied, in most cases it won’t achieve the desired result of increasing sales. If it is expected that the unwanted goods will be shipped back to the seller, then they should not be treated as sales in the first place. (Note: The practice of shipping more goods than were ordered in order to meet sales goals and get rid of extra inventory is referred to as channel stuffing.)

LO 3 BT: E Diff: H TOT: 5 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical Thinking 10.

In most industries returns are not significant, and they are therefore accounted for as they occur. When returns are expected to be significant, the company should make an adjusting entry at the end of the period to estimate the amount of returns that will result from the period’s sales, so that revenues will not be overstated during the period.

LO 3 BT: C Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 11.

July 24

Accounts Payable ($1,900 – $300) ............................................... Cash ($1,600 – $32).............................................................. Inventory ($1,600 X 2%)........................................................

1,600 1,568 32

LO 2 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 12.

Gross profit .................................................................................................... Less: Net income .......................................................................................... Operating expenses.......................................................................................

LO 4 BT: AP Diff: E TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

$560,000 230,000 $330,000

13.

Its current terms of 1/10, n/30 means that customers get a 1% discount if they pay within 10 days, otherwise they have to pay the full amount within 30 days. If they switch to 2/10, n/45 customers would get a 2% discount for paying within 10 days, otherwise they have to pay the full amount in 45 days. By offering 2%, more of Mai’s customers would likely pay within the 10 day period. Management would have to determine whether it is worth the additional cost to be paid quicker. Also, by extending the full payment period from 30 to 45 days, Mai would end up receiving its money even later from its slow payers.

LO 2 & 3 BT: E Diff: H TOT: 5 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical Thinking 14.

The gain on the sale of the plant represents a one-time gain. That is, it won’t be recurring next year. If you eliminate the effect of this one-time gain, then the company’s income actually declined by $5 million relative to the prior year. When predicting future earnings investors frequently place little weight on non-recurring events such as this.

LO 4 BT: AN Diff: H TOT: 4 min. AACSB: Analytic & Reflective Thinking AICPA BB: Critical Thinking 15.

There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit.

LO 4 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting 16.

The normal operating cycle for a merchandising company is likely to be longer than for a service company because inventory must first be purchased and sold, and then the receivables must be collected.

LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting 17. Apple uses the term gross margin. Total gross margin increased by $6,233 million. LO 4 BT: AP Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 18. Of the merchandising accounts, only Inventory will appear in the post-closing trial balance. LO 4 BT: E Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 19. Businesses most likely to use a perpetual inventory system would include automobile dealerships, equipment supply companies, and other companies selling products having a high unit-value. With automation, perpetual systems are becoming increasingly cost-effective. LO 1 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting 20. Accounts Purchase Returns and Allowances Purchase Discounts Freight-In

(a) Added/Deducted Deducted Deducted Added

LO 5 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

(b) Normal Balance Credit Credit Debit

21. (a)

X = Purchase returns and allowances and Y = Purchase discounts, or vice versa. (b) X = Freight-in. (c) X = Cost of goods purchased. (d) X = Ending inventory.

LO 5 BT: C Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting 22. Profitability is affected by gross profit, as measured by the gross profit rate, and by management’s ability to control operating expenses, as measured by the profit margin. LO 6 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting 23. Factors affecting a company’s gross profit rate include selling products with a higher (or lower) “markup,” increased competition that results in lower selling prices, and price increases or decreases from suppliers. LO 6 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting 24. Gross profit represents the amount by which sales exceeds cost of goods sold. In order for the company to be profitable, gross profit must exceed the company’s operating expenses. Before the selling price is cut, the company should do a careful analysis estimating what its gross profit and operating expenses would be if more units were sold at a lower selling price. In addition, a big concern is what the likely reaction of competitors will be. If competitors also cut their price, then volume will not increase, and the company’s net income will be lower. LO 6 BT: AN Diff: M TOT: 4 min. AACSB: Analytic AICPA BB: Critical Thinking 25. Mark Coney should calculate the company’s quality of earnings ratio. This is calculated by dividing net cash provided by operating activities by net income. A measure significantly below 1 would suggest that the company might be using aggressive accounting techniques to recognize income early. LO 6 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA PC: Problem Solving *26. July 24

Accounts Payable ($1,900 – $400) .................................. Cash ($1,500 – $30) ............................................... Purchase Discounts ($1,500 X 2%) ........................

LO 7 BT: AP Diff: M TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

1,500 1,470 30

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a) (b) (c) (d) (e) (f)

Sales = $181,500 ($71,900 + $109,600). Cost of goods sold = $41,200 ($71,200 – $30,000). Gross profit = $38,000 ($108,000 – $70,000). Operating expenses = $17,900 ($30,000 – $12,100). Operating expenses = $8,500 ($38,000 (from c) – $29,500). Net income = $63,400 ($109,600 – $46,200).

LO 1, 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-2 Rita Company Inventory .............................................................. Accounts Payable ........................................

900

Linus Company Accounts Receivable........................................... Sales Revenue..............................................

900

Cost of Goods Sold ............................................. Inventory.......................................................

900

900 590 590

LO 2, 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-3 (a) March 2 2 (b)

6 6

Accounts Receivable ....................... Sales Revenue ........................

800,000

Cost of Goods Sold.......................... Inventory..................................

540,000

Sales Returns and Allowances ....... Accounts Receivable ..............

140,000

Inventory........................................... Cost of Goods Sold ................

94,000

800,000 540,000 140,000 94,000

BRIEF EXERCISE 5-3 (Continued) (c)

Cash ($660,000 – $13,200) ............... Sales Discounts ($660,000 X 2%) .... Accounts Receivable ($800,000 – $140,000) ..........

646,800 13,200 660,000

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-4 (a) (b) (c)

March 2 6 12

Inventory........................................... Accounts Payable ...................

800,000

Accounts Payable ............................ Inventory..................................

140,000

Accounts Payable ($800,000 – $140,000) .................... Cash ($660,000 – $13,200) ...... Inventory ($660,000 X 2%) ......

800,000

140,000 660,000 646,800 13,200

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-5 BARTO COMPANY Income Statement (Partial) For the Month Ended October 31, 2017 Sales Sales revenue ($300,000 + $150,000) ..................... Less: Sales returns and allowances ..................... Sales discounts ............................................ Net sales ......................................................................

$450,000 $19,000 5,000

LO 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

24,000 $426,000

BRIEF EXERCISE 5-6 As the name suggests, numerous steps are required in determining net income in a multiple-step statement. Item

Section

Gain on disposal of plant assets Cost of goods sold Depreciation expense Sales returns and allowances

Other revenues and gains Cost of goods sold Operating expenses Sales revenues

LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-7 (a) Service revenue ................................................... Less: Salaries and wages expense .............................. Rent expense ....................................................... Utilities expense .................................................. Advertising expense............................................ Total expenses............................................... Net Income ...........................................................

$ 62,500 $28,000 10,400 3,100 1,800 43,300 $19,200

(b) KAREN WEIGEL INC. Comprehensive Income Statement For the Year Ended December 31, 2017 Net income................................................................. Other comprehensive income (net of tax) ............... Comprehensive income ............................................ LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

$ 19,200 400 $ 19,600

BRIEF EXERCISE 5-8 Beginning inventory.................................................. Add: Purchases ....................................................... Cost of goods available for sale............................... Less: Ending inventory ............................................ Cost of goods sold ....................................................

$ 67,000 380,000 447,000 50,000 $397,000

LO 5 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-9 Purchases .................................................................. Less: Purchase returns and allowances................ Purchase discounts ...................................... Net purchases............................................................

$404,000 $13,000 9,000

Net purchases............................................................ Add: Freight-in........................................................... Cost of goods purchased .........................................

22,000 $382,000 $382,000 16,000 $398,000

LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-10 Net sales .................................................................... Beginning inventory.................................................. Add: Cost of goods purchased* ............................. Cost of goods available for sale............................... Less: Ending inventory ............................................ Cost of goods sold .................................................... Gross profit................................................................

$612,000 $ 60,000 398,000 458,000 90,000

*Information taken from Brief Exercise 5-9. LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

368,000 $244,000

BRIEF EXERCISE 5-11 (a) Profit margin = $32,500 ÷ $250,000 = 13.0% The profit margin measures the extent by which selling price covers all expenses. In this case 87% of sales revenues cover all expenses (cost of goods sold, operating expenses, and other expenses) leaving 13% of revenues as net income. Or, for every dollar of net sales, the company earns $0.13 in net income. (b) Gross profit rate = ($250,000 – $150,000) ÷ $250,000 = 40.0% The gross profit rate measures the margin by which selling price exceeds cost of goods sold. In this case, 40% of sales revenues remain (after deducting cost of goods sold) to cover all other expenses and produce net income. Or, for every dollar of net sales, the company generates $0.40 in gross profit. LO 6 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-12 (a) Profit margin = $68,000 ÷ $800,000 = 8.5% The profit margin measures the extent by which selling price covers all expenses. In this case, 91.5% of sales revenues cover all expenses (cost of goods sold and operating expenses) leaving 8.5% of revenues as net income. Or, for every dollar of net sales, the company earns $0.085 in net income. (b) Gross profit rate = ($800,000 – $520,000) ÷ $800,000 = 35.0% The gross profit rate measures the margin by which selling price exceeds cost of goods sold. In this case, 35% of sales revenues remain (after deducting cost of goods sold) to cover operating expenses and produce net income. Or, for every dollar of net sales, the company generates $0.35 in gross profit. LO 6 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 5-13 The quality of earnings ratio is calculated by dividing net cash provided by operating activities by net income. For Cabo Corporation this would be $221,200 ÷ $346,000 = .64. This is significantly less than 1, which suggests that the company may be using aggressive accounting techniques in order to recognize income early. The factors that are causing net income to differ from net cash provided by operating activities should be examined. LO 6 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Measurement

*BRIEF EXERCISE 5-14 (a) March 2 (b)

(c)

Purchases......................................... Accounts Payable ...................

800,000

Accounts Payable ............................ Purchase Returns and Allowances ...........................

95,000

Accounts Payable ($800,000 – $95,000) ...................... Cash ($705,000 – $14,100) ...... Purchase Discounts ($705,000 X 2%) ....................

800,000

95,000 705,000

LO 7 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

690,900 14,100

SOLUTIONS TO DO IT! EXERCISES DO IT! 5-1 1. 2. 3. 4.

True False. Under a perpetual inventory system, a company determines the cost of goods sold at each time a sale occurs. False. Both service and merchandising companies are likely to use accounts receivable. True.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement

DO IT! 5-2 Oct. 5

Oct. 8

Inventory ........................................................................ 5,000 Accounts Payable............................................. (To record goods purchased on account) Accounts Payable ..................................................... Inventory ........................................................... (To record return of defective goods)

5,000

640 640

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 5-3 Oct. 5

Oct. 8

Accounts Receivable .................................................... 5,000 Sales Revenue .................................................. (To record credit sales)

5,000

Cost of Goods Sold ....................................................... 3,000 Inventory ........................................................... (To record cost of goods sold on account)

3,000

Sales Returns and Allowances ................................ Accounts Receivable........................................ (To record credit granted for receipt of returned goods)

640

Inventory.................................................................... Cost of Goods Sold .......................................... (To record scrap value of goods returned)

240

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

640

240

DO IT! 5-4 BERLIN CORP. Income Statement For the Year Ended December 31, 2017 Sales Sales revenue............................................... Less: Sales returns and allowances........... Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses........................................... Income from operations .................................... Other revenues and gains ................................. Other expenses and losses............................... Income before income taxes ............................. Income tax expense........................................... Net income .........................................................

$592,000 40,000 $552,000 156,000 396,000 186,000 210,000 12,700 (13,300)

(600) 209,400 62,820 $146,580

(Revenues – Contra revenues – Cost of goods sold – Operating expenses = Income from operations) BERLIN CORP. Comprehensive Income Statement For the Year Ended December 31, 2017 Net income ............................................................... Other comprehensive Income (net of $1,620*) ...... Comprehensive income .......................................... * $5,400 × .30 LO 4 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

$146,580 3,780 $150,360

DO IT! 5-5 (a) Cost of goods purchased $161,400: Purchases – Purchase returns and allowances – Purchase discounts + Freight-in $162,500 – $3,600 – $5,900 + $8,400 (b) Cost of goods sold $165,170: Beginning inventory + Cost of goods purchased – Ending inventory $31,720 + $161,400 – $27,950 LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 5-6 Gross profit rate

2017 ($150,000–$90,000) = 40% $150,000

2016 ($120,000–$72,000) = 40% $120,000

Profit margin

$10,000 ÷ $150,000 = 6.7%

$22,000 ÷ $120,000 = 18.3%

The company’s gross profit rate remained constant, however, its profit margin decreased significantly due to sharp increase in its operating costs as a percentage of sales. They increased from 13.3% ($16,000 ÷ $120,000) to 21.3% ($32,000 ÷ $150,000). LO 6 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 5-1 (a) (1) April (2) April (3) April (4) April

5 6 7 8

(5) April 15

Inventory.......................................... Accounts Payable....................

28,000

Inventory.......................................... Cash .........................................

700

Equipment ....................................... Accounts Payable....................

30,000

Accounts Payable ........................... Inventory ..................................

3,600

Accounts Payable ($28,000 – $3,600)......................... Cash ($24,400 – $488) ............. Inventory [($28,000 – $3,600) X 2%] .....

Accounts Payable ($28,000 – $3,600) .... Cash..................................................

(b) May 4

28,000 700 30,000 3,600 24,400 23,912 488 24,400 24,400

LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-2 Sept. 6 9 10 12

Inventory........................................................ Accounts Payable..................................

1,650

Inventory........................................................ Cash .......................................................

Accounts Payable ......................................... Inventory ................................................

Accounts Receivable .................................... Sales Revenue .......................................

690

Cost of Goods Sold....................................... Inventory ................................................

520

1,650 50 66 690 520

EXERCISE 5-2 (Continued) Sept. 14 14 20

Sales Returns and Allowances ..................... Accounts Receivable .............................

Inventory ........................................................ Cost of Goods Sold................................

Accounts Receivable..................................... Sales Revenue........................................

760

Cost of Goods Sold ....................................... Inventory.................................................

570

45 34 760 570

LO 2, 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-3 (a) (1) Dec. 3

Accounts Receivable ................... Sales Revenue......................

500,000

Cost of Goods Sold ..................... Inventory ...............................

330,000

Sales Returns and Allowances ... Accounts Receivable ...........

25,000

Cash ($475,000 – $4,750) ............. Sales Discounts [($500,000 – $25,000) X 1%] ..... Accounts Receivable ($500,000 – $25,000) .........

470,250

Cash..................................................... Accounts Receivable ($500,000 – $25,000) ................

475,000

(2) Dec. 8 (3) Dec. 13

(b) Jan. 2

500,000

330,000 25,000

4,750 475,000

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

475,000

EXERCISE 5-4 (a) June 10 11 12 19

(b) June 10

Inventory ................................................. Accounts Payable ...........................

9,000

Inventory ................................................. Cash .................................................

400

9,000 400

Accounts Payable........................................ Inventory...............................................

600

Accounts Payable ($9,000 – $600).............. Cash ($8,400 – $252) ............................ Inventory ($8,400 X 3%) .......................

8,400

Accounts Receivable................................... Sales Revenue......................................

9,000

Cost of Goods Sold ..................................... Inventory...............................................

5,000

600 8,148 252 9,000 5,000

No entry

Sales Returns and Allowances ................... Accounts Receivable ...........................

600

Inventory ...................................................... Cost of Goods Sold..............................

310

Cash ($8,400 – $252).................................... Sales Discounts ($8,400 X 3%) ................... Accounts Receivable ($9,000 – $600)..................................

8,148 252

600 310

LO 2, 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

8,400

EXERCISE 5-5 DOQE COMPANY Income Statement (Partial) For the Year Ended October 31, 2017 Sales Sales revenue .................................................... Less: Sales returns and allowances ............... Sales discounts ...................................... Net sales ....................................................................

$900,000 $22,000 13,500

35,500 $864,500

Note: Freight-out is a selling expense. LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-6 (a)

LIEU CO. Income Statement For the Month Ended January 31, 2017 Sales

Sales revenue ............................................. $370,000 Less: Sales returns and allowances ........ $20,000 Sales discounts .............................. 8,000 28,000 Net sales............................................................. 342,000 Cost of goods sold ............................................ 212,000 Gross profit ........................................................ 130,000 Operating expenses Salaries and wages expense ..................... 60,000 Rent expense.............................................. 32,000 Insurance expense..................................... 12,000 Freight-out .................................................. 7,000 Total operating expenses .................. 111,000 Income before income taxes............................. 19,000 Income tax expense........................................... 5,000 Net income ......................................................... $ 14,000 (Revenues–Contra-revenues – Cost of goods sold – Operating expenses = Income before income taxes).

EXERCISE 5-6 (Continued) (b) LIEU CO. Comprehensive Income Statement For the Month Ended January 31, 2017 Net income ............................................................................................. $14,000 Other comprehensive income (net of $400 tax) ................................... 2,000 Comprehensive income ........................................................................ $16,000 (c) Profit margin =

$14,000

= 4.1% $342,000 $130, 000 Gross profit rate = = 38.0% $342, 000

LO 4, 6 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-7 (a) Yoste Company Sales ..................................................................................... *Sales returns and allowances ($90,000 – $84,000) ............ Net sales ...............................................................................

$ 90,000 (6,000) $ 84,000

Net sales ............................................................................... Cost of goods sold .............................................................. *Gross profit ..........................................................................

$ 84,000 (58,000) $ 26,000

Gross profit .......................................................................... Operating expenses............................................................. *Net income ...........................................................................

$ 26,000 (14,380) $ 11,620

Noone Company *Sales ($100,000 + $5,000) .................................................... Sales returns and allowances ............................................. Net sales ...............................................................................

$105,000 (5,000) $100,000

Net sales ............................................................................... *Cost of goods sold ($100,000 – $40,000) ........................... Gross profit ..........................................................................

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

Gross profit .......................................................................... *Operating expenses ($40,000 – $17,000)............................ Net income ........................................................................... *Indicates missing amount

$ 40,000 (23,000) $ 17,000

EXERCISE 5-7 (Continued) (b)

Yoste

Noone

Profit margin

$11,620 ÷ $84,000 = 14%

$17,000 ÷ $100,000 = 17%

Gross profit rate

$26,000 ÷ $84,000 = 31%

$40,000 ÷ $100,000 = 40%

(c) Noone has a higher profit margin than Yoste. Each dollar of net sales by Noone results in 17 cents of net income compared to only 14 cents for Yoste. Noone also has a higher gross profit rate. For each dollar of Noone’s net sales, 60 cents is required to cover cost of goods sold leaving 40 cents to cover other expenses and produce net income. Yoste’s gross profit of .31 indicates that only 31 cents of each dollar of net sales is available to cover other expenses and produce net income. LO 4, 6 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic Communication AICPA FC: Reporting AICPA PC: Communication

EXERCISE 5-8 (a)

DARREN COMPANY Income Statement For the Year Ended December 31, 2017 Sales Sales revenue .............................. Less: Sales discounts................. Net sales.............................................. Cost of goods sold ............................. Gross profit ......................................... Operating expenses Salaries and wages expense ...... Depreciation expense ................. Utilities expense.......................... Total operating expenses................... Income from operations .....................

$2,210,000 160,000 $2,050,000 987,000 1,063,000 465,000 310,000 110,000 885,000 178,000

EXERCISE 5-8 (Continued) Other revenues and gains Interest revenue........................... Other expenses and losses Loss on disposal of plant assets .............................. Interest expense .......................... Income before income taxes .............. Income tax expense............................ Net income ..........................................

65,000 83,500 71,000

154,500 88,500 25,000 $ 63,500

(Revenues – contra revenues – Cost of goods sold – Operating expenses = Income from operations) (b) Profit margin: $63,500 ÷ $2,050,000 = 3% Gross profit rate: $1,063,000 ÷ $2,050,000 = 52% (c) During the current year Darren had a loss on the sale of property, plant, and equipment of $83,500. This loss is not part of operating income, and it is most likely a non-recurring event, meaning that we wouldn’t expect it to happen again next year. If we ignore this loss, then Darren Company’s net income would have been $147,000 ($63,500 + $83,500) and its profit margin would have been 7.2% ($147,000 ÷ $2,050,000). Therefore, while the loss is not good news, it is less of a concern than a similar drop in income from operations. LO 4, 6 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-9 (a)

THE CLOROX COMPANY Income Statement For the Year Ended June 30, 2017 (amounts in millions) Sales Sales revenue............................................... Less: Sales returns and allowances........... Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................

$5,730 280 $5,450 3,104 2,346

EXERCISE 5-9 (Continued) Operating expenses Advertising expense .................................. Salaries and wages expense ..................... Research and development expense........ Rent expense.............................................. Depreciation expense ................................ Utilities expense......................................... Total operating expenses .................. Income from operations .................................... Other expenses and losses Interest expense......................................... Loss on disposal of plant assets .............. Income before income taxes............................. Income tax expense........................................... Net income .........................................................

499 460 114 105 90 60 1,328 1,018 161 46

207 811 276 $ 535

(Revenues – contra revenues – Cost of goods sold – Operating expenses = Income from operations) (b) Gross profit rate: $2,346 ÷ $5,450 = 43.0% Profit margin: $535 ÷ $5,450 = 9.8% The gross profit rate indicates that about 57 cents of each dollar of net sales is required to cover the cost of goods sold, leaving about 43 cents to cover all remaining expenses and produce net income. The profit margin indicates that each dollar of net sales results in about 10 cents of net income.

EXERCISE 5-9 (Continued) (c)

THE CLOROX COMPANY Income Statement For the Year Ended June 30, 2017 (amounts in millions) Sales Net sales* ........................................................... Cost of goods sold**.......................................... Gross profit ........................................................ Operating expenses Advertising expense*** .............................. Salaries and wages expense ..................... Research and development expense........ Rent expense.............................................. Depreciation expense ................................ Utilities expense ......................................... Total operating expenses................... Income from operations .................................... Other expenses and losses Interest expense ......................................... Loss on disposal of plant assets .............. Income before income taxes ............................. Income tax expense........................................... Net income ......................................................... *$5,450 + (.25 X $5,450) **$3,104 + (.25 X $3,104) ***$499 + $340

$6,813 3,880 2,933 $839 460 114 105 90 60 1,668 1,265 161 46

207 1,058 360 $ 698

Gross profit rate: $2,933 ÷ $6,813 = 43.1% Profit margin: $698 ÷ $6,813 = 10.2% The gross profit rate remained nearly unchanged at 43.1%. This result would be expected since advertising expenses are not part of cost of goods sold. The profit margin increased from 9.8% to 10.2% because net income increased over 30% ($163 ÷ $535) while net sales rose only 25%. It appears that the marketing department’s plan has merit. If the expected increases in sales materialize, net income will increase $163 million ($698 – $535). LO 4, 6 BT: AP Difficulty: Hard TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-10 (a)

LAINE INC. Income Statement For the Year Ended December 31, 2017 Net sales ............................................................... Cost of goods sold............................................... Gross profit .......................................................... Operating expenses ............................................. Income from operations ...................................... Other revenue and gains Interest revenue ................................................... Other expenses and losses Loss on disposal of plant assets ..................... .. Interest expense................................................... Net Income before income taxes ........................ Income tax expense ............................................. Net income............................................................

$ 2,200,000 1,256,000 944,000 725,000 219,000 33,000 $(17,000) (70,000)

(87,000) 165,000 47,000 $118,000

(Net sales – Cost of goods sold – Operating expenses = Income from operations) (b)

LAINE INC. Comprehensive Income Statement For the Year Ended December 31, 2017 Net income........................................................................ Other comprehensive income (Net of $1,200 tax).......... Comprehensive income...................................................

LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

$ 118,000 8,300 $ 126,300

EXERCISE 5-11 BLUE DOOR CORPORATION Income Statement For the Year Ended December 31, 2017 Sales ........................................................................ Less: Sales returns and allowances .......................... $41,000 Sales discounts............................................. 8,500 Net sales .................................................................. Cost of goods sold ................................................. Gross profit ............................................................. Operating expenses: Salaries and wages expense.......................... 675,000 Depreciation expense ..................................... 125,000 Advertising expense ....................................... 55,000 Freight-out....................................................... 25,000 Insurance expense ............................................. 15,000 Total operating expenses ................................... Income from operations ......................................... Other revenues and gains Interest revenue ............................................. 30,000 Rent revenue .................................................. 24,000 Other expenses and losses Interest expense............................................. Income before income taxes ............................ Income tax expense .......................................... Net income ........................................................

$2,400,000 49,500 2,350,500 1,085,000 1,265,500

895,000 370,500

54,000 (70,000) 354,500 70,000 $284,500

(Net sales – Cost of goods sold – Operating expenses = Income from operations) LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-12 Inventory, September 1, 2016 ................................... Purchases .................................................................. Less: Purchase returns and allowances................ Net purchases ........................................................... Add: Freight-in ....................................................... Cost of goods purchased ......................................... Cost of goods available for sale............................... Inventory, August 31, 2017 ....................................... Cost of goods sold ............................................

$ 18,700 $154,000 5,000 149,000 8,000 157,000 175,700 (21,000) $154,700

LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-13 (a) $1,420 ($1,500 – $80) (b) $1,550 (1,420 + $130) (c) $1,490 ($1,800 – $310) (d) $40 (e) $190 (f) $120

($1,080 – $1,040) ($1,230 – $1,040) ($1,350 – $1,230)

(g) (h) (i)

$7,700 $640 $8,750

($290 + $7,410) ($8,050 – $7,410) ($700 + $8,050)

(j) (k) (I)

$5,000 ($49,530 – $44,530 from (I)) $1,300 ($43,590 – $42,290) $44,530 ($42,290 + $2,240)

LO 5 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 5-14 (a) Earnings have high quality if they provide a full and transparent depiction of how a company performed. (b) One indicator of earnings quality is the quality of earnings ratio which is net cash provided by operating activities divided by net income. For Dorsett Corporation this is $23,200 ÷ $45,300 = .51. This is significantly lower than 1, which indicates that the company might be using aggressive accounting techniques in order to accelerate the recognition of net income.

EXERCISE 5-14 (Continued) (c) In order to identify potential aggressive accounting techniques one should examine the factors that are causing net income to differ from net cash provided by operating activities. Many of these differences would be due to adjusting entries used for accrual accounting. The fact that the company’s Accounts Receivable balance is increasing so rapidly is a possible concern because it might suggest that the company is recording credit sales that really aren’t sales. For example, it might be shipping goods to customers that the company didn’t order. This would cause sales to increase, but since the customers probably won’t ever pay, it would cause the balance in accounts receivable to build up. LO 6 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement

*EXERCISE 5-15 (a) (1) April 5 (2) April 6 (3) April 7 (4) April 8

(5) April 15

(b)

May 4

Purchases .......................................... Accounts Payable.....................

27,000

Freight-In............................................ Cash ..........................................

1,200

Equipment .......................................... Accounts Payable.....................

30,000

Accounts Payable.............................. Purchase Returns and Allowances.............................

3,600

Accounts Payable ($27,000 – $3,600) ........................... Cash ($23,400 – $468) .............. Purchase Discounts [($27,000 – $3,600) X 2%] ...... Accounts Payable ($27,000 – $3,600) ........................... Cash ..........................................

27,000 1,200 30,000

3,600

23,400 22,932 468 23,400

LO 7 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

23,400

SOLUTIONS TO PROBLEMS PROBLEM 5-1A

(a) General Journal Date May 1 2

5 9

11 12 15 17

Account Titles Inventory ........................................................ Accounts Payable ..................................

Debit 8,000

Accounts Receivable..................................... Sales Revenue........................................

4,400

Cost of Goods Sold ....................................... Inventory.................................................

3,300

Accounts Payable .......................................... Inventory.................................................

200

Cash ($4,400 – $88)........................................ Sales Discounts ($4,400 X 2%) ..................... Accounts Receivable .............................

4,312 88

Accounts Payable ($8,000 – $200) ................ Cash ........................................................ Inventory ($7,800 X 1%) .........................

7,800

Supplies.......................................................... Cash ........................................................

900

Inventory ........................................................ Cash ........................................................

3,100

Cash................................................................ Inventory.................................................

230

Inventory ........................................................ Accounts Payable ..................................

2,500

Credit 8,000 4,400 3,300 200

4,400 7,722 78 900 3,100 230 2,500

PROBLEM 5-1A (Continued) General Journal Date May 19 24

25 27

Account Titles Inventory ......................................................... Cash .........................................................

Debit 250

Cash................................................................. Sales Revenue.........................................

5,500

Cost of Goods Sold ........................................ Inventory..................................................

4,100

Inventory ......................................................... Accounts Payable ...................................

800

Accounts Payable........................................... Cash ......................................................... Inventory ($2,500 X 2%) ..........................

2,500

Sales Returns and Allowances ...................... Cash .........................................................

124

Inventory ......................................................... Cost of Goods Sold.................................

Accounts Receivable...................................... Sales Revenue.........................................

1,280

Cost of Goods Sold ........................................ Inventory..................................................

830

Credit 250 5,500 4,100 800 2,450 50

124 90 1,280 830

PROBLEM 5-1A (Continued) (b) 5/1 Bal. 5/9 5/15 5/24

5/31 Bal.

Cash 8,000 5/10 4,312 5/11 230 5/12 5,500 5/19 5/27 5/29 3,496

7,722 900 3,100 250 2,450 124

Accounts Receivable 5/2 4,400 5/9 4,400 5/31 1,280 5/31 Bal. 1,280

5/31 Bal.

Inventory 8,000 5/2 3,100 5/5 2,500 5/10 250 5/15 800 5/24 90 5/27 5/31 5,952

5/11 5/31 Bal.

Supplies 900 900

5/1 5/12 5/17 5/19 5/25 5/29

5/5 5/10 5/27

Accounts Payable 200 5/1 7,800 5/17 2,500 5/25 5/31 Bal.

3,300 200 78 230 4,100 50 830

8,000 2,500 800 800

Common Stock 5/1 Bal. 8,000 5/31 Bal. 8,000 Sales Revenue 5/2 4,400 5/24 5,500 5/31 1,280 5/31 Bal. 11,180 Sales Returns and Allowances 5/29 124 5/31 Bal. 124 Sales Discounts 5/9 88 5/31 Bal. 88 Cost of Goods Sold 5/2 3,300 5/29 5/24 4,100 5/31 830 5/31 Bal. 8,140

PROBLEM 5-1A (Continued) (c)

WINTERS HARDWARE STORE Income Statement (Partial) For the Month Ended May 31, 2017 Sales Sales revenue .................................................... Less: Sales returns and allowances ............... Sales discounts...................................... Net sales .................................................................... Cost of goods sold ................................................... Gross profit ...............................................................

$11,180 $124 88

(d) Profit margin: ($2,828 – $1,400) ÷ $10,968 = 13.0% Gross profit rate: $2,828 ÷ $10,968 = 25.8% LO 2-4, 6 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

212 10,968 8,140 $ 2,828

PROBLEM 5-2A

June 1 3

6 9

15 17

20 24

Inventory.............................................................. Accounts Payable........................................

1,040

Accounts Receivable .......................................... Sales Revenue .............................................

1,200

Cost of Goods Sold............................................. Inventory ......................................................

720

Accounts Payable ............................................... Inventory ......................................................

Accounts Payable ($1,040 – $40) ....................... Cash ............................................................. Inventory ($1,000 X .02)...............................

1,000

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

1,200

Accounts Receivable .......................................... Sales Revenue .............................................

1,200

Cost of Goods Sold............................................. Inventory ......................................................

730

Inventory.............................................................. Accounts Payable........................................

720

Cash ..................................................................... Sales Discounts ($1,200 X .02) ........................... Accounts Receivable ..................................

1,176 24

1,040 1,200 720 40 980 20 1,200 1,200 730 720

1,200

PROBLEM 5-2A (Continued) June 26

Accounts Payable ............................................... Cash.............................................................. Inventory (720 X .01) ....................................

720

Accounts Receivable .......................................... Sales Revenue .............................................

1,300

Cost of Goods Sold............................................. Inventory ......................................................

780

Sales Returns and Allowances........................... Accounts Receivable...................................

130

Inventory.............................................................. Cost of Goods Sold .....................................

713 7

LO 2, 3 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

1,300 780 130 80

PROBLEM 5-3A

(a) General Journal Date Apr. 5 7 9 10

12 14

17 20

Account Titles Inventory ........................................................ Accounts Payable ..................................

Debit 1,500

Inventory ........................................................ Cash ........................................................

Accounts Payable.......................................... Inventory.................................................

200

Accounts Receivable .................................... Sales Revenue........................................

1,340

Cost of Goods Sold ....................................... Inventory.................................................

820

Inventory ........................................................ Accounts Payable ..................................

830

Accounts Payable ($1,500 – $200)................ Cash ........................................................... Inventory ($1,300 X 3%) ..........................

1,300

Accounts Payable.......................................... Inventory.................................................

Accounts Receivable .................................... Sales Revenue........................................

810

Cost of Goods Sold ....................................... Inventory.................................................

550

Accounts Payable ($830 – $30)..................... Cash ........................................................ Inventory ($800 X 1%) ............................

800

Credit 1,500 80 200 1,340 820 830 1,261 39 30 810 550 792 8

PROBLEM 5-3A (Continued) Date Apr. 27 30

Account Titles Sales Returns and Allowances .................... Accounts Receivable ............................

Debit 80

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

1,220

Credit 80

1,220

(b) 4/1 Bal. 4/30 4/30 Bal.

Cash 2,500 4/7 1,220 4/14 4/21 1,587

80 1,261 792

Accounts Receivable 4/10 1,340 4/27 80 4/20 810 4/30 1,220 4/30 Bal. 850

4/1 Bal. 4/5 4/7 4/12

4/30 Bal.

4/9 4/14 4/17 4/21

Inventory 3,500 4/9 1,500 4/10 80 4/14 830 4/17 4/20 4/21 4,263

Accounts Payable 200 4/5 1,300 4/12 30 800 4/30 Bal.

Common Stock 4/1 Bal. 4/30 Bal.

6,000 6,000

Sales Revenue 4/10 4/20 4/30 Bal.

1,340 810 2,150

Sales Returns and Allowances 4/27 80 4/30 Bal. 80 200 820 39 30 550 8

1,500 830

Cost of Goods Sold 4/10 820 4/20 550 4/30 Bal. 1,370

PROBLEM 5-3A (Continued) GRANITE HILLS PRO SHOP Trial Balance April 30, 2017

(c)

Cash........................................................................ Accounts Receivable............................................. Inventory ................................................................ Common Stock ...................................................... Sales Revenue ....................................................... Sales Returns and Allowances ............................. Cost of Goods Sold ...............................................

Debit $1,587 850 4,263

Credit

6,000 2,150 80 1,370 $8,150

$8,150

Sales revenue ..................................................................... Less: Sales returns and allowances ................................ Net sales..................................................................................... Cost of goods sold .................................................................... Gross profit ................................................................................

$2,150 80 2,070 1,370 $ 700

(d)

GRANITE HILLS PRO SHOP Income Statement (Partial) For the Month Ended April 30, 2017 Sales

LO 2-4 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 5-4A

(a)

WOLFORD DEPARTMENT STORE Income Statement For the Year Ended November 30, 2017 Sales Sales revenue .................................. Less: Sales returns and allowances............................ Net sales ................................................. Cost of goods sold .................................. Gross profit.............................................. Operating expenses Salaries and wages expense .......... Rent expense................................... Advertising expense ....................... Depreciation expense ..................... Utilities expense .............................. Insurance expense .......................... Freight-out ....................................... Total operating expenses....... Income from operations.......................... Other revenues and gains Gain on disposal of plant assets.... Other expenses and losses Interest expense .............................. Income before income taxes .................. Income tax expense ................................ Net income ...............................................

$904,000 20,000 884,000 614,300 269,700 $117,000 34,000 33,500 13,500 10,600 9,000 6,200 223,800 45,900 2,000 5,000 42,900 10,000 $ 32,900

(Income from operations + Other revenues/gains – Other expenses/losses = Income before income taxes)

PROBLEM 5-4A (Continued) WOLFLORD DEPARTMENT STORE Retained Earnings Statement For the Year Ended November 30, 2017 Retained earnings, December 1, 2016 ..................................... Add: Net income ..................................................................... Less: Dividends ....................................................................... Retained earnings, November 30, 2017 ...................................

$14,200 32,900 47,100 12,000 $35,100

WOLFORD DEPARTMENT STORE Balance Sheet November 30, 2017 Assets Current assets Cash...................................................... $ 8,000 Accounts receivable............................ 17,200 Inventory .............................................. 26,200 Prepaid insurance................................ 6,000 Total current assets...................... $ 57,400 Property, plant, and equipment Equipment ............................................ $157,000 Less: Accumulated depreciation— equipment................................. 68,000 89,000 Total assets................................... $146,400

PROBLEM 5-4A (Continued) WOLFORD DEPARTMENT STORE Balance Sheet (Continued) November 30, 2017 Liabilities and Stockholders’ Equity Current liabilities Accounts payable................................................. $26,800 Salaries and wages payable ................................ 6,000 Total current liabilities .............................. Long-term liabilities Note payable due 2021 .................................... Total liabilities ........................................... Stockholders’ equity Common stock ................................................. 35,000 Retained earnings ............................................ 35,100 Total stockholders’ equity ........................ Total liabilities and stockholders’ equity ......................................................

$ 32,800 43,500 76,300

70,100 $146,400

(b) Profit margin: $32,900 ÷ $884,000 = 3.7% Gross profit rate: $269,700 ÷ $884,000 = 30.5% (c) Revised net income = Current net income + increase in gross profit – increase in operating expenses $14,743 = $32,900 + $40,443 – $58,600 Revised net sales = Current net sales + .15 (current net sales) $1,016,600 = $884,000 + $132,600 Revised gross profit = Current gross profit + $40,443 $310,143 = $269,700 + $40,443 Revised profit margin: $14,743 ÷ $1,016,600 = 1.5% Revised gross profit rate: $310,143 ÷ $1,016,600 = 30.5%

PROBLEM 5-4A (Continued) This plan increased net sales and gross profit but did not change the gross profit rate. This is not surprising since the proposed change affects selling expenses rather than cost of goods sold. An increase in sales would increase the dollar amount of cost of goods sold but not cost of goods sold as a percentage of sales dollars. The plan decreased net income by $18,157 ($32,900 – $14,743) or 55%. Since net sales increased 15% and net income decreased 55%, the profit margin decreased from 3.7% to 1.5%. A 55% decrease in net income combined with the smaller profit margin indicates that the proposal should not be adopted. LO 4, 6 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 5-5A

SIMON COMPANY Income Statement For the Year Ended December 31, 2017 Sales Sales revenue....................................... Less: Sales returns and allowances ................................ Sales discounts ........................ Net sales ............................................... Cost of goods sold ...................................... Gross profit.................................................. Operating expenses Salaries and wages expense* ............. Freight-out............................................ Rent expense ($24,000 – $6,000)......... Advertising expense ............................ Utilities expense .................................. Depreciation expense .......................... Total operating expenses ............ Income from operations.............................. Other revenues and gains Rent revenue ........................................ Other expenses and losses Interest expense .................................. Income before income taxes ...................... Income tax expense .................................... Net income ...................................................

$911,000 $28,000 18,000

46,000 865,000 555,000 310,000

136,000 33,000 18,000 13,000 12,000 10,000 222,000 88,000 4,000 2,000 90,000 22,500 $ 67,500

*($80,000 + $6,000 + $3,000 + $47,000) (Sales revenue – Contra revenues – Cost of goods sold = Gross profit) LO 4 BT: AP Difficulty: Hard TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 5-6A

(a) Dec. 31

31 31

Depreciation Expense .............................. Accumulated Depreciation— Buildings ....................................... Accumulated Depreciation— Equipment .....................................

15,000

Interest Expense ...................................... Interest Payable ................................

4,500

Income Tax Expense................................ Income Taxes Payable .....................

24,000

8,000 7,000 4,500 24,000

(b) Accumulated Depreciation—Buildings 12/31 Bal. 60,000 12/31 8,000 12/31 Bal. 68,000 Accumulated Depreciation— Equipment 12/31 Bal. 40,500 12/31 7,000 12/31 Bal. 47,500 Depreciation Expense 12/31 15,000 12/31 Bal. 15,000

Interest Expense 12/31 4,500 12/31 Bal. 4,500 Interest Payable 12/31 4,500 12/31 Bal. 4,500 Income Tax Expense 12/31 24,000 12/31 Bal. 24,000 Income Taxes Payable 12/31 24,000 12/31 Bal. 24,000

PROBLEM 5-6A (Continued) (c)

PEOPLE’S CHOICE WHOLESALE COMPANY Adjusted Trial Balance December 31, 2017 Cash ............................................................ Accounts Receivable ................................. Inventory..................................................... Land ............................................................ Buildings .................................................... Accumulated Depreciation— Buildings................................................. Equipment .................................................. Accumulated Depreciation— Equipment .............................................. Notes Payable ............................................ Accounts Payable ...................................... Interest Payable ......................................... Income Taxes Payable ............................... Common Stock........................................... Retained Earnings...................................... Dividends.................................................... Sales Revenue............................................ Sales Discounts ......................................... Cost of Goods Sold.................................... Salaries and Wages Expense .................... Utilities Expense ........................................ Maintenance and Repairs Expense .......... Advertising Expense.................................. Insurance Expense .................................... Depreciation Expense................................ Income Tax Expense.................................. Interest Expense ........................................ Totals...................................................

Debit $ 31,400 37,600 70,000 92,000 200,000

Credit

68,000

83,500 47,500 54,700 17,500 4,500 24,000 160,000 67,200 10,000 922,100 6,000 709,900 51,300 11,400 8,900 5,200 4,800 15,000 24,000 4,500 $1,365,500

(Total debit account balances = Total credit account balances)

$1,365,500

PROBLEM 5-6A (Continued) PEOPLE’S CHOICE WHOLESALE COMPANY Income Statement For the Year Ended December 31, 2017

(d)

Sales Sales revenue ............................................. Less: Sales discounts............................... Net sales............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Salaries and wages expense ..................... Depreciation expense ................................ Utilities expense......................................... Maintenance and repairs expense ............ Advertising expense .................................. Insurance expense..................................... Total operating expenses .................. Income from operations .................................... Other expenses and losses Interest expense......................................... Income before income taxes............................. Income tax expense........................................... Net income .........................................................

$922,100 6,000 916,100 709,900 206,200 $51,300 15,000 11,400 8,900 5,200 4,800 96,600 109,600 4,500 105,100 24,000 $ 81,100

PEOPLE’S CHOICE WHOLESALE COMPANY Retained Earnings Statement For the Year Ended December 31, 2017 Retained earnings, January 1 ............................................... Add: Net income .................................................................. Less: Dividends .................................................................... Retained earnings, December 31..........................................

$ 67,200 81,100 148,300 10,000 $138,300

PROBLEM 5-6A (Continued) PEOPLE’S CHOICE WHOLESALE COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash ............................................... Accounts receivable...................... Inventory ........................................ Total current assets ................ Property, plant, and equipment Land................................................ Buildings ........................................ Less: Accum. depreciation— buildings............................. Equipment...................................... Less: Accum. depreciation— equipment .......................... Total assets .............................

$ 31,400 37,600 70,000 $139,000 92,000 $200,000 68,000 83,500

132,000

47,500

36,000

Liabilities and Stockholders’ Equity Current liabilities Notes payable.................................................. $ 15,000 Accounts payable............................................ 17,500 Income taxes payable ..................................... 24,000 Interest payable .................................................. 4,500 Total current liabilities.............................. Long-term liabilities Notes payable ($54,700 – $15,000) ................. Total liabilities ............................................ Stockholders’ equity Common stock ................................................. 160,000 Retained earnings ............................................ 138,300 Total stockholders’ equity......................... Total liabilities and stockholders’ equity .......................................................

260,000 $399,000

$ 61,000 39,700 100,700

298,300 $399,000

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings) LO 4 BT: AP Difficulty: Medium TOT: 60 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 5-7A OATES DEPARTMENT STORE Income Statement (Partial) For the Year Ended November 30, 2017 Sales Sales revenue .......................... Less: Sales returns and allowances.................... Net sales ......................................... Cost of goods sold Inventory, Dec. 1, 2016............ Purchases ................................ Less: Purchase discounts ..... Purchase returns and allowances ............ Net purchases.......................... Add: Freight-in ...................... Cost of goods purchased ....... Cost of goods available for sale....................................... Less: Inventory, Nov. 30, 2017 ............... Cost of goods sold ........... Gross profit.....................................

$902,000 20,000 882,000 $ 41,300 $613,000 $7,000 6,760

13,760 599,240 5,060 604,300 645,600 36,200 609,400 $272,600

(Beginning inventory + Net purchases + Freight-in = Cost of goods purchased) LO 4, 5 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 5-8A (a)

(a) Cost of goods sold = Sales revenue – Gross profit = $96,890 – $67,800 = $29,090 (b) Net income = Gross profit – Operating expenses = $67,800 – $63,640 = $4,160 (c) Merchandise inventory = 2015 Inventory + Purchases – CGS = $13,000 + $25,890 – $29,090 = $9,800 (d) Cash payments to suppliers = 2015 Accounts payable + Purchases – 2016 Accounts payable = $5,800 + $25,890 – $6,500 = $25,190 (e) Sales revenue = Cost of goods sold + Gross profit = $28,060 + $59,620 = $87,680 (f) Operating expenses = Gross profit – Net income = $59,620 – $3,510 = $56,110 (g) 2016 Inventory + Purchases – 2017 Inventory = CGS Purchases = CGS – 2016 Inventory + 2017 Inventory = $28,060 – $9,800 [from (c)] + $14,700 = $32,960 (h) Cash payments to suppliers = 2016 Accounts payable + Purchases – 2017 Accounts Payable = $6,500 + $32,960 [from (g)] – $4,600 = $34,860 (i) Gross profit = Sales revenue – CGS = $82,220 – $26,490 = $55,730 (j) Net income = Gross profit – Operating expenses = $55,730 – $52,870 = $2,860

PROBLEM 5-8A (Continued) (k) 2017 Inventory + Purchases – 2018 Inventory = CGS Inventory = 2017 Inventory + Purchases – CGS = $14,700 + $24,050 – $26,490 = $12,260 (I) Accounts payable = 2017 Accounts payable + Purchases – Cash payments = $4,600 + $24,050 – $24,650 = $4,000 (Sales revenue – Cost of goods sold – Operating expenses = Net income; Beginning inventory + Purchases of inventory on account – Ending inventory = Cost of goods sold) (b)

No. A decline in sales does not necessarily mean that profitability declined. Profitability is affected by sales, cost of goods sold and operating expenses. If cost of goods sold or operating expenses decline more than sales, profitability can increase even when sales decline. However, in this particular case, sales declined with insufficient offsetting cost savings to improve profitability. Therefore, profitability declined for Zhou Inc.

Gross profit rate Profit margin

2016 2017 $67,800 ÷ $96,890 $59,620 ÷ $87,680 = 70.0% = 68.0%

2018 $55,730 ÷ $82,220 = 67.8%

$4,160 ÷ $96,890 = 4.3%

$2,860 ÷ $82,220 = 3.5%

$3,510 ÷ $87,680 = 4.0%

LO 4-6 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 5-9A

(a) Date Apr.

General Journal Account Titles and Explanation 5 Purchases...................................................... Accounts Payable ...............................

Debit 1,500

Credit 1,500

7 Freight-In ....................................................... Cash .....................................................

9 Accounts Payable ......................................... Purchase Returns and Allowances .................................

200

10 Accounts Receivable .................................... Sales Revenue.....................................

1,340

12 Purchases...................................................... Accounts Payable ...............................

830

14 Accounts Payable ($1,500 – $200) ............... Cash ($1,300 – $39) ............................. Purchase Discounts (1,300 X 3%) ................................

1,300

17 Accounts Payable ......................................... Purchase Returns and Allowances .................................

20 Accounts Receivable .................................... Sales Revenue.....................................

810

21 Accounts Payable ($830 – $30) .................... Cash ($800 – $8) .................................. Purchase Discounts............................ ($800 X 1%).................................

800

200

1,340 830 1,261 39

810 792 8

*PROBLEM 5-9A (Continued) Date Apr.

Account Titles and Explanation 27 Sales Returns and Allowances .................... Accounts Receivable..........................

Debit 80

30 Cash............................................................... Accounts Receivable..........................

1,220

Credit 80 1,220

(b) Cash 4/1 Bal. 2,500 4/7 4/30 1,220 4/14 4/21 4/30 Bal. 1,587

Common Stock 80 1,261 792

Accounts Receivable 4/10 1,340 4/27 80 4/20 810 4/30 1,220 4/30 Bal. 850 Inventory 4/1 Bal. 3,500 4/30 Bal. 3,500

4/9 4/14 4/17 4/21

Accounts Payable 4/1 Bal. 6,000 4/30 Bal. 6,000 200 4/5 1,500 1,300 4/12 830 30 800 4/30 Bal. 0

Sales Revenue 4/10 1,340 4/20 810 4/30 Bal. 2,150 Sales Returns and Allowances 4/27 80 4/30 Bal. 80 Purchases 4/5 1,500 4/12 830 4/30 Bal. 2,330

*PROBLEM 5-9A (Continued) Purchase Returns and Allowances 4/9 200 4/17 30 4/30 Bal. 230

Purchase Discounts 4/14 4/21 4/30 Bal.

4/7 4/30 Bal.

39 8 47

Freight-In 80 80

(c) GRANITE HILLS PRO SHOP Trial Balance April 30, 2017 Debit Cash .................................................................. Accounts Receivable ....................................... Inventory ........................................................... Common Stock ................................................. Sales Revenue .................................................. Sales Returns and Allowances........................ Purchases ......................................................... Purchase Returns and Allowances ................. Purchase Discounts ......................................... Freight-In...........................................................

Credit

$1,587 850 3,500 $6,000 2,150 80 2,330 230 47 80 $8,427

(Total of debit account balances = Total of credit account balances)

$8,427

*PROBLEM 5-9A (Continued) (d) GRANITE HILLS PRO SHOP Income Statement (Partial) For the Month Ended April 30, 2017 Sales Sales revenue .......................... Less: Sales returns and allowances.................... Net sales .................................. Cost of goods sold Inventory, April 1 ..................... Purchases ................................ Less: Purchase returns and allowances ............ Purchase discounts..... Net purchases ......................... Add: Freight-in ...................... Cost of goods purchased ....... Cost of goods available for sale........................................ Less: Inventory, April 30 ....... Cost of goods sold .............. Gross profit .............................

$2,150 80 2,070 $3,500 $2,330 $230 47

277 2,053 80 2,133 5,633 4,263 1,370 $ 700

(Beginning inventory+ Cost of goods purchased – Ending inventory = Cost of goods sold) LO 5, 7 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

ACCOUNTING CYCLE REVIEW

(a)

Dec. 6

8 10

13 15 18

20 23

Salaries and Wages Payable .................... Salaries and Wages Expense ................... Cash ...................................................

1,000 600

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

1,900

Cash ........................................................... Sales Revenue ...................................

6,300

Cost of Goods Sold................................... Inventory ............................................

4,100

Inventory.................................................... Accounts Payable..............................

9,000

Supplies ..................................................... Cash ...................................................

2,000

Accounts Receivable ................................ Sales Revenue ...................................

12,000

Cost of Goods Sold................................... Inventory ............................................

8,000

Salaries and Wages Expense ................... Cash ...................................................

1,800

Accounts Payable ..................................... Cash ................................................... Inventory ($9,000 X .02).....................

9,000

Cash ........................................................... Sales Discounts ($12,000 X .03) ............... Accounts Receivable.........................

11,640 360

1,600 1,900 6,300 4,100 9,000 2,000 12,000 8,000 1,800 8,820 180

12,000

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) (c)

Dec. 31

Salaries and Wages Expense.................... Salaries and Wages Payable .............

800

Depreciation Expense................................ Accumulated Depreciation— Equipment........................................

200

Supplies Expense ...................................... Supplies ($3,200 – $1,500) .................

1,700

Income Tax Expense.................................. Income Taxes Payable .......................

200

(b) & (c) Cash 12/1 Bal. 7,200 12/6 12/8 1,900 12/15 12/10 6,300 12/20 12/27 11,640 12/23 12/31 Bal. 12,820

Supplies 12/1 Bal. 1,200 12/31 12/15 2,000 12/31 Bal. 1,500

200 1,700 200

General Ledger

1,600 2,000 1,800 8,820

Accounts Receivable 12/1 Bal. 4,600 12/8 1,900 12/18 12,000 12/27 12,000 12/31 Bal. 2,700 Inventory 12/1 Bal. 12,000 12/10 12/13 9,000 12/18 12/23 12/31 Bal. 8,720

800

4,100 8,000 180

1,700

Equipment 12/1 Bal. 22,000 12/31 Bal. 22,000 Accumulated Depr.—Equipment 12/1 Bal. 2,200 12/31 200 12/31 Bal. 2,400

12/23

Accounts Payable 9,000 12/1 Bal. 4,500 12/13 9,000 12/31 Bal. 4,500

Salaries and Wages Payable 12/6 1,000 12/1 Bal. 1,000 12/31 800 12/31 Bal. 800 Income Taxes Payable 12/31 12/31 Bal.

200 200

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) Common Stock 12/1 Bal. 15,000 12/31 Bal. 15,000 Retained Earnings 12/1 Bal. 24,300 12/31 Bal. 24,300 Sales Revenue 12/10 6,300 12/18 12,000 12/31 Bal. 18,300 Sales Discounts 12/27 360 12/31 Bal. 360 Cost of Goods Sold 12/10 4,100 12/18 8,000 12/31 Bal. 12,100

Depreciation Exp. 12/31 200 12/31 Bal. 200 Salaries and Wages Expense 12/6 600 12/20 1,800 12/31 800 12/31 Bal. 3,200 Supplies Expense 12/31 1,700 12/31 Bal. 1,700 Income Tax Expense 12/31 200 12/31 Bal. 200

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) (d)

DEVINE DISTRIBUTING COMPANY Adjusted Trial Balance December 31, 2017 Cash............................................................... Accounts Receivable.................................... Inventory ....................................................... Supplies......................................................... Equipment ..................................................... Accumulated Depreciation—Equipment ..... Accounts Payable ......................................... Salaries and Wages Payable ........................ Income Taxes Payable.................................. Common Stock ............................................. Retained Earnings ........................................ Sales Revenue .............................................. Sales Discounts ............................................ Cost of Goods Sold ...................................... Depreciation Expense .................................. Salaries and Wages Expense....................... Supplies Expense ......................................... Income Tax Expense ....................................

DR. $12,820 2,700 8,720 1,500 22,000

CR.

$ 2,400 4,500 800 200 15,000 24,300 18,300 360 12,100 200 3,200 1,700 200 $65,500

$65,500

(Total of debit account balances = Total of credit account balances) (e)

DEVINE DISTRIBUTING COMPANY Income Statement For the Month Ending December 31, 2017 Sales revenue................................................ Less: Sales discounts ................................. Net sales........................................................ Cost of goods sold ....................................... Gross profit ................................................... Operating expenses Salaries and wages expense ................ Supplies expense .................................. Depreciation expense ........................... Income before income taxes........................ Income tax expense...................................... Net income ....................................................

$18,300 360 17,940 12,100 5,840 $3,200 1,700 200

5,100 740 200 $ 540

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) DEVINE DISTRIBUTING COMPANY Retained Earnings Statement For the Month Ended December 31, 2017 Retained earnings, Dec. 1............................................. Add: Net income.......................................................... Retained Earnings, Dec. 31 ..........................................

$24,300 540 $24,840

DEVINE DISTRIBUTING COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash.......................................................... Accounts receivable ................................ Inventory .................................................. Supplies.................................................... Total current assets ...........................

$12,820 2,700 8,720 1,500

Property, plant, and equipment Equipment ................................................ Less: Accumulated depreciation ........... Total assets .....................................................

22,000 2,400

$25,740

19,600 $45,340

Liability and Stockholders’ Equity Current liabilities Accounts payable .................................... Salaries and wages payable.................... Income taxes payable.............................. Total current liabilities .......................

$ 4,500 800 200

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

15,000 24,840

$ 5,500

39,840 $45,340

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings) LO 4 BT: AP Difficulty: Medium TOT: 60 min. AACSB: Analytic AICPA FC: Reporting

ACR5-2 (b) Date Nov. 8

General Journal Account Titles Salaries and Wages Payable Salaries and Wages Expense Cash

Debit 1,700 1,850

Cash

1,900

3,550

Accounts Receivable 11 12

15 19

1,900

Inventory Accounts Payable

8,000

Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

5,500

Accounts Payable Inventory

8,000 5,500 4,000 4,000 300 300

Cash ($5,500 – $110) Sales Discounts ($5,500 × 2%) Accounts Receivable

5,390 110

Accounts Payable ($8,000 – $300) Inventory ($7,700 × 2%) Cash

7,700

Cash

2,300

5,500 154 7,546

Service Revenue 25 27 28

Credit

2,300

Equipment Accounts Payable

5,000

Supplies Accounts Payable

1,700

Accounts Payable Cash

3,000

5,000 1,700 3,000

ACR5-2 (Continued) 29 29 29 29

Rent Expense Cash Salaries and Wages Expense Cash

30 30

1,300 1,300 700

Cash Unearned Service Revenue

675

700 675

960 960

Salaries and Wages Expense Salaries and Wages Payable

500

Depreciation Expense Accum. Depr.—Equipment

250

Unearned Service Revenue Service Revenue ($4,675 – $650)

CLOSING ENTRIES 30 Service Revenue Sales Revenue Income Summary 30

375

Accounts Receivable Service Revenue

ADJUSTING ENTRIES 30 Supplies Expense Supplies 30

375

500

250 4,025 4,025 7,025 5,500 12,525

Income Summary Salaries and Wages Expense Rent Expense Depreciation Expense Supplies Expense Cost of Goods Sold Sales Discounts

9,345

Income Summary Retained Earnings

3,180

3,650 375 250 960 4,000 110 3,180

(a), (c) & (e) Cash 11/1 Bal. 9,000 11/8 11/10 1,900 11/20 11/19 5,390 11/28 11/22 2,300 11/29 11/29 675 11/29 11/30 Bal. 3,494

3,550 7,546 3,000 375 1,300

Accounts Receivable 11/1 Bal. 2,240 11/10 1,900 11/12 5,500 11/19 5,500 11/29 700 11/30 Bal. 1,040

11/11

11/30

Inventory 8,000 11/12 11/15 11/20 3,546

Supplies 11/1 Bal. 860 adj 11/27 1,700 11/30 Bal. 1,600

11/15 11/20 11/28

adj

Accounts Payable 300 11/1 Bal. 3,400 7,700 11/11 8,000 3,000 11/25 5,000 11/27 1,700 11/30 Bal. 7,100

Unearned Service Revenue 4,025 11/1 Bal. 4,000 11/29 675 11/30 Bal. 650

4,000 300 154

Salaries and Wages Payable 11/8 1,700 11/1 Bal. 1,700 adj 500 11/30 Bal. 500

960

Common Stock 11/1 Bal. 20,000 11/30 Bal. 20,000

Equipment 11/1 Bal. 25,000 11/25 5,000 11/30 Bal. 30,000 Accumulated Depreciation— Equipment 11/1 Bal. 1,000 adj 250 11/30 Bal. 1,250

Retained Earnings 11/1 Bal. 7,000 Close 3,180 11/30 Bal 10,180

ACR5-2 (Continued)

Service Revenue 11/22 2,300 11/29 700 4,025 7,025 adj 11/30 Bal. 0

Depreciation Expense adj 250 Close 11/30 Bal. 0

Supplies Expense adj 960 Close 11/30 Bal. 0

11/30 Close

250

Rent Expense 11/29 375 Close 11/30 Bal. 0

Close 960

Income Summary 9,345 11/30 12,525 3,180 11/30

Salaries and Wages Expense 11/8 1,850 11/29 1,300 adj 500 Close 3,650 11/30 Bal. 0

3,180

375

Sales Revenue 5,500 11/12 5,500 11/30 Bal. 0

Cost of Goods Sold 11/12 4,000 Close 4,000 11/30 Bal. 0 Sales Discounts 11/19 110 Close 11/30 Bal. 0

110

ACR 5-2 (Continued) (d)

IKONK, INC. Adjusted Trial Balance November 30, 2017 Cash............................................................... Accounts Receivable.................................... Inventory ....................................................... Supplies......................................................... Equipment ..................................................... Accumulated Depreciation........................... Accounts Payable ......................................... Unearned Service Revenue.......................... Salaries and Wages Payable ........................ Common Stock ............................................. Retained Earnings ........................................ Service Revenue ........................................... Sales Revenue .............................................. Sales Discounts ............................................ Cost of Goods Sold ...................................... Salaries and Wages Expense....................... Rent Expense ................................................ Depreciation Expense .................................. Supplies Expense .........................................

DR. $3,494 1,040 3,546 1,600 30,000

CR.

$ 1,250 7,100 650 500 20,000 7,000 7,025 5,500 110 4,000 3,650 375 250 960 $49,025

$49,025

ACR5-2 (Continued) (f)

IKONK, INC. Income Statement For the Month Ended November 30, 2017 Sales Sales revenue ................................................. Less Sales discounts ..................................... Net sales ............................................. Service revenue.............................................. Total revenues ....................................... Less Cost of goods sold ....................................... Gross profit ............................................................ Expenses Salaries and wages expense ......................... Supplies expense ........................................... Rent expense.................................................. Depreciation expense .................................... Total expenses........................................ Net income .............................................................

$5,500 110 $5,390 7,025 12,415 4,000 8,415 $3,650 960 375 250 5,235 $ 3,180

IKONK, INC. Retained Earnings Statement For the Month Ended November 30, 2017 Retained earnings, November 1............................ Add: Net income ................................................... Retained earnings, November 30..........................

$7,000 3,180 $10,180

ACR5-2 (Continued) IKONK, INC. Balance Sheet November 30, 2017 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Inventory........................................................ Supplies ......................................................... Total current assets .............................. Property, plant and equipment Equipment ..................................................... Less: Accumulated depreciation— equipment.................................................. Total assets............................................

$ 3,494 1,040 3,546 1,600 $ 9,680 30,000 1,250

28,750 $38,430

Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................. $ 7,100 Salaries and wages payable............................. 500 Unearned service revenue .................................... 650 Total current liabilities .............................. Stockholders’ equity Common stock .................................................. 20,000 Retained earnings ............................................. 10,180 Total stockholders’ equity ........................ Total liabilities and stockholders’ equity .

$ 8,250

30,180 $38,430

CT 5-1

FINANCIAL REPORTING PROBLEM

(a) Percentage change in total revenue: 2013 to 2014 ($182,795 – $170,910) ÷ $170,910 = 7.0% Percentage change in net income: 2013 to 2014 ($39,510 – $37,037) ÷ $37,037 = 6.7% (b) Profit margin: 2012 2013 2014

$41,733 ÷ $156,508 = 26.7% $37,037 ÷ $170,910 = 21.7% $39,510 ÷ $182,795 = 21.6%

The profit margin decreased by 19% in 2013 but remained roughly in the same 2014. (c) Gross profit rates: 2012 2013 2014

$68,662 ÷ $156,508 = 43.9% $64,304 ÷ $170,910 = 37.6% $70,537 ÷ $182,795 = 38.6%

The gross profit rate decreased in 2013 due to an increasing cost of goods sold, but remained roughly the same in 2014. LO 6 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 5-2

COMPARATIVE ANALYSIS PROBLEM

(a)

Columbia Sportswear $141, 859 (1) Profit margin

= 6.8.%

(3) Gross profit rate

= 45.5%

$2,100,590 (4) Operating income (000’s) (5) Percent change in operating income

$198,844 – $131,794

$5,993,971

= 48.8%

$12,282,161

$198,844

$131,794

= 8.5%

$5,993,971 = $12,282,161 – $6,288,190

$954,951 $954,951

$1, 047, 505 $12, 282, 161

$2, 100, 590 (2) Gross profit (000’s)

VFC

$1,437,724

= 50.9%

$1,437,724 – $1,647,147

= (12.7%)

$1,647,147

(b) VFC’s higher profit margin suggests that it was better at turning sales dollars into net income. Its gross profit rate suggests that VFC can command a higher markup on its goods or that it is better at controlling its cost of goods sold. VFC’s operating income decreased 12.7% while Columbia’s increased by 50.9%. A major reason for VFC’s decline in operating income was due to an impairment of goodwill and intangible assets. LO 6 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 5-3

COMPARATIVE ANALYSIS PROBLEM

(a) (1) Profit margin

Amazon.com

Wal-Mart stores

($241)

$16, 363

= (0.3%)

(2) Gross profit (millions)

(3) Gross profit rate

$26,236 = $88,988 – $62,752 $26,236

= 29.5%

(4) Operating income (000’s)

$178

(5) Percent change in operating income

$178 – $745

$482,229 – $365,086 = $117,143 $117, 143

= 24.3%

$482, 229

$88,988

$745

= 3.4%

$485, 651

$88,988

$27,147

= (76.1%)

$27, 147 – $26, 872

= 1.0%

$26, 872

(b) Wal-Mart’s higher profit margin suggests that it was better at turning sales dollars into net income. Amazon’s gross profit rate suggests that it can command a higher markup on its goods or that it is better at controlling its cost of goods sold. Amazon’s operating income decreased 76.1% while Wal-Mart’s increased by 1%. LO 6 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

CT 5-4

INTERPRETING FINANCIAL STATEMENTS

(a) Carrefour (Euros) Gross profit rate

(€70, 486 – €54, 630) €70, 486

Wal-Mart (Dollars) = 22.5%

($256, 329 – $198, 747) = 22.5% $256, 329

The ratio is the same for each company, indicating that they have similar markups on the cost of their products. (b) Profit margin

€1,738 ÷ €70,486 = 2.5%

$9,054 ÷ $256,329 = 3.5%

Wal-Mart is renowned for its efficiency—this is what has caused it to dominate its U.S. competitors. It would appear from this data that it is also more efficient in its ability to generate net income from each dollar of sales than Carrefour. (c)

Current ratio

€14,521 ÷ €13,660 = 1.06:1

$34,421 ÷ $37,418 = .92:1

Debt to assets ratio

€29,434 ÷ €39,063 = .75

$61,289 ÷ $104,912 = .58

Both companies report low current ratios. This is not surprising since in recent years most large companies have tried to reduce costs and increase profitability by limiting the amount of current assets that they hold. However, Wal-Mart’s current ratio is less than 1:1 and might be cause for further investigation. The debt to assets ratio reveals that Carrefour relies more heavily on debt financing. This reduces Carrefour’s solvency and makes Carrefour more susceptible to swings in the economy. This could reduce its ability to compete head-to-head with Wal-Mart.

CT 5-4 (Continued) (d) Ratios improve our ability to compare these two companies that report financial information using different currencies. However, other factors can still reduce our ability to compare them. Different accounting standards in the two countries might result in dramatically different results under the same circumstances. Also, differences in laws, such as bankruptcy laws, can affect the results. For example, if French bankruptcy laws favor shareholders more than U.S. bankruptcy laws, then it would be prudent for a French company to rely more on debt financing than a U.S. company. LO 6 BT: AN Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

CT 5-5

REAL-WORLD FOCUS

Answers will vary depending on the company and article chosen by the student. LO None BT: S Difficulty: Hard TOT: 60 min. AACSB: Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 5-6 (a) (1)

DECISION MAKING ACROSS THE ORGANIZATION GIGASALES DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2018 Net sales [$700,000 + ($700,000 X 4%)]..... Cost of goods sold ($728,000 X 75%)* ...... Gross profit ($728,000 X 25%)** ................ Operating expenses Selling expenses................................. Administrative expenses.................... Total operating expenses ........... Net income..................................................

$728,000 546,000 182,000 $100,000 20,000 120,000 $ 62,000

*Alternatively: Net sales, $728,000 – gross profit, $182,000. **25% = ($140,000 ÷ $700,000) + 5%. (2)

GIGASALES DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2018 Net sales ..................................................... Cost of goods sold..................................... Gross profit................................................. Operating expenses Selling expenses................................. Administrative expenses.................... Net income..................................................

$700,000 560,000 140,000 $68,000* 20,000

88,000 $ 52,000

*$100,000 – $30,000 – ($40,000 X 40%) + ($700,000 X 2%) = $68,000. (b) Karen’s proposed changes will increase net income by $42,000. Reece’s proposed changes will reduce operating expenses by $32,000 and result in a corresponding increase in net income. Thus, if the choice is between Karen’s plan and Reece’s plan, Karen’s plan should be adopted. While Reece’s plan will increase net income, it may also have an adverse effect on sales personnel. Under Reece’s plan, sales personnel will be taking a cut of $16,000 in compensation [$60,000 – ($30,000 + $14,000)].

CT 5-6 (Continued) (c)

GIGASALES DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2018 Net sales............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Selling expenses ........................................ Administrative expenses ........................... Total operating expenses .................. Net income .........................................................

$728,000 546,000 182,000 $68,560* 20,000 88,560 $ 93,440

*$68,000 + [2% X ($728,000 – $700,000)] = $68,560. If both plans are implemented, net income will be $73,440 ($93,440 – $20,000) higher than the 2017 results. This is an increase of over 360%. Given the size of the increase, Reece’s plan to compensate sales personnel might be modified so that they would not have to take a pay cut. For example, if sales commissions were 3%, the compensation cut would be reduced to $8,160 [$60,000 – ($30,000 + ($728,000 X 3%))]. (d) A variety of factors might be presented by the student. For example, increasing the quantity of inventory purchased will increase warehousing and other costs of inventory. It will also increase the risk of holding obsolete or out-of-fashion inventory. Cutting salespersons’ salaries and making them more dependent on commissions might actually be viewed favorably by the sales staff if they have the potential to increase their total compensation. Reduced store deliveries may anger customers, especially if competitors provide more frequent service. LO 4, 6 BT: S Difficulty: Hard TOT: 45 min. AACSB: Communication and Reflective Thinking AICPA PC: Interaction, Leadership, and Communication

CT 5-7

COMMUNICATION ACTIVITY

(a) , (b)

President Surfing Hawaii Co. Dear Sir: As you know, the financial statements for Surfing Hawaii Co. are prepared in accordance with generally accepted accounting principles. One of these principles is the revenue recognition principle, which provides that revenues should be recognized when the performance obligation is satisfied. Typically, sales revenues are recognized when the goods are transferred from the buyer to the seller. At this point, the sales transaction is completed and the sales price is established. Thus, in the typical situation, revenue on the surfboard ordered by Aikau is recognized at event No. 8, when Aikan picks up the surfboard. The circumstances pertaining to this sale may seem to you to be atypical because Aiken has ordered a specific kind of surfboard. From an accounting standpoint, this would be true only if you could not reasonably expect to sell this surfboard to another customer. In such case, it would be proper under generally accepted accounting principles to recognize sales revenue when you have completed the surfboard for Aiken. Whether Aikan makes a down payment with the purchase order is irrelevant in recognizing sales revenue because at this time, you have not done anything to earn the revenue. A down payment may be an indication of Aikan’s “good faith.” However, its effect on your financial statements is limited entirely to recognizing the down payment as unearned revenue. If you have further questions about the accounting for this sale, please let me know. Sincerely, LO 2 BT: S Difficulty: Medium TOT: 30 min. AACSB: Communication and Reflective Thinking AICPA FC: Measurement AICPA PC: Communication

CT 5-8

ETHICS CASE

(a) Tabitha Andes, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue an unethical practice previously performed by him. The unethical practice is taking undeserved cash discounts. Her dilemma is either follow her boss’s unethical instructions or offend her boss and maybe lose the job she just assumed. (b) The stakeholders (affected parties) are: Tabitha Andes, the assistant treasurer. Pete Wilson, the treasurer. Southside Stores, the company. Creditors of Southside Stores (suppliers). Mail room employees (those assigned the blame). (c) Tabitha’s alternatives: 1. Tell the treasurer (her boss) that she will attempt to take every allowable cash discount by preparing and mailing checks within the discount period—the ethical thing to do. This will offend her boss and may jeopardize her continued employment. 2. Join the team and continue the unethical practice of taking undeserved cash discounts. 3. Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to Pete. The company may not condone this practice. Tabitha definitely has a choice, but probably not without consequence. To continue the practice is definitely unethical. If Tabitha submits to this request, she may be asked to perform other unethical tasks. If Tabitha stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things—if she isn’t fired. Maybe nobody has ever challenged Pete’s unethical behavior and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job. LO 2 BT: E Difficulty: Hard TOT: 45 min. AACSB: Ethics AICPA FC: Measurement AICPA PC: Personal Demeanor

CT 5-9

ALL ABOUT YOU ACTIVITY

In order for revenue to be recognized the performance obligation must be satisfied. In this case FarWest has an obligation to provide goods with a value equal to the gift card. That obligation is not fulfilled until one of two things happens: Either the customer redeems the card for goods, or the card expires. Until either of those events occurs FarWest cannot record revenue. LO 3 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement

CT 5-10

FASB CODIFICATION ACTIVITY

(a) 1. Inventory is the aggregate of those items of tangible personal property that have any of the following characteristics: a. Held for sale in the ordinary course of business b. In process of production for such sale c. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. 2. A customer is a reseller or a consumer, either an individual or a business that purchases a vendor’s products or services for end use rather than for resale. This definition is consistent with paragraph 280-10-50-42, which states that a group of entities known to a reporting entity to be under common control shall be considered as a single customer, and the federal government, a state government, a local government (for example, a county or municipality), or a foreign government each shall be considered as a single customer. Customer includes any purchaser of the vendor’s products at any point along the distribution chain, regardless of whether the purchaser acquires the vendor’s products directly or indirectly (for example, from a distributor) from the vendor. For example, a vendor may sell its products to a distributor who in turn resells the products to a retailer. The retailer in that example is a customer of the vendor.

CT 5-10 (Continued) (b) 330-10-35-15 Only in exceptional cases may inventories properly be

stated above cost. For example, precious metals having a fixed monetary value with no substantial cost of marketing may be stated at such monetary value; any other exceptions must be justifiable by inability to determine appropriate costs, immediate marketability at quoted market price, and the characteristic of unit interchangeability. LO 2 BT: S Difficulty: Medium TOT: 25 min. AACSB: Communication and Technology AICPA FC: Measurement AICPA PC: Communication

IFRS CONCEPTS AND APPLICATION

IFRS5-1 Expenses may be classified by “nature” or by “function”. The “nature-ofexpense” classification organizes expenses by type of expense, such as salaries, depreciation, rent, or supplies. The “function-of-expense” classification presents expenses by type of business activity. Examples would include cost of goods sold, selling, administrative, operating, and non-operating. LO 4 BT: K Difficulty: Easy TOT: 5 min. AACSB: Diversity AICPA FC: Measurement

IFRS5-2 By function By nature By nature By function By nature By nature By function

Cost of goods sold Depreciation expense Salaries and wages expense Selling expenses Utilities expense Delivery expense General and administrative expenses

LO 4 BT: K Difficulty: Easy TOT: 5 min. AACSB: Diversity AICPA FC: Measurement

IFRS5-3 MATILDA COMPANY Comprehensive Income Statement For the Year Ended 2017 (in thousands of euros) Net income............................................................................... Unrealized gain related to revaluation of buildings.............. Unrealized loss non-trading securities.................................. Items not recognized on the income statement.................... Total comprehensive income ........................................

€ 10 (35)

LO 4 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Diversity and Analytic AICPA FC: Reporting

€150 (25) €125

IFRS5-4

INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) Vuitton uses a multiple step format. The income statement isolates gross margin, profit from recurring operations and operating profit rather than simply showing total revenues less total expenses to arrive at net income. (b) Vuitton uses Cost of Net Financial Debt rather than Interest Expense on its income statement. (c) Inventory is composed of: Wines and eaux-de-vie in process of aging Other raw materials and work in process Goods purchased for resale Finished products Amount of inventory (gross) before impairment is €10,700M LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Diversity and Analytic AICPA FC: Reporting

CHAPTER 6 Reporting and Analyzing Inventory Learning Objectives 1. Discuss how to classify and determine inventory. 2. Apply inventory cost flow methods and discuss their financial effects. 3. Explain the statement presentation and analysis of inventory. *4. Apply inventory cost flow methods to perpetual inventory records. *5. Indicate the effects of inventory errors on the financial statements.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item

17. 18. 19. 20. 21.

3 3 3 3 3

AP K K K C

22. *23. *24. *25.

3 4 4 5

C C C AN

8. 9.

3 3

AP AP

*10. *11.

4 5

AP AN

3b.

13. *14. *15. *16.

3 4 4 5

AP AP AP AN

*17.

7. *8.

3 4

AP AP

*9.

Questions 1. 2. 3. 4. 5. 6.

1 1 1 1 1 2

C K K C C AP

7. 8. 9. 10. 11.

2 2 2 2 2

K C K C K

12. 13. 14. 15. 16.

2 2 2 2 3

C C C C C

Brief Exercises 1. 2. 3.

1 2 2

C AP AP

4. 5.

2 2

C AP

6. 7.

2 3

C AP

DO IT! Exercises 1.

3a.

Exercises 1. 2. 3. 4.

1 1 1 2

AN AN K AP

5. 6. 7. 8.

2 2 2 2

AP AN AP AP

9. 10. 11. 12.

3 3 3 3

AP AP AP AP

Problems: Set A 1. 2.

1 2

AN AP

3. 4.

2 2

AP AN

5. 6.

2 2

AP AP

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine items and amounts to be recorded in inventory.

Moderate

15–20

Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.

Moderate

30–40

Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost in a periodic inventory system and assess financial statement effects.

Moderate

30–40

Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.

Moderate

30–40

Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results.

Moderate

30–40

Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to influence earnings.

Moderate

20–30

Compute inventory turnover and days in inventory; compute current ratio based on LIFO and after adjusting for LIFO reserve.

Moderate

20–30

*8A

Calculate cost of goods sold, ending inventory, and gross profit for LIFO, FIFO, and moving-average under the perpetual system; compare results.

Difficult

30–40

*9A

Determine ending inventory under a perpetual inventory system.

Difficult

30–40

ANSWERS TO QUESTIONS 1. Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales. 2. Inventory items have two common characteristics: (1) they are owned by the company and (2) they are intended to be sold to customers in the ordinary course of business. 3. Just-in-time inventory management is the practice of manufacturing or purchasing inventory “just-intime” to fill a sales order. Since inventory quantities are kept at very low amounts, just-in-time management reduces the costs associated with carrying inventory as well as the risk of obsolescence. 4. Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand. Retailers, such as hardware stores, generally have thousands of different items to count. This is normally done when the store is closed. Will will probably count items and mark the quantity, description, and inventory number on prenumbered inventory tags. 5. (a) (1) (2)

The goods will be included in Bonita Company’s inventory if the terms of sale are FOB destination. The goods will be included in Myan Corporation’s inventory if the terms of sale are FOB shipping point.

(b) Bonita Company should include goods shipped to a consignee in its inventory. Goods held by Bonita Company on consignment should not be included in inventory. 6. Inventoriable costs are $3,015 (invoice cost $3,000 + freight charges $75  purchase discounts $60). 7. The primary basis of accounting for inventories is cost in accordance with the historical cost principle. 8. Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may be inappropriate because management may be able to manipulate net income through specific identification of items sold. 9. The major advantage of the specific identification method is that it tracks the actual physical flow of the goods available for sale. The major disadvantage is that management could manipulate net income. 10. No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied. 11. (a) FIFO, (b) Average-cost, (c) LIFO.

Questions Chapter 6 (Continued) 12. Short Company is using the FIFO method of inventory costing, and King Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Short Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs. 13. Mamosa Corporation may experience severe cash shortages if this policy continues. All of its net income is being paid out as dividends, yet some of the earnings must be reinvested in inventory to maintain inventory levels. Some earnings must be reinvested because net income is computed with cost of goods sold based on older, lower costs while the inventory must be replaced at current, higher costs. Because of this factor, net income under FIFO is sometimes referred to as including “phantom profits.” In addition, Mamosa is also depleting cash more quickly under FIFO because FIFO results in higher income tax payments. 14. Oscar is partially correct. In a period of inflation, FIFO produces higher net income because the lower unit costs of the first units purchased is matched against revenues. A switch from LIFO to FIFO will thus produce higher net income and a larger bonus for Oscar, which he perceives as being “better off”. It is more difficult to determine if the company would be “better off” if it used FIFO instead of LIFO. Using FIFO would mean higher reported income and higher inventory values which investors usually interpret as “better” results. On the other hand, the higher net income reported with FIFO would mean higher bonus and income tax expenses. Since both of these items require cash, switching to FIFO may leave the company with an inadequate amount of cash to meet normal operating needs. 15. When prices are increasing, LIFO results in higher cost of goods sold, and lower income relative to FIFO. Because LIFO income is lower the company pays lower taxes, which results in higher cash flows. The quality of earnings ratio is net cash provided by operating activities divided by income. The use of LIFO will increase the numerator (net cash provided by operating activities) and decrease the denominator (net income), both of which increase the value of the ratio. 16. Hank should know the following: (a) A departure from the cost basis of accounting for inventories is justified when the value of the goods is no longer as great as its cost. The writedown to market should be recognized in the period in which the price decline occurs. (b) Market means current replacement cost, not selling price. For a merchandising company, market is the cost at the present time from the usual suppliers in the usual quantities. 17. Jackson Music Center should report the TVs at $350 each for a total of $1,750. $350 is the current replacement cost under the lower-of-cost-or-market (LCM) basis of accounting for inventories. A decline in replacement cost usually leads to a decline in the selling price of the item. Valuation at LCM is conservative. 18. Lower-of-cost-or-market can be applied after any of the cost flow assumptions has been used, including LIFO, FIFO, average-cost, or specific identification. 19. Freight-out expense is not a cost associated with purchasing goods, so it should not affect cost of goods sold. It is an expense incurred to sell goods already purchased, so it should be reported as a selling expense.

Questions Chapter 6 (Continued) 20.

Tilton Company should disclose (1) the major inventory classifications, (2) the basis of accounting (cost or lower-of-cost-or-market), and (3) the costing method (FIFO, LIFO, or average).

21.

An inventory turnover that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales.

22.

The LIFO reserve is a required disclosure for companies that employ LIFO. It is the difference between ending inventory using LIFO and ending inventory if FIFO were used instead. Ignoring a large LIFO reserve when analyzing a company can distort any comparisons that an analyst might try to make with a company’s competitors that used FIFO.

*23. Disagree. The results under the FIFO method are the same but the results under the LIFO method may be different. The reason is that the pool of inventoriable costs (costs of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale. *24. In a perpetual inventory system, the average is a moving average of goods available for sale after each purchase. In a periodic inventory system, the average is a weighted average based on total goods available for sale for the period. *25. (a) Albert Company’s 2016 net income will be understated $5,000; (b) 2017 net income will be overstated $5,000; and (c) the combined net income for the two years will be correct.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a) Ownership of the goods belongs to the owner (Peete). Thus, these goods should be included in Peete’s inventory. (b) The goods in transit should not be included in the inventory count because ownership by Peete does not occur until the goods reach the buyer. (c) The goods being held belong to the customer. They should not be included in Peete’s inventory. (d) Ownership of these goods rests with the other company (the owner). Thus, these goods should not be included in the physical inventory. LO 1 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 6-2 (a) The ending inventory under FIFO consists of 200 units at $9 for a total allocation of $1,800. (b) The ending inventory under LIFO consists of 200 units at $6 for a total allocation of $1,200. LO 2 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-3 Average unit cost is $7.917 computed as follows: 300 400 500 1,200

X X X

$6 $8 $9

= $1,800 = 3,200 = 4,500 $9,500

$9,500 ÷ 1,200 = $7.917 The cost of the ending inventory is $1,583 (200 X $7.917). LO 2 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-4 (a) FIFO would result in the highest net income. (b) FIFO would result in the highest ending inventory. (c) LIFO would result in the lowest income tax expense (because it would result in the lowest taxable income). (d) Average cost would result in the most stable income over a number of years because it averages out any big changes in the cost of inventory. LO 2 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-5 Cost of goods sold under: LIFO

FIFO

Cost of goods available for sale Less: Ending inventory Cost of goods sold

$6 X 100 $7 X 200 $8 X 140 $ 3,120 $ 1,160* $ 1,960

$6 X 100 $7 X 200 $8 X 140 $ 3,120 $ 1,400** $ 1,720

*(100 X $6) + (80 X $7)

**(140 X $8) + (40 X $7)

Purchases

Since the cost of goods sold is $240 ($1,960 – $1,720) less under FIFO that is the amount of the phantom profit. It is referred to as “phantom profit” because FIFO matches current selling prices with old inventory costs. To replace the units sold the company will have to pay the current price of $8 per unit, rather than the $6 per unit which some of the units were priced at under FIFO. Therefore, profit under LIFO is more representative of what the company can expect to earn in future periods. LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-6 (a) LIFO results in a higher quality of earnings ratio. (b) FIFO results in higher phantom profits. (c) FIFO results in higher net income. (d) LIFO results in lower taxes. (e) FIFO results in lower net cash provided by operating activities. LO 2 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-7 Inventory Categories Cameras Camcorders DVDs Total valuation

Cost $12,500 9,000 13,000

Market $13,400 9,500 12,200

LCM $12,500 9,000 12,200 $33,700

The lower-of-cost-of-market value is $33,700. LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 6-8 Inventory turnover: Days in inventory:

$349,114 $349,114 = = 2.54 times ($119,035+$155,377) ÷ 2 $137,206 365

2.54

=144 days

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 6-9 2017 ending inventory using LIFO ............................ 2017 LIFO reserve....................................................... 2017 ending inventory assuming FIFO ..................... LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Reporting

$46,850,000 30,346,000 $77,196,000

*BRIEF EXERCISE 6-10 (1) FIFO June 1 sale: Aug. 27 sale:

Cost of Goods Sold 25 units @ $10 = $250 25 units @ $10 = $250 5 units @ $15 = 75 325 $575 (2) LIFO

June 1 sale: Aug. 27 sale:

25 units @ $10 = 30 units @ $15 =

Cost of Goods Sold $250 $450 $700

(3) MOVING-AVERAGE June 1 sale: Aug. 27 sale:

Cost of Goods Sold 25 units @ $10 = $250 30 units @ $12.727* = 382 $632

*[(50 – 25) X$10]+(30X $15) 55 units

(A new average cost per unit is computed each time a purchase is made under the moving–average method) LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*BRIEF EXERCISE 6-11 The understatement of ending inventory caused cost of goods sold to be overstated $7,000 and net income to be understated $7,000. The correct net income for 2017 is $99,000 ($92,000 + $7,000). Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $7,000. LO 5 BT: AN Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 6-1 Inventory per physical count.................................................. Inventory out on consignment ............................................... Inventory sold, in transit at year-end ..................................... Inventory purchases, in transit at year-end........................... Correct December 31 inventory .............................................

$300,000 28,000 0 13,000 $341,000

LO 1 BT: AN Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

DO IT! 6-2 Cost of goods available for sale = (3,000 X $5) + (8,000 X $7) = $71,000 Ending inventory = 3,000 + 8,000 – 9,400 = 1,600 units (a) FIFO: $71,000 – (1,600 X $7) = $59,800 (b) LIFO: $71,000 – (1,600 X $5) = $63,000 (c) Average-cost: $71,000/11,000 = $6.455 per unit 9,400 X $6.455 = $60,677 LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Measurement and Reporting

DO IT! 6-3a The lowest value for each inventory type is: Small $61,000, Medium $260,000, and Large $152,000. The total inventory value under the lower-of-cost-ormarket approach is the sum of these figures, $473,000. LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

DO IT! 6-3b 2016 Inventory turnover Days in inventory

2017

$1,200,000 $1,425,000 = 6.3 = 9.5 ($170,000 + $210,000)/2 ($210,000 + $90,000)/2 365 ÷ 6.3 = 57.9 days

365 ÷ 9.5 = 38.4 days

The company experienced a very significant decline in its ending inventory as a result of the just-in-time inventory. This decline improved its inventory turnover ratio and its days in inventory. Also, its sales increased by 19%. It is possible that this increase is the result of a more focused inventory policy. It appears that this change is a win-win situation for Fedor Company. LO 3 BT: AN Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 6-1 Ending inventoryphysical count................................................ $275,000 1. No effecttitle passes to purchaser upon shipment when terms are FOB shipping point .............................. 0 2. No effecttitle does not transfer to Pohl until goods are received .......................................................... 0 3. Add to inventory: Title passed to Pohl when goods were shipped ........................................................ 25,000 4. Add to inventory: Title remains with Pohl until purchaser receives goods .............................................. 51,000 5. Subtract from inventory: The goods did not arrive prior to year-end. The goods,therefore, cannot be included in the inventory .................................................................... (42,000) Correct inventory ........................................................................... $309,000 (Legal title determines of an item should be included in inventory) LO 1 BT: AN Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-2 Ending inventory-as reported ...................................................... 1.

$740,000

Subtract from inventory: The goods belong to Nader Corporation. Ryder is merely holding them as a consignee...............................................

(228,000)

Add to inventory: The goods belong to Ryder as soon as they are shipped (December 28). ....................................................................

40,000

Subtract from inventory: Office supplies should be carried in a separate account. They are not considered inventory held for resale. .........................

(17,000)

Add to inventory: The goods belong to Ryder until they are shipped (Jan. 1).............................................

29,000

EXERCISE 6-2 (Continued) 5.

Subtract from inventory: GAAP requires that inventory be valued at the lower of cost or market. Obsolete parts should be adjusted from cost to zero if they have no other use.......................

Correct inventory ..........................................................................

(50,000) $514,000

(Legal title determines if an item should be included in inventory) LO 1 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-3 (a) Do not include—Gato does not own items held on consignment. (b) Include in inventory—Gato still owns the items as they were only shipped on consignment. (c) Include in inventory—Shipping terms FOB destination means that Gato owns the items until they reach the customer. (d) Do not include in inventory—Because the shipping terms are FOB shipping point, ownership has transferred to the customer. Gato should record this amount as a sale on the income statement. (e) Do not include in inventory—Because the shipping terms are FOB destination, Gato does not own the goods until they arrive at Gato’s premises. (f) Include in inventory—Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, Gato owns the goods in transit. (g) Do not include in inventory. Record as Supplies on the balance sheet. LO 1 BT: K Difficulty: Medium TOT: 8 min. AACSB: None AICPA FC: Measurement and Reporting

EXERCISE 6-4 FIFO Beginning inventory (12 X $100) .................................. Purchases Sept. 12 (45 X $103)................................................ Sept. 19 (50 X $104)................................................ Sept. 26 (20 X $105)................................................ Cost of goods available for sale................................... Less: Ending inventory (20 X $105) + (5 X $104)....... Cost of goods sold........................................................ Date 9/1 9/12 9/19

Units 12 45 45 102

PROOF Unit Cost $100 103 104

LIFO Cost of goods available for sale........................................... Less: Ending inventory (12 X $100) + (13 X $103)............ Cost of goods sold................................................................ Date 9/26 9/19 9/12

Units 20 50 32 102

PROOF Unit Cost $105 104 103

$ 1,200 $4,635 5,200 2,100

11,935 13,135 2,620 $10,515 Total Cost $ 1,200 4,635 4,680 $10,515 $13,135 2,539 $10,596 Total Cost $ 2,100 5,200 3,296 $10,596

AVERAGE-COST $13,135 ÷ 127 = $103.425 weighted-average unit cost Cost of goods available for sale........................................... Less: Ending inventory (25 X $103.425) ............................. Cost of goods sold ............................................................... Units 102

PROOF Unit Cost $103.425

$13,135 2,586 $10,549 Total Cost $ 10,549

LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-5 (a) FIFO Beginning inventory (30 X $9) ......................................... Purchases May 15 (25 X $10) ....................................................... May 24 (38 X $11) ....................................................... Cost of goods available for sale (93 units) ..................... Less: Ending inventory [(93 – 74) X $11] ....................... Cost of goods sold ...........................................................

$270 $250 418

668 938 209 $729

PROOF Date 5/1 5/15 5/24

Units 30 25 19 74

Unit Cost $ 9 10 11

Total Cost $270 250 209 $729

(b) LIFO Cost of goods available for sale................................................. Less: Ending inventory (19 X $9) .............................................. Cost of goods sold ......................................................................

$938 171 $767

PROOF Date 5/24 5/15 5/1

Units 38 25 11 74

Unit Cost $11 10 9

Total Cost $418 250 99 $767

EXERCISE 6-5 (Continued) (c) AVERAGE-COST $938 ÷ 93 = $10.086 weighted-average unit cost Cost of goods available for sale................................................... Less: Ending inventory (19 X $10.086) ........................................ Cost of goods sold........................................................................

$938.00 191.63 $746.37

PROOF Units 74

Unit Cost $10.086

Total Cost $746.36*

*$.01 rounding difference. LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-6 (a) FIFO

Cost

Goods

Sold

(#1012) $52 + (#1045) $48 = $100 (b) It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased at higher costs–in which case the Cost of Goods Sold would be $100. If it wished to maximize earnings it would choose to sell the units purchased at lower costs–in which case the cost of goods sold would be $88 ($40 + $48). (c) The FIFO method provides a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings. (The answer may vary depending on the method the student chooses.) LO 2 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 6-7 (a)

(1) FIFO Beginning inventory (120 X $5) ................................. Purchases June 12 (370 X $6) ............................................... June 23 (200 X $7) ............................................... Cost of goods available for sale................................ Less: Ending inventory (200 X $7) + (30 X $6)........ Cost of goods sold.....................................................

$ 600 $2,220 1,400

3,620 4,220 1,580 $2,640

(2) LIFO Cost of goods available for sale................................ Less: Ending inventory (120 X $5) + (110 X $6)...... Cost of goods sold.....................................................

$4,220 1,260 $2,960

(3) AVERAGE-COST Cost of Goods Total Units Weighted-Average Available for Sale ÷ Available for Sale = Unit Cost $4,220 690 $6.116 Ending inventory (230 X $6.116) $1,407 Cost of goods sold (460 X $6.116) $2,813 or $4,220 – $1,407 = $2,813 (b) The FIFO method will produce the highest ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. The LIFO method will produce the highest cost of goods sold for Jeters Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. (c) The average-cost ending inventory ($1,407) is higher than LIFO ($1,260) but lower than FIFO ($1,580). For cost of goods sold, average cost ($2,813) is higher than FIFO ($2,640) but lower than LIFO ($2,960). (d) The simple average would be (($5 + $6 + $7)/3) = $6. However, the average cost method uses a weighted average unit cost, not a simple average of unit costs. LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-8 (a) Sales...................................................................... Cost of goods sold ............................................... Operating expenses (including depreciation) .... Income before income taxes ............................... Income tax expense ............................................. Net income ............................................................ (b) Sales...................................................................... Less: Cash paid for inventory purchases.......... Cash paid for operating expenses ($27,000 – $10,000)................................. Cash paid for income tax.......................... Net cash provided by operating activities .......... (c) Net cash provided by operating activities .......... ÷ Net income ......................................................... Quality of earnings ratio ......................................

LIFO $86,000 38,000 27,000 21,000 6,300 $14,700

FIFO $86,000 29,000 27,000 30,000 9,000 $21,000

LIFO $86,000 32,000

FIFO $86,000 32,000

17,000 6,300 $30,700

17,000 9,000 $28,000

LIFO $30,700 $14,700 2.09

FIFO $28,000 $21,000 1.33

LIFO results in a higher quality of earnings ratio because, assuming rising prices, it results in lower taxes, and thus higher net cash provided by operating activities. This increases the numerator of the ratio relative to FIFO. Also, LIFO results in lower net income, which decreases the denominator of the ratio relative to FIFO. Both effects result in a higher quality of earnings ratio. LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-9

Cost/Unit Cameras: Minolta Canon Light Meters: Vivitar Kodak Total

Inventory at Market Lower-of-CostLower-of-CostValue/Unit or-Market Units or-Market

$170 145

$158 152

$158 145

5 7

$ 790 1,015

125 120

114 135

114 120

12 10

1,368 1,200 $4,373

LO 3 BT: AP Difficulty: Easy TOT: 8 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-10 Type of Bean Coffea arabica Coffea robusta

Quantity 13,000 bags 5,000 bags

Unit Total Total Cost Cost Market Market LCM $5.60 $72,800 $5.55 $72,150 $72,150 3.40 17,000 3.50 17,500 17,000 $89,800 $89,650 $89,150

LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 6-11

(a) Inventory turnover

(b) Days in inventory (c) Gross profit rate

2015

2016

2017

$18,038 ($1,926 +$2,290) ÷ 2 $18,038 = 8.6 times $2,108

$20,351 ($2,290 +$2,522) ÷ 2 $20,351 = 8.5 times $2,406

$20,099 ($2,522+$2,618) ÷2 $20,099 = 7.8 times $2,570

365

= 42.4 days

8.6 $39,474 – $18,038 = 54.3% $39,474

365

= 42.9 days

8.5 $43,251 – $20,351 = 52.9% $43,251

365

= 46.8 days

7.8 $43,232 – $20,099 = 53.5% $43,232

EXERCISE 6-11 (Continued) (d) The inventory turnover decreased by approximately 10% from 2015 to 2017 while the days in inventory increased by a similar amount (10%) over the same time period. Both of these changes would be considered unfavorable since it’s better to have a higher inventory turnover with a corresponding lower days in inventory. PepsiCo., Inc.’s gross profit rate decreased by 1.5% from 2015 to 2017. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 6-12

Inventory Turnover (2017): Days in Inventory (2017):

$1,552,000 = 2.8 times ($553,000 + $568,000) ÷ 2

365

=130days

Gross Profit Rate (2017):

2.8 ($1,948,000  $1,552,000) = 20.3% $1,948,000

Inventory Turnover (2016):

$1, 288, 000 = 2.9 times ($568, 000 + $332, 000) ÷ 2 365

=126days

Days in Inventory (2016):

2.9

Gross Profit Margin (2016):

$1,725,000- $1,288,000 =25.3% $1,725,000

(b) In 2017, Zoe’s Activewear experienced a deterioration in liquidity and profitability. The liquidity has been deteriorated due to the increase in time required to turn over its inventory, from 126 days to 130 days. The company has experienced deteriorated profitability due to a significant drop in its gross profit rate from 25.3% to 20.3%. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 6-13 (a) Inventory turnover

$16,255 $16,255 = = 5.98 ($3,042 + $2,397) ÷ 2 $2,719.5 365 = 61 days 5.98

Days in inventory

(b) Based on data presented: Current ratio $30,857 ÷ $12,753 = 2.42 : 1 After adjusting for LIFO reserve: Current ratio ($30,857 + $1,367) ÷ $12,753 = 2.53 : 1 (c) After adjusting for the LIFO reserve, Deere’s current ratio increases from 2.42 : 1 to 2.53 : 1. Deere’s liquidity looks slightly better after the adjustment. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 6-14 (a)

Date June 1

Purchases

June 12

(370 @ $6) $2,220

FIFO Cost of goods sold

Balance (120 @ $5) $ 600 (120 @ $5) (370 @ $6)

June 15 June 23

(120 @ $5)

$ 600

(290 @ $6)

$1,740

(200 @ $7) $1,400

(80 @ $6) $ 480 (80 @ $6) (200 @ $7)

June 27

(50 @ $6)

$ 300 $2,640

Ending inventory: $1,580. Cost of goods sold: $2,640.

$2,820

$1,880

(30 @ $6) $1,580 (200 @ $7)

*EXERCISE 6-14 (Continued)

Date Purchases June 1 June 12 (370 @ $6) $2,220 June 15 June 23

LIFO Cost of Goods Sold

(370 @ $6) (40 @ $5)

$2,220 $ 200

(50 @ $7)

$ 350 $2,770

Balance (120 @ $5) $ 600 (120 @ $5) $2,820 (370 @ $6) (80 @ $5) $ 400 (80 @ $5) $1,800 (200 @ $7) (80 @ $5) $1,450 (150 @ $7)

(200 @ $7) $1,400

June 27

Ending inventory: $1,450. Cost of goods sold: $2,770.

Date

Purchases

Moving-Average Cost of Goods Sold

June 1 June 12

(120 @ $5) (370 @ $6) $2,220

June 15 June 23 June 27

Balance $ 600

(490 @ $5.755) $2,820 (410 @ $5.755) $2,360* (80 @ $5.755)

(200 @ $7) $1,400

$ 460*

(280 @ $6.643*) $1,860 (50 @ $6.643) $ 332* (230 @ $6.643) $1,528 $2,692

*rounded Ending inventory: $1,528. Cost of goods sold: $2,692. (A new average cost per unit is computed each time a purchase is made)

*EXERCISE 6-14 (Continued) (b) FIFO gives the same ending inventory and cost of goods sold values

under both the periodic and perpetual inventory system. LIFO and moving-average give different ending inventory and cost of goods sold values under the periodic and perpetual inventory systems. (c) The simple average would be [($5 + $6 + $7) ÷ 3] or $6. However, the

moving-average method uses a weighted-average unit cost that changes each time a purchase is made rather than a simple average. LO 4 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 6-15 Date 9/1 9/5 9/12

FIFO Cost of Goods Sold

Purchases

9/26

800

(4 @ $100) (44 @ $103)

$ 4,932

(45 @ $103) $4,635

9/16 9/19

(8 @ $100)

(50 @ $104) $5,200 (20 @ $105) $2,100

9/29

Ending inventory = $2,620

(1 @ $103) (45 @ $104)

$ 4,783 $10,515

Balance (12 @ $100) $1,200 (4 @ $100) $ 400 (4 @ $100) (45 @ $103) $5,035 (1 @ $103) (1 @ $103) (50 @ $104) (1 @ $103) (50 @ $104) (20 @ $105) (5 @ $104) (20 @ $105)

$ 103 $5,303 $7,403 2,620

*EXERCISE 6-15 (Continued) Date 9/1 9/5 9/12

LIFO Cost of Goods Sold

Purchases

9/19 9/26

(8 @ $100)

(45 @ $103) (3 @ $100)

$ 4,935

(45 @ $103) $4,635

9/16 (50 @ $104) $5,200 (20 @ $105) $2,100

9/29

Balance (12 @ $100) $1,200 800 (4 @ $100) $ 400 (4 @ $100) (45 @ $103) $5,035

(20 @ $105) (26 @ $104)

(1 @ $100) (1 @ $100) (50 @ $104) (1 @ $100) (50 @ $104) (20 @ $105)

$ 4,804 (1 @ $100) $10,539 (24 @ $104)

$ 100 $5,300 $7,400

$2,596

Ending inventory = $2,596 Date 9/1 9/5 9/12 9/16 9/19 9/26 9/29

Purchases

MOVING-AVERAGE Cost of Goods Sold

Balance (12 @ $100) $1,200 (8 @ $100) $ 800 (4 @ $100) $ 400 a (45 @ $103) $4,635 (49 @ $102.755) $5,035 (48 @ $102.755) $ 4,932* (1 @ $102.755) $ 103 (50 @ $104) $5,200 (51 @ $103.980)b $5,303 (20 @ $105) $2,100 (71 @ $104.268)c $7,403 (46 @ $104.268) $ 4,796* (25 @ $104.268) $2,607 $10,528

Ending inventory = $2,607 *Rounded a 5,035 ÷ 49 = $102.755 b 5,303 ÷ 51 = $103.980 c 7,403 ÷ 71 = $104.268 (A new average cost percent is computed each time a purchase is made) LO 4 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 6-16 Beginning inventory................................................... Cost of goods purchased .......................................... Cost of goods available for sale................................ Less: Corrected ending inventory............................ Cost of goods sold ..................................................... a

2016 2017 $ 20,000 $ 28,000 164,000 175,000 184,000 203,000 28,000a 42,000b $156,000 $161,000

$30,000 – $2,000 = $28,000 $37,000 + $5,000 = $42,000

LO 5 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 6-17 (a) Sales..................................................................... Cost of goods sold Beginning inventory .................................... Cost of goods purchased ............................ Cost of goods available for sale ................. Less: Ending inventory ($40,000 – $8,000).............................. Cost of goods sold ............................. Gross profit..........................................................

2016 2017 $210,000 $250,000 32,000 173,000 205,000

32,000 202,000 234,000

32,000 173,000 $ 37,000

55,000 179,000 $ 71,000

(b) The cumulative effect on total gross profit for the two years is zero as shown below: Incorrect gross profits: Correct gross profits: Difference

$45,000 + $63,000 = $108,000 $37,000 + $71,000 = 108,000 $ 0

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

*EXERCISE 6-17 (Continued) (c) Dear Mr./Ms. President: Because your ending inventory of December 31, 2016 was overstated by $8,000, your net income for 2016 was overstated and net income for 2017 was understated by $8,000. In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is overstated, as it was in December 2016, the cost of goods sold is understated and therefore net income will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience. Sincerely, LO 5 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO PROBLEMS PROBLEM 6-1A

(a) The goods should not be included in inventory as they were shipped FOB shipping point and shipped February 26. Title to the goods transfers to the customer February 26. Pitt should have recorded the transaction in the Sales Revenue and Accounts Receivable accounts at the sales price. (Legal title determines if an item should be included in inventory) (b) The amount should not be included in inventory as they were shipped FOB destination and not received until March 2. The seller still owns the inventory. No entry is recorded. (Legal title determines if an item should be included in inventory) (c) Include $500 in inventory. (Legal title determines if an item should be included in inventory) (d) Include $400 in inventory. (Legal title determines if an item should be included in inventory) (e) $750 should be included in inventory as the goods were shipped FOB shipping point. (Legal title determines if an item should be included in inventory) (f)

The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $280. (Legal title determines if an item should be included in inventory)

(g) The damaged goods should not be included in inventory. They should be recorded in a loss account since they are not saleable. (Legal title determines if an item should be included in inventory) LO 1 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-2A

(a) COST OF GOODS AVAILABLE FOR SALE Date March 1 5 13 21 26

Explanation Units Beginning inventory 2,500 Purchase 2,000 Purchase 3,500 Purchase 5,000 Purchase 2,000 Total 15,000

Unit Cost $ 7 8 9 10 11

Total Cost $ 17,500 16,000 31,500 50,000 22,000 $137,000

(b) FIFO (1)

Ending Inventory Unit Total Date Units Cost Cost March 26 2,000 $11 $22,000 21 1,000 10 10,000 3,000* $32,000

(2) Cost of Goods Sold Cost of goods available for sale $137,000 Less: Ending inventory 32,000 Cost of goods sold $105,000

*15,000 – 12,000 = 3,000 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 1 2,500 $7 $ 17,500 5 2,000 8 16,000 13 3,500 9 31,500 21 4,000 10 40,000 12,000 $105,000

PROBLEM 6-2A (Continued) LIFO (1)

Ending Inventory Unit Total Date Units Cost Cost March 1 2,500 $7 $17,500 5 500 8 4,000 3,000 $21,500

(2) Cost of Goods Sold Cost of goods available for sale $137,000 Less: Ending inventory 21,500 Cost of goods sold $115,500

Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 26 2,000 $ 11 $ 22,000 21 5,000 10 50,000 13 3,500 9 31,500 5 1,500 8 12,000 12,000 $115,500

AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $137,000 ÷ 15,000 = $9.133 available for sale $137,000 Less: Ending Unit Total inventory 27,399 Units Cost Cost Cost of goods sold $109,601 3,000 $9.133 $27,399

(c) (1) As shown in (b), FIFO produces the highest inventory amount, $32,000. (2) As shown in (b), LIFO produces the highest cost of goods sold, $115,500. LO 2 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-3A

(a)

COST OF GOODS AVAILABLE FOR SALE Date

Explanation

Units

Unit Cost

Jan. 1 Feb. 20 May 5 Aug. 12 Dec. 8

Beginning inventory Purchase Purchase Purchase Purchase Total

100 600 500 400 100 1,700

$ 8 9 10 11 12

Total Cost $

800 5,400 5,000 4,400 1,200 $16,800

(b) FIFO (1) Date Dec. 8 Aug. 12

Ending Inventory Unit Units Cost 100 100 200*

$12 11

Total Cost

(2) Cost of Goods Sold Cost of goods available for sale $16,800

$1,200 1,100 $2,300

Less: Ending inventory Cost of goods sold

*1,700 – 1,500 = 200 Proof of Cost of Goods Sold Total Unit Date Units Cost Cost Jan. 1 Feb. 20 May 5 Aug. 12

100 600 500 300 1,500

$ 8 9 10 11

800 5,400 5,000 3,300 $14,500

2,300 $14,500

PROBLEM 6-3A (Continued) LIFO (1)

Ending Inventory Total Unit Date Units Cost Cost Jan. 1 100 $8 $ 800 Feb. 20 100 9 900 200 $1,700

(2) Cost of Goods Sold Cost of goods $16,800 available for sale Less: Ending inventory 1,700 Cost of goods sold $15,100

Proof of Cost of Goods Sold Total Unit Date Units Cost Cost Dec. 8 Aug. 12 May 5 Feb. 20

100 400 500 500 1,500

$12 11 10 9

$ 1,200 4,400 5,000 4,500 $15,100

AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $16,800 ÷ 1,700 = $9.882 available for sale $16,800 Less: Ending Unit Total inventory 1,976 Units Cost Cost Cost of goods sold $14,824 200 $9.882 $1,976 Proof of Cost of Goods Sold 1,500 @ $9.882 = $14,824* *Rounded up $1 (c) LIFO results in the lowest inventory amount for the balance sheet, $1,700. FIFO results in the lowest cost of goods sold for the income statement $14,500. LO 2 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-4A

(a)

NATIONAL, INC. Condensed Income Statements For the Year Ended December 31, 2017 Sales..................................................................... Cost of goods sold Beginning inventory .................................... Cost of goods purchased ........................... Cost of goods available for sale ................. Less: Ending inventory.............................. Cost of goods sold ...................................... Gross profit.......................................................... Operating expenses ............................................ Income before income taxes .............................. Income tax expense (28%).................................. Net income........................................................... a

FIFO $750,000

LIFO $750,000

35,000 35,000 468,500 468,500 503,500 503,500 132,300a 116,400b 371,200 387,100 378,800 362,900 124,000 124,000 254,800 238,900 71,344 66,892 $183,456 $172,008

(25,000 @ $4.20) + (7,000 @ $3.90) = $132,300. (10,000 @ $3.50) + (22,000 @ $3.70) = $116,400.

(b) Answers to questions: (1) The FIFO method produces the inventory amount that most closely approximates the amount that would have to be paid to replace the inventory because the units are costed at the most recent purchase’s cost. (2) The LIFO method produces the net income amount that is a more likely induction of next period’s net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.

PROBLEM 6-4A (Continued) (4) There will be $4,452 additional cash available under LIFO because income taxes are $66,892 under LIFO and $71,344 under FIFO. (5) The illusionary gross profit is $15,900 ($378,800 – $362,900) under FIFO. Under LIFO, National Inc. has recovered the current replacement cost of the units ($387,100), whereas under FIFO, it has only recovered the earlier costs ($371,200). This means that under FIFO, the company must reinvest $15,900 of the gross profit to replace the units used. Answer in business-letter form: Dear National Inc. After preparing the comparative condensed income statements for 2017 under the FIFO and LIFO methods, we have found the following: The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. This method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. There will be $4,452 additional cash available under LIFO because income taxes are $66,892 under LIFO and $71,344 under FIFO. There exists an illusionary gross profit of $15,900 ($378,800 – $362,900). Under LIFO, you have recovered the current replacement cost of the units ($387,100) whereas under FIFO you have only recovered the earlier costs ($371,200). This means that under FIFO, the company must reinvest $15,900 of the gross profit to replace the units used. Sincerely, LO 2 BT: AN Difficulty: Medium TOT: 35 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-5A

Cost of Goods Available for Sale Date Explanation October 1 Beginning inventory 9 Purchase 17 Purchase 25 Purchase

Ending Inventory in Units

Units 60 120 100 70 350

Unit Cost $24 26 27 29

Total Cost $1,440 3,120 2,700 2,030 $9,290

Sales revenue

Units available for sale Sales (100 + 60 + 110) Units remaining in ending inventory

350 270 80

Date October 11 22 29

Units 100 60 110 270

Unit Price $35 40 40

Total Sales $ 3,500 2,400 4,400 $10,300

(a) (1) LIFO (i) Ending inventory October 1 60 @ $24 = $1,440 9 20 @ $26 = $ 520 80 $1,960

(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold

(iii) Gross profit Sales revenue Cost of goods sold Gross profit

(iv) Gross profit rate $10,300 7,330 $ 2,970

$9,290 1,960 $7,330

Gross profit $2,970 = 28.8% Net Sales $10,300

PROBLEM 6-5A (Continued) (2) FIFO (i) Ending inventory

(ii) Cost of goods sold Cost of goods available October 25 70 @ $29 = $2,030 for sale October 17 10 @ $27 = $ 270 Less: Ending inventory 80 $2,300 Cost of goods sold

(iii) Gross profit Sales revenue Cost of goods sold Gross profit

$10,300 6,990 $ 3,310

(3) Average-Cost Weighted-average cost per unit:

$9,290 2,300 $6,990

(iv) Gross profit rate Gross profit $3,310 =32.1% = Net sales $10,300

Cost of goods available for sale Units available for sale $9,290 =$26.543 350

(i) Ending inventory 80 @ $26.543 = $2,123* *rounded to nearest dollar

(iii) Gross profit Sales revenue Cost of goods sold Gross profit

$10,300 7,167 $ 3,133

(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold

$9,290 2,123 $7,167

(iv) Gross profit rate Gross profit $3,133 =30.4% = Net sales $10,300

(b) LIFO produces the lowest ending inventory value, gross profit, and gross profit rate because its cost of goods sold is higher than FIFO or average-cost. LO 2 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-6A

(a) (1) To maximize gross profit, Jewels’ Gems should sell the diamonds with the lowest cost. Sale Date March 5 March 25

Cost of goods sold 150 @ $310 $ 46,500 30 @ $350 10,500 170 @ $350 59,500 220 @ $375 82,500 570 $199,000

Sales Revenue 180 @ $600 $108,000 390 @ 650 570

253,500 $361,500

Gross profit $361,500 – $199,000 = $162,500 (2) To minimize gross profit, Jewels’ Gems should sell the diamonds with the highest cost. Sale Date March 5 March 25

Cost of goods sold 180 @ $350 $ 63,000 330 @ $375 123,750 20 @ $350 7,000 40 @ $310 12,400 570 $206,150

Sales Revenue 180 @ $600 $108,000 390 @ 650 253,500 570 $361,500

Gross profit: $361,500 – $206,150 = $155,350 (b) FIFO Cost of goods available for sale March 1 3 10

Beginning inventory Purchase Purchase

Goods available for sale Units sold Ending inventory

150 @ $310 200 @ $350 330 @ $375 680

$ 46,500 70,000 123,750 $240,250

680 570 110 @ $375

$41,250

PROBLEM 6-6A (Continued) Cost of goods available for sale – Ending inventory Cost of goods sold Gross profit:

$361,500 – $199,000 = $162,500.

$240,250 41,250 $199,000

$240,250 34,100 $206,150

$361,500 – $206,150 = $155,350.

(d) The choice of inventory method depends on the company’s objectives. Since the diamonds are marked and coded, the company could use specific identification. This could, however, result in “earnings management” by the company because, as shown, it could carefully choose which diamonds to sell to result in the maximum or minimum income. Employing a cost flow assumption, such as LIFO or FIFO, would reduce record-keeping costs; FIFO would result in higher income, but LIFO would reduce income taxes and provide better matching of current sales revenue with current costs. LO 2 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 6-7A

(a) Inventory turnover

$166,259 ($13,921+ $14,939)÷2 $166,259

=11.5 times

$14,430 Days in inventory (b) Current ratio

365

=31.7days

11.5

$60,135 =.86:1 $70,308

Current ratio

$60,135 1,423 $61,558 $61,558

=.88:1

$70,308

(d) The current ratio was slightly higher in (c) compared to (b) because current assets (i.e., inventory) are larger in (c). LO 3 BT: AP Difficulty: Moderate TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 6-8A (a) Sales: Date January 6 January 10 January 30 Total sales

180 @ $40 50 @ $45 130 @ $48

$ 7,200 2,250 6,240 $15,690

(1) LIFO Date January

Purchases

Cost of goods sold

January 2 January 6

(100 @ $22) $2,200

January

(75 @ $24) $1,800

(100 @ $22) $3,800 (80 @ $20)

January 10 January 23

January 30

(50 @ $24) $1,200 (100 @ $25) $2,500

(100 @ $25) (25 @ $24) $3,200 (5 @ $20) $8,200

Balance (160 @ $20) $3,200 (160 @ $20) $5,400 (100 @ $22) (80 @ $20) $1,600 (80 @ $20) $3,400 (75 @ $24) (80 @ $20) $2,200 (25 @ $24) (80 @ $20) (25 @ $24) $4,700 (100 @ $25) (75 @ $20) $1,500

(i) Cost of goods sold: $8,200. (ii) Ending inventory = $1,500. (iii) Gross profit = $15,690 – $8,200 = $7,490.

*PROBLEM 6-8A (Continued) (2) FIFO Date January

January

Purchases

(100 @ $22) $2,200 (160 @ $20) (20 @ $22)

$3,640

(75 @ $24) $1,800

January 10 January 23

Cost of goods sold

(50 @ $22)

$1,100

(100 @ $25) $2,500

January 30

(30 @ $22) (75 @ $24) (25 @ $25)

$3,085

Balance (160 @ $20) $3,200 (160 @ $20) (100 @ $22)

$5,400

(80 @ $22)

$1,760

(80 @ $22) (75 @ $24)

$3,560

(30 @ $22) (75 @ $24)

$2,460

(30 @ $22) (75 @ $24) (100 @ $25)

$4,960

(75 @ $25)

$1,875

$7,825

(i) Cost of goods sold: $7,825. (ii) Ending inventory = $1,875. (iii) Gross profit = $15,690 – $7,825 = $7,865. (3) Moving-Average: Date January 1 January 2 January 6 January 9 January 10 January 23 January 30 a

Purchases

Cost of goods sold

(100 @ $22) $2,200 (180 @ $20.769) $3,738* (75 @ $24) $1,800 (50 @ $22.335)

$1,117

(100 @ $25) $2,500

$5,400 ÷ 260 = $20.769 b $3,462 ÷ 155 = $22.335 *Rounded

(130 @ $23.634) $3,072 $7,927 c

Balance (160 @ $20) $3,200 a (260 @ $20.769) $5,400 (80 @ $20.769) $1,662 (155 @ $22.335)b $3,462 (105 @ $22.335) $2,345 (205 @ $23.634)c $4,845 (75 @ $23.634) $1,773

$4,845 ÷ 205 = $23.634

(i) Cost of goods sold: $7,927. (ii) Ending inventory = $1,773. (iii) Gross profit = $15,690 – $7,927 = $7,763. (A new average cost per unit is computed each time a purchase is made)

*PROBLEM 6-8A (Continued) (b) Gross profit: LIFO

FIFO

MovingAverage

$15,690

8,200

7,825

7,927

Gross profit

$ 7,490

$ 7,865

$ 7,763

Ending Inventory

$ 1,500

$ 1,875

$ 1,773

Sales – Cost of goods sold

In a period of rising costs, the LIFO cost flow assumption results in the highest cost of goods sold and lowest gross profit. FIFO gives the lowest cost of goods sold and highest gross profit. The moving-average cost flow assumption results in amounts between the other two. On the balance sheet, FIFO gives the highest ending inventory (representing the most current costs); LIFO gives the lowest ending inventory (representing the oldest costs); and moving-average cost results in an ending inventory falling between the other two. LO 4 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*PROBLEM 6-9A (a) (1) Date Purchases July 1 (7 @ $ 62) $434 6 11 (3 @ $ 66) $198 14 21 27

FIFO Cost of Goods Sold (5 @ $62) $310 (2 @ $62) (1 @ $66) $190

(4 @ $ 71) $284 (2 @ $66) (1 @ $71) $203

Balance (7 @ $ 62) $434 (2 @ $ 62) $124 (2 @ $ 62) (3 @ $ 66) $322 (2 @ $ 66) $132 (2 @ $ 66) (4 @ $ 71) $416 (3 @ $ 71) $213

(2)

MOVING-AVERAGE Cost of Date Purchases Goods Sold Balance July 1 (7 @ $ 62) $434 (7 @ $62) $434 6 (5 @ $62) $310 (2 @ $62) $124 11 (3 @ $ 66) $198 (5 @ $64.40)* $322 14 (3 @ $64.40) $193 (2 @ $64.40) $129 21 (4 @ $ 71) $284 (6 @ $68.83)** $413 27 (3 @ $68.83) $206*** (3 @ $68.83) $207*** *$322 ÷ 5 = $64.40. **$413 ÷ 6 = $68.83. ***rounded (A new average cost per unit is computed each time a purchase is made under the moving average method.) (3)

LIFO Cost of Goods Sold

Date Purchases July 1 (7 @ $ 62) $434 6 (5 @ $ 62) $310 11 (3 @ $ 66) $198 14 (3 @ $ 66) $198 21 (4 @ $ 71) $284 27 (b)

(3 @ $ 71) $213

Balance (7 @ $ 62) $434 (2 @ $ 62) $124 (2 @ $ 62) $322 (3 @ $ 66) (2 @ $ 62) $124 (2 @ $ 62) (4 @ $ 71) $408 (2 @ $ 62) $195 (1 @ $ 71)

The highest ending inventory is $213 under the FIFO method.

LO 4 BT: AP Difficulty: Hard TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

ACCOUNTING CYCLE REVIEW SOLUTION (a)

Dec. 3 5

17 22

Inventory (4,000 X $0.72) ........................... Accounts Payable...............................

2,880

Accounts Receivable (4,400 X $0.90)........ Sales Revenue ....................................

3,960

Cost of Goods Sold.................................... Inventory (3,000 X $0.60) + (1,400 X $0.72)..................................

2,808

Sales Returns and Allowances ................. Accounts Receivable..........................

180

Inventory..................................................... Cost of Goods Sold ............................

144

Inventory (2,200 X $0.80) ........................... Cash ....................................................

1,760

Accounts Receivable (2,000 X $0.95)........ Sales Revenue ....................................

1,900

Cost of Goods Sold (2,000 X $0.72) .......... Inventory .............................................

1,440

Salaries and Wages Expense .................... Salaries and Wages Payable..............

400

Depreciation Expense................................ Accumulated Depreciation— Equipment ........................................

200

Income Tax Expense.................................. Income Taxes Payable .......................

215

2,880 3,960

2,808

180 144 1,760 1,900 1,440 400

200 215

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) (b)

General Ledger

Bal. Bal. Bal.

Bal.

Cash 4,800 3,040 Accounts Receivable 3,900 3,960 1,900 9,580

Bal.

Inventory 1,800 2,880 144 1,760 2,336

Bal.

Equipment 21,000

Bal.

Sales Revenue 2,808 1,440

3,000 2,880 5,880

Salaries and Wages Payable 400 Bal. 400 Income Taxes Payable Bal.

10,000

Retained Earnings Bal. 17,000

180

Accumulated Depreciation—Equipment Bal. 1,500 200 Bal. 1,700 Accounts Payable Bal.

Common Stock Bal.

1,760

215 215

Bal.

Cost of Goods Sold 2,808 1,440 4,104

Bal.

Depreciation Expense 200 200

3,960 1,900 5,860 144

Salaries and Wages Expense 400 Bal. 400 Sales Returns & Allowances 180 Bal. 180

Bal.

Income Tax Expense 215 215

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) (c)

WAYLON COMPANY Adjusted Trial Balance December 31, 2017 Cash .............................................................. Accounts Receivable ................................... Inventory....................................................... Equipment .................................................... Accumulated Depreciation—Equipment .... Accounts Payable ........................................ Salaries and Wages Payable ....................... Income Taxes Payable ................................. Common Stock............................................. Retained Earnings........................................ Sales Revenue.............................................. Sales Returns & Allowances ....................... Cost of Goods Sold...................................... Salaries and Wages Expense ...................... Depreciation Expense.................................. Income Tax Expense....................................

(d)

DR. $ 3,040 9,580 2,336 21,000

CR.

$ 1,700 5,880 400 215 10,000 17,000 5,860 180 4,104 400 200 215 $41,055

$41,055

WAYLON COMPANY Income Statement For the Month Ending December 31, 2017 Sales revenue............................................. Less: Sales returns and allowances ........ Net sales ..................................................... Cost of goods sold..................................... Gross profit ................................................ Operating expenses Salaries and wages expense ............. Depreciation expense......................... Income before income tax ......................... Income tax expense ................................... Net income..................................................

$5,860 180 $5,680 4,104 1,576 400 200

600 976 215 $ 761

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) WAYLON COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash ....................................................... Accounts receivable.............................. Inventory ................................................ Total current assets......................... Property, plant, and equipment Equipment.............................................. Less: Accumulated depreciation— Equipment .................................. Total assets ...................................................

$ 3,040 9,580 2,336 $14,956 21,000 1,700

19,300 $34,256

Liabilities and Stockholders’ Equity Current liabilities Accounts payable.................................. Salaries and wages payable ................. Income taxes payable ........................... Total current liabilities..................... Stockholders’ equity Common stock ...................................... Retained earnings ($17,000 + $761) ..... Total stockholders’ equity............... Total liabilities and stockholders’ equity ....

$ 5,880 400 215 $ 6,495 10,000 17,761 27,761 $34,256

(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)

ACCOUNTING CYCLE REVIEW SOLUTION (Continued) (e) FIFO Method

Beg. Inventory Dec. 3 purchase Dec. 17 purchase

Units 3,000 4,000 2,200 9,200

Unit Cost $0.60 $0.72 $0.80

Cost of Goods Available for Sales $1,800 2,880 1,760 $6,440

Ending Inventory

Cost of Goods Sold

Dec. 17 2,200 X $0.80 = $1,760 Dec. 3 800* X $0.72 = 576 3,000 $2,336

Cost of goods available for sale Less: Ending inventory Cost of goods sold

$6,440 2,336 $4,104

*(9,200 – 4,400 + 200 – 2,000) – 2,200 (f)

LIFO Method Ending Inventory

Cost of Goods Sold

Dec. 1

Cost of goods available for sale Less: Ending inventory Cost of goods sold

3,000 X $0.60 = $1,800

$6,440 1,800 $4,640

LO 2 BT: AP Difficulty: Hard TOT: 120 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 6-1

FINANCIAL REPORTING PROBLEM

(Note: All dollar amounts are in millions) (a) Inventories were $2,111 at September 27, 2014 and $1,764 at September 28, 2013. (b) Inventories increased $347 in 2014. Using 2013 as the base year, the increase was approximately 19.7% ($347 ÷ $1,764). In 2014, inventories were approximately 3.1% of current assets ($2,111 ÷ $68,531). (c) Cost of sales was: 2014, $112,258; 2013, $106,606; and 2012, $87,846. In 2014, cost of sales was 61.4% of net sales ($112,258 ÷ $182,795). LO 3 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 6-2

COMPARATIVE ANALYSIS PROBLEM

(a)

Columbia Sportswear $1, 145, 639

$6,288,190

($384, 650 + $329, 228) ÷ 2

($1,482,804 + $1,399,062) ÷ 2

1. Inventory turnover

$1, 145, 639 $356, 939 2. Days in inventory

VF Corporation

365 3.2

= 3.2 times

= 114.1 days

$6,288,190 $1,440,933 365 4.4

= 4.4 times

= 83.0 days

(b) Generally, companies that are able to keep their inventory at lower levels and higher turnovers and still satisfy customer needs are the most successful. Both companies have low inventory turnovers. As a result, Columbia keeps more than three months of inventory on hand and VFC keeps more than two months on hand. LO 3 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 6-3

COMPARATIVE ANALYSIS PROBLEM

(a)

Amazon.com 1. Inventory turnover

2. Days in inventory

Wal-Mart

$62,752

$365,069

($7,411 + $8,299) ÷ 2

($45,141 + $44,858) ÷ 2

$62, 752

$365, 069

= 8.0 times

$7, 855 365 = 45.6 days 8.0

= 8.1 times

$44, 999.5 365 = 45.1 days 8.1

(b) The two companies have performed similarly in inventory management. LO 3 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 6-4

INTERPRETING FINANCIAL STATEMENTS

(a) Finished goods are manufactured inventory items that are ready for resale. Work in process is inventory that has been put into production but is not complete. Raw materials are the basic materials that will be used in production. (b) American Greetings may use LIFO for U.S. operations because of its tax advantages. Since many foreign countries do not allow the use of LIFO, American Greetings may use FIFO for non-domestic inventories. Using FIFO will result in higher reported profit and inventory values than LIFO. (c) Inventory turnover:

Days in inventory:

2017 $809, 956 ($216, 671 + $203, 873)/2 $809, 956 = 3.9 times $210, 272 365/3.9 = 93.6 days

2016 $780, 771 ($182, 618 + $216, 671)/2 $780, 771 = 3.9 times $199, 644.5 365/3.9 = 93.6 days

The inventory turnover remain unchanged from 2016 to 2017. (d) The LIFO reserve, $86,025, represents 42% of total inventory ($86,025/$203,873 = .42). Ending inventory using LIFO .................... Ending LIFO reserve.................................. Ending inventory assuming FIFO.............

$203,873 86,025 $289,898

This difference is probably considered “material” since it exceeds 10 percent. Since the reserve is disclosed, analysts can include both FIFO and LIFO amounts when analyzing performance. The FIFO value better represents the current value of American Greetings’ inventory.

CT 6-4 (Continued) (e) Current ratio:

$561, 395

= 1.63 : 1

$343, 405 Current assets using LIFO Ending LIFO reserve Current assets assuming FIFO Current ratio:

$647, 420

$561,395 86,025 $647,420

= 1.89 : 1

$343, 405 LO 3 BT: AN Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 6-5

REAL-WORLD FOCUS

Answers will vary depending on the company chosen. LO 2, 3 BT: S Difficulty: Medium TOT: 30 min. AACSB: Analytic and Technology AICPA FC: Measurement and Reporting

CTP 6-6

REAL WORLD FOCUS

(a) Companies with slow moving inventory, such as industrial manufacturers, benefit most from the use of LIFO, because the extended time that they hold their inventory make them more susceptible to price changes. (b) A proposed 2011 budget estimated that eliminating the use of LIFO for tax purposes would increase federal tax receipts by $59 billion over 10 years. (c) If the U.S. decides to adopt IFRS for financial reporting purposes, LIFO usage would probably end. This is because IFRS does not allow LIFO for financial reporting. Current tax laws require that if LIFO is used for taxes it must also be used for financial reporting. Therefore, unless this so called “conformity rule” was eliminated, the use of LIFO would end. (d) Proponents of LIFO argue that without LIFO, there is mismatch between the price that was paid for the inventory many months earlier, and the price that would now have to be paid to replenish the inventory at the current, higher, price. They argue that this mismatch makes it appear that their profits are higher than they really are, because it is including an inflation component that is not really profit. (e) FIFO tends to be preferred by retailers and manufacturers of fastmoving inventory such as electronics or perishable goods. They say that it better reflects the current values of their inventories. LO 2 BT: S Difficulty: Medium TOT: 30 min. AACSB: Analytic and Technology AICPA FC: Measurement and Reporting

CT 6-7

DECISION MAKING ACROSS THE ORGANIZATION

(a)

2017 Current ratio

2016

$1, 800 = 3.00:1 $600

Gross profit rate

$9, 428 – $6, 328 $9, 428 $754

Days in inventory

= 2.41 : 1 $8, 674 – $5, 474

= 36.9%

$8, 674 = 8 .0%

$9, 428 Inventory turnover

$1, 183

$1, 423 $590

= 32.9% Profit margin

2015

$6, 328

$987

$7, 536 – $4, 445

$979 = 11.4%

$5,474

= 8.1 times

= 13.0%

$7, 536 $4, 445

($925 + $757)/ 2

($757 +$602)/ 2

($602 + $418)/ 2

365

7.5

= 48.7 days

= 45.1 days 8.1

= 41.0%

$7, 536

$8, 674 = 7.5 times

= 2.25:1 $525

= 8.7 times

= 42.0 days 8.7

(b) The company’s current ratio has increased steadily over this period. While this might be interpreted as a positive, since it would normally represent improved liquidity, the company started this period with a current ratio in excess of 2, thus it already had good liquidity. With its current ratio now 3 it would appear that the company has too many funds tied up in current assets. In particular, it would appear that the company has a surplus of unsold inventory. This is supported by the fact that inventory as a percent of total assets has increased significantly. The gross profit rate has been steadily declining. From the CEO’s comments we learned that the company has frequently been forced to discount its products in order to move them off the shelves. This discounting will directly reduce the gross profit rate. The profit margin has also declined. Originally the company made a profit of 13 cents on each dollar of sales. Now it only makes 8 cents per sales dollar. A significant portion of this decline is most likely the result of the decline in the gross profit rate.

CT 6-7 (Continued) Inventory turnover, as measured by the days in inventory has worsened considerably during this period. At the beginning of this period it took 42 days to sell the average inventory item, now it takes 49. (c) The evaluation above suggests that many of the company’s problems stem from poor inventory management. As the company has grown, its ability to manage its inventory has declined. This has caused a decline in its profitability. By implementing a just-in-time inventory system the company could reduce the amount of resources that it has tied up in inventory, thus reducing its storage and handling costs. Also, it should reduce the need for product discounting, since the company will be less likely to be stuck with surplus inventory. (d) The marketing and sales department may well be concerned that a justin-time inventory system will result in more stock-outs. The company already is having stock-out problems, even though it has a lot of inventory. The company’s current inventory system appears to lack good technological support, which would allow it to identify which products are selling well. As discussed in the case of both Caterpillar and Dell computers in the chapter, a well implemented just-in-time system, supported by technology and coordination with suppliers, would enable the company to reduce its inventory balance while actually increasing its ability to deliver products to customers in a timely fashion. LO 1, 3 BT: E Difficulty: Hard TOT: 45 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Interaction, Leadership, and Communication

AICPA FC:

CT 6-8

COMMUNICATION ACTIVITY

In a period of changing prices, the cost flow assumption can have a significant impact on income and on evaluations based on income. Under the FIFO method, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold. Under the average-cost method, the calculation of cost of goods sold is made on the basis of the weightedaverage unit cost incurred. In a period of rising prices, FIFO will produce a lower cost of goods sold and a higher net income. Starbucks’ change from FIFO to average-cost will result in a higher cost of goods sold and a lower net income. Because of increasing competition, Starbucks probably is not able to pass the coffee bean price increase on to its customers. Using the average-cost method allows Starbucks to average its changing inventory prices and avoid a distortion of income. A possible disadvantage of the change is the related balance sheet effect. Since inventory is a current asset, Starbucks’ current ratio will be lower because of the change. In addition, the company’s inventory turnover and days in inventory could be adversely affected. LO 2 BT: E Difficulty: Hard TOT: 30 min. AACSB: Reflective Thinking and Communication AICPA FC: Measurement AICPA PC: Communication AICPA BB: Critical Thinking

*CT 6-9 COMMUNICATION ACTIVITY

MEMO To:

H.K. Logan, President

From:

Student

Subject: 2016 ending inventory error As you know, 2016 ending inventory was overstated by $1 million. Of course, this error will cause 2016 net income to be incorrect because the ending inventory is used to compute 2016 cost of goods sold. Since the ending inventory is subtracted in the computation of cost of goods sold, an overstatement of ending inventory results in an understatement of cost of goods sold and therefore an overstatement of net income. Unfortunately, unless corrected, this error will also affect 2017 net income. The 2016 ending inventory is also the 2017 beginning inventory. Therefore, 2017 beginning inventory is also overstated, which causes an overstatement of cost of goods sold and an understatement of 2017 net income. LO 5 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic and Communication AICPA FC: Measurement AICPA PC: Communication

CT 6-10

ETHICS CASE

(a) The higher cost of the items ordered, received, and on hand at yearend will be charged to cost of goods sold, thereby lowering current year’s income and income taxes. Next year’s income will be increased because the inventory carried at lower costs from the earlier year will be charged to next year’s cost of goods sold. If the purchase at yearend had been made in the next year, the next year’s cost of goods sold would have absorbed the higher cost. (b) No. The president would not have given the same directive because the purchase under FIFO would have had no effect on net income of the current year. (c) The accountant has no grounds for not ordering the goods if the president insists. The purchase is legal and ethical, even though it allows the company to “manage” this year’s net income. LO 2 BT: E Difficulty: Medium TOT: 20 min. AACSB: Ethics, Reflective Thinking and Communication AICPA FC: Measurement AICPA PC: Communication and Personal Demeanor

CT 6-11

ALL ABOUT YOU

Students responses to this question will vary depending on the inventory fraud they choose to investigate. Here are responses for the two examples given in the activity. The fraud at Leslie Fay involved a number of illegal actions, all of which increased net income. The company intentionally overstated ending inventory, which has the effect of understating cost of goods sold. It also understated or completely omitted discounts and allowances that it gave to retailers. In addition, it recorded inventory costs at amounts that differed from the invoice amount. It also reported sales in incorrect periods. McKesson Corporation increased its reported net income through manipulation of inventory and sales records. It back-dated many transactions to increase current period results. It also swapped inventory to increase reported revenue. Many of the transactions that it reported as sales, and which resulted in reductions in inventory, were actually not sales because they had negotiated side agreements which allowed the buyer to return the merchandise. LO 2 BT: E Difficulty: Hard TOT: 40 min. AACSB: Technology, Reflective Thinking and Communication AICPA FC: Reporting AICPA PC: Communication and Personal Demeanor

CT 6-12

FASB CODIFICATION ACTIVITY

(a) The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations. (330-10-30-1) (b) The basis of stating inventories shall be consistently applied and shall be disclosed in the financial statements; whenever a significant change is made therein, there shall be disclosure of the nature of the change and, if material, the effect on income. A change of such basis may have an important effect upon the interpretation of the financial statements both before and after that change, and hence, in the event of a change, a full disclosure of its nature and of its effect, if material, upon income shall be made. Codification reference (330-10-50-1). (c) A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. Codification reference (330-10-35-1). LO 1, 3 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Technology, Reflective Thinking and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication AICPA BB: Critical Thinking

CT 6-13

CONSIDERING PEOPLE, PLANET, AND PROFIT

(a) The company’s goals were separated into two groups as follows: 2020 Goals for Operations ● Reduce recordable workplace Injury rate to 0.6 and lost-time case rate due to Injury to 0.15 ● Reduce energy intensity by 50% from 2006. ● Reduce greenhouse gas emissions intensity by 50% from 2006. ● Reduce by-product materials intensity by 50% from 2006. ● Reduce water consumption intensity by 50% from 2006. ● Design all new facility construction to meet Leadership in Energy and Environmental Design (LEED) or comparable green building criteria 2020 Goals for Product Stewardship ● Provide leadership in the safety of people in, on and around our products. ● Leverage technology and innovation to improve sustainability of our products, services and solutions for our customers. ● Increase managed fleet hours by 100% from 2013. ● Increase remanufactured and rebuild business sales by 20% from 2013. (b) The company improved its Recordable Injury Frequency rate by 89 percent from our 2003 baseline year and 9 percent from its last reporting period. It improved its Lost-Time Case Frequency rate by 92 percent from our 2003 baseline year and 21 percent from our last reporting period. Both of these would appear to be significant improvements in the area of worker conditions and safety. (c) The company measures its energy intensity by dividing its total revenue in dollars into a measure of its total energy used. This then provides a measure of how much energy it uses to generate revenue. Based on this measure, the company showed significant improvement relative to the base year of 2006. LO None BT: AP Difficulty: Hard TOT: 40 min. AACSB: Technology, Reflective Thinking and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication AICPA BB: Critical Thinking

IFRS CONCEPTS AND APPLICATION IFRS6-1 Key Similarities are (1) the definitions for inventory are essentially the same, (2) the guidelines on who owns the goods—goods in transit, consigned goods, and the costs to include in inventory are essentially accounted for the same under IFRS and U.S. GAAP; (3) use of specific identification cost flow assumption, where appropriate. Key differences are related to (1) the LIFO cost flow assumption—U.S. GAAP permits the use of LIFO for inventory valuation, but IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS; (2) lower-of-cost-or-market test for inventory valuation—IFRS defines market as net realizable value. U.S. GAAP on the other hand defines market as replacement cost; (3) The requirements for accounting and reporting for inventories are more principles-based under IFRS. That is, U.S. GAAP provides more detailed guidelines for inventory accounting. IFRS6-2 Under IFRS, LaTour’s inventory turnover is computed as follows: Cost of Goods Sold/Average Inventory €578/€154 = 3.75 or approximately 97 days (365 ÷ 3.75). Difficulties in comparison to a company using U.S. GAAP could arise if the U.S. company uses the LIFO cost flow assumption, which is prohibited under IFRS. Generally in times of rising prices, LIFO results in a lower inventory balance reported on the balance sheet (assume more recently purchased items are sold first). Thus, the U.S. GAAP company will report higher inventory turnovers. The LIFO reserve can be used to adjust the reported LIFO numbers to FIFO and to permit an “apples to apples” comparison.

IFRS6-3

INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) Louis Vuitton’s Note 1.16 states that inventories are valued using the weighted average or FIFO methods. (b) Note 10 reports €1,323 million (net) of goods purchased for resale and €2,877 million (net) of finished products.

CHAPTER 7 Fraud, Internal Control, and Cash Learning Objectives 1. Define fraud and the principles of internal control. 2. Apply internal control principles to cash. 3. Identify the control features of a bank account. 4. Explain the reporting of cash and the basic principles of cash management. *5. Explain the operation of a petty cash fund.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item

19. 20. 21. 22. 23. 24.

2 2 3 3 3 4

C K K C C C

25. 26. 27. 28.

3 4 4 5*

C C C C

10. 11. 12.

3 3 4

AP AP C

13. 14.

4 5*

AP AP

4a.

4b.

11. 12. 13.

3 4 4

AP AP C

14. 15. 16.

4 5* 5*

AP AP AP

Questions 1. 2. 3. 4. 5. 6.

1 1 1 1 1 1

C C C C K C

7. 8. 9. 10. 11. 12.

1 1 1 1 1 1

C C C C C C

13. 14. 15. 16. 17. 18.

1 4 2 2 2 2

C AP C C C C

1. 2. 3.

1 1 1

C C C

4. 5. 6.

2 2 2

C AP C

Brief Exercises 7 3 C 8. 3 C 9. 3 C Do It Exercises 3. 3 K

E AP AP

Exercises 8. 3 AP 9. 3 AP 10. 3 AP

1. 2. 3. 4.

1 1 2 2

C C E E

5. 6. 7.

2 3 3

Problems: Set A 1. 2.

2 2

C C

3. 4.

3 3

AP AP

5. 6.

3 1,2,3

AP E

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Description

Difficulty Level

Time Allotted (min.)

Identify internal control weaknesses for cash receipts.

Simple

20–30

Identify internal control weaknesses in cash receipts and cash disbursements.

Simple

20–30

Prepare a bank reconciliation and adjusting entries.

Simple

20–30

Prepare a bank reconciliation and adjusting entries from detailed data.

Moderate

40–50

Prepare a bank reconciliation and adjusting entries.

Moderate

30–40

Prepare a comprehensive bank reconciliation with theft and internal control deficiencies.

Complex

40–50

Prepare a cash budget.

Moderate

30–40

Prepare a cash budget.

Moderate

30–40

Problem Number

ANSWERS TO QUESTIONS 1.

Fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. An example of fraud that might occur at a bank would be a computer operator embezzling funds by transferring a customer’s deposits into another account.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

The three main factors that contribute to employee fraud are opportunity, financial pressure, and rationalization. Opportunities that an employee can take advantage of occur when the workplace lacks sufficient controls to deter and detect fraud. Financial pressure occurs when employees want to lead a lifestyle that they cannot afford on their current salary. Rationalization involves employees justifying fraud because they believe they are underpaid while their employer is making lots of money.

LO 1 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

The five components of a good internal control system are: (1) A control environment, (2) Risk assessment, (3) Control activities, (4) Information and communication, and (5) Monitoring.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

Disagree. Internal control is also concerned with the safeguarding of company assets, increasing efficiency of operations, and ensuring compliance with laws and regulations.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 5.

The Sarbanes-Oxley Act requires that a company develop sound principles of internal control over financial reporting and continually verify that these controls are working. The act specifically requires top management to attest that the company’s internal controls are reliable and effective.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

The principles of internal control that apply to most businesses are: (a) establishment of responsibility, (b) segregation of duties, (c) documentation procedures, (d) physical controls, (e) independent internal verification, and (f) human resource controls.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA: Reporting

Yes, this is a violation of the internal control principle of establishing responsibility. In this case, each sales clerk should have a separate cash register or cash register drawer.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

The two applications of segregation of duties are: (1) The responsibility for related activities should be assigned to different individuals. (2) The responsibility for record keeping for an asset should be separate from the physical custody of that asset.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

Documentation procedures contribute to good internal control by providing evidence of the occurrence of transactions and events and, when signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to accounting contributes to recording transactions in the proper period, and the prenumbering of documents helps to ensure that a transaction is not recorded more than once or not at all.

LO 1 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

10.

Safes, vaults, and locked warehouses contribute to the safeguarding of company assets. Cash registers and computerized accounting equipment contribute to the accuracy and reliability of the accounting records, and electronic burglary systems and sensors help to safeguard assets.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

11.

(a)

Independent internal verification involves the review, comparison, and reconciliation of data prepared by employees. (b) Maximum benefit is obtained from independent internal verification when: (1) The verification is made periodically or on a surprise basis. (2) The verification is done by an employee who is independent of the personnel responsible for the information. (3) Discrepancies and exceptions are reported to a management level that can take appropriate corrective action.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

12.

(a) The concept of reasonable assurance means that the costs of establishing control procedures should not exceed their expected benefit. Ordinarily, a system of internal control provides reasonable but not absolute assurance, since absolute assurance would be too costly. (b) The human element is an important factor in a system of internal control. A good system may become ineffective as the result of employee fatigue, carelessness, or indifference. Moreover, internal control may become ineffective as a result of collusion.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

13.

The human resources department plays an important role in internal control by (a) bonding employees who handle cash, (b) rotating employees’ duties and requiring employees to take vacations, (c) conducting thorough background checks.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

14.

Cash should be reported at $21,100 ($8,000 + $1,100 + $12,000).

LO 4 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

15.

Daily cash counts pertain primarily to the principles of segregation of duties, documentation procedures, and independent internal verification. Daily cash counts also involve the establishment of responsibility for performing the counts.

LO 2 BT: C Difficluty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

16.

Cash registers are readily visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount and pocketing the difference. In addition, the customer receives an itemized receipt, and the cash register tape is locked into the register for further verification, providing documentation and enabling independent internal verification.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

17.

Two mail clerks contribute to a more accurate listing of mail receipts and to the endorsement of all checks “For Deposit Only.” In addition, two clerks reduce the likelihood of mail receipts being diverted to personal use.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

18.

True. Payment by check contributes to effective internal control over cash disbursements. However, effective control is also possible when small payments are made from petty cash.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

19.

The procedure and related principle are: Procedure

Principle

(1) Treasurer signs checks. (2) Checks imprinted by a checkwriter. (3) Comparing check with approved invoice before signing.

  

Establishment of responsibility. Physical controls. Independent internal verification.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

20. (a) Physical controls apply to cash disbursements when blank checks are stored in a safe, and access to the safe is restricted to authorized personnel, and a check-writing machine is used to print amounts on checks with indelible ink. (b) Human resource controls apply when the company bonds personnel who handle cash, requires employees to take vacations, and conducts background checks. LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

21. Electronic funds transfer is a cash disbursement system that uses wire, telephone, or computers to transfer cash balances from one location to another. LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

22. True. A bank contributes significantly to internal control over cash because it: (1) safeguards cash on deposit, (2) minimizes the amount of cash that must be kept on hand, and (3) provides a double record of all bank transactions. LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

23. The lack of agreement between the balances may be due to either: (1) Time lags—a check written in July does not clear the bank until August. (2) Errors—a check for $110 is recorded by the depositor as $101. LO 3 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 24. The basic principles of cash management are: (1) increase the speed of receivables collection, (2) keep inventory low, (3) monitor payment of liabilities, (4) plan timing of major expenditures, and (5) invest idle cash. LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

An NSF check occurs when the checkwriter’s bank balance is less than the amount of the check. (b) In a bank reconciliation, a customer’s NSF check is deducted from the balance per books. (c) An NSF check results in an adjusting entry in the company’s books, as a debit to Accounts Receivable and a credit to Cash.

25. (a)

LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 26. (a) Cash equivalents are short-term highly liquid investments that may be converted to a specific amount of cash. Cash equivalents may be reported with cash in the current assets section of the balance sheet. (b) Cash restricted for a special purpose should be reported separately as a current or noncurrent asset depending on when the cash is expected to be used. LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 27.

At September 27, 2014, Apple reported cash and cash equivalents of $13,844 (millions). It reported no restricted cash. In Note 1 to its financial statements it defines cash equivalents as “All highly liquid investments with maturities of three months or less at the date of purchase.”

LO 4 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

*28.

The activities in a petty cash system and the related principles are:  Establishment of responsibility for custody of the fund. (2) Making payments from the fund.  Documentation procedures because the custodian must use a prenumbered petty cash receipt. (3) Replenishing the fund.  Independent internal verification because the request for replenishment must be approved before the check is written.

(a) (1) Establishing the fund.

(b) Journal entries are required for a petty cash fund when it is established and replenished. Entries are also required when the size of the fund is increased or decreased.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 (a) (b) (c) (d)

Financial Pressure Rationalization Financial Pressure Opportunity

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-2 The purposes of internal control are to: 1.

Safeguard a company’s assets from employee theft, robbery, and unauthorized use. An application for Young Co. is the use of a cash register to safeguard assets.

Enhance the accuracy and reliability of a company’s accounting records by reducing the risk of errors (unintentional mistakes) and irregularities (intentional mistakes and misrepresentations) in the accounting process. An application for Young Co. is preparation of a bank reconciliation.

Increase efficiency of operations. An application is assignment of responsibility to specific employees.

Ensure compliance with laws and regulations. An application is use of cash register tapes to document sales and applicable sales taxes.

All of these purposes are important to the success of any business endeavor. LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-3 (a) Segregation of duties. (b) Independent internal verification. (c) Documentation procedures. LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-4 (a) (b) (c) (d) (e)

Physical controls. Human resource controls. Independent internal verification. Segregation of duties. Establishment of responsibility.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-5 Cash ($1,125.74 – $150.00)...................................... Cash Over and Short............................................... Sales Revenue .................................................

975.74 12.88 988.62

LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 7-6 (a) (b) (c) (d) (e)

Documentation procedures. Independent internal verification. Physical controls. Establishment of responsibility. Segregation of duties.

LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-7 (a) The use of a checking account minimizes the amount of currency that must be kept on hand. Therefore, cash is safeguarded by using the bank as a depository and clearinghouse for checks written and received. (b) A bank statement provides a double record of a depositor’s bank transactions. It also is used in making periodic independent bank reconciliations. LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 7-8 (a) Outstanding checks—deducted from cash balance per bank. (b) Bank debit memorandum for service charge—deducted from cash balance per books. (c) Bank credit memorandum for EFT—added to cash balance per books. (d) Deposit in transit—added to cash balance per bank. LO 3 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 7-9 (a) The reconciling items per the books, items (b) and (c) above, will require adjustment on the books of the depositor. (b) The other reconciling items, deposits in transit and outstanding checks, do not require adjustment because they have already been recorded on the depositor’s books. LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 7-10 Cash balance per bank statement................................................. Add: Deposits in transit............................................................... Less: Outstanding checks............................................................ Adjusted cash balance per bank...................................................

$7,291 1,350 8,641 762 $7,879

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 7-11 Checks written in November ........................................................ Less: Checks paid by bank in November .................................. Checks outstanding at the end of November.............................. Add: Checks written in December............................................. Less: Checks paid by bank in December .................................. Checks outstanding at the end of December .............................. LO 3 BT: AP Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

$ 9,750 8,800 950 11,762 10,889 $ 1,823

BRIEF EXERCISE 7-12 Spahn Company should report cash in bank and payroll bank account as current assets. Plant expansion fund cash should be reported as restricted cash, a non-current asset, assuming the fund is not expected to be used during the next year. LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 7-13 BONKERS COMPANY Cash Budget For the Month of January Beginning cash balance................................................................ Add: Cash receipts...................................................................... Total available cash....................................................................... Less: Cash disbursements .......................................................... Excess of available cash over cash disbursements ................... Add: Borrowings .......................................................................... Ending cash balance.....................................................................

$12,000 59,000 71,000 67,000 4,000 5,000 $ 9,000

LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 7-14 Mar. 20

Postage Expense.......................................................... Supplies ........................................................................ Travel Expense ............................................................. Cash .......................................................................

LO 5 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

40 26 15 81

SOLUTIONS TO DO IT! EXERCISES DO IT! 7-1 1.

Violates the control activity of documentation procedures. Source documents should be promptly forwarded to the accounting department so accounting entries can be made. This control activity helps to ensure timely recording of sales transactions and contributes directly to the accuracy and reliability of the accounting records.

Violates the control activity of segregation of duties. Different individuals should be responsible for related activities, such as these three related purchasing activities. Many abuses could occur: placing orders with friends and getting kickbacks; approving fictitious invoices for payment.

Violates the control activity of establishment of responsibility. Guillen’s would be unable to determine who was responsible for a cash shortage; this lapse could even encourage employee theft.

LO 1 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement

DO IT! 7-2 All mail receipts should be opened in the presence of two mail clerks. Those mail clerks should immediately stamp each check “For Deposit Only.” The mail clerks should prepare, in triplicate, a list of the checks received each day. The checks and the original copy of the list should be sent on to the cashier’s department each day. A copy of the list is sent to the accounting department for recording in the accounting process. The clerks also keep a copy. LO 2 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA PC: Measurement

DO IT! 7-3 Ned should treat the reconciling items as follows: 1.

Outstanding checks: Deduct from balance per bank.

A deposit in transit: Add to balance per bank.

The bank charged to our account a check written by another company: Add to balance per bank and notify the bank of its error.

A debit memorandum for a bank service charge: Deduct from balance per books.

LO 3 BT: K Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Reporting

DO IT! 7-4a 1. 2. 3. 4.

True. False. A company that has received NSF checks should report these checks as a current asset (accounts receivable) on the balance sheet. False. Restricted cash that is a current asset is not reported as part of cash and cash equivalents. True.

LO 4 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 7-4b Beginning cash balance................................................ Add: Cash receipts for September .............................. Total available cash....................................................... Less: Cash disbursements for September ................. Excess (deficiency) of available cash over cash disbursements ............................................................ Add: Borrowings .......................................................... Ending cash balance.....................................................

$ 12,270 97,200 109,470 115,000 (5,530) 13,530 $ 8,000

To maintain the desired minimum cash balance of $8,000 Stern must borrow $13,530 of cash. LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 7-1 The principles of internal control inherent in the “maker-checker” procedure are: 1.

Segregation of duties. The employee records the transactions. The supervisor verifies and approves the transactions.

Physical controls. Access to the computer system is passwordprotected and task-specific.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement

EXERCISE 7-2 1.

Establishment of responsibility. The counter clerk is responsible for handling cash. Other employees are responsible for making the pizzas.

Segregation of duties. Employees who make the pizzas do not handle cash.

Documentation procedures. The counter clerk uses your order invoice (ticket) in registering the sale on the cash register. The cash register produces a tape of all sales.

Physical controls. A cash register is used to record the sale.

Independent internal verification. The counter clerk, in handling the pizza, compares the size of the pizza with the size indicated on the order.

Human resource controls. No visible application possible.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement

EXERCISE 7-3 (a) Principle Violated

(b) Recommended Change

Procedure

Weakness

Cashiers are not bonded and background checks are not conducted.

Human resource controls.

Cashiers should be bonded and background checks should be performed.

Inability to establish responsibility for cash on a specific clerk.

Establishment of responsibility.

There should be separate cash drawers and register codes for each clerk.

Cash is not adequately protected from theft.

Physical controls.

Cash should be stored in a safe until it is deposited in bank.

Cash is not independently counted.

Independent internal verification.

A cashier office supervisor should count cash, and reconcile the total to the cash register tape.

The accountant should not handle cash.

Segregation of duties.

The cashier’s department should make the deposits.

LO 2 BT: E Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 7-4 (a) Procedure

Weakness

(b) Principle Violated

Recommended Change

Checks are not stored in a secure area.

Physical controls.

Checks should be stored in a safe or locked file drawer.

The approval and payment of bills is done by the same individual.

Segregation of duties.

The store manager should approve bills for payment and the treasurer should sign and issue checks.

Unauthorized employees making purchases.

Establishment of responsibility.

Only employees granted authority should make purchases for the store.

Use of cash instead of checks; no prenumbered invoices.

Documentation procedures.

Purchases should be paid with prenumbered checks and the purchases should be documented by a prenumbered invoice signed by the seller.

Filing does not prevent a bill from being paid more than once.

Documentation procedures.

Bills should be stamped PAID after payment.

The bank reconciliation is not independently prepared.

Independent internal verification.

Someone with no other responsibilities relating to cash should prepare the bank reconciliation.

LO 2 BT: E Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 7-5 (a) Weaknesses

(b) Suggested Improvement

Checks are not prenumbered. (Documentation procedures)

Use prenumbered checks.

The purchasing agent signs checks. (Establishment of responsibility)

Only the treasurer’s department personnel should sign checks.

Unissued checks are stored in unlocked file cabinet. (Physical controls)

Unissued checks should be stored in a locked file cabinet with access restricted to authorized personnel.

Purchasing agent approves and pays for goods purchased. (Segregation of duties)

Purchasing should approve bills for payment by the treasurer.

After payment, the invoice is filed. (Documentation procedures)

The invoice should be stamped PAID.

The purchasing agent records payments in cash disbursements journal. (Segregation of duties)

Only accounting department personnel should record cash disbursements.

The treasurer records the checks in cash disbursements journal. (Segregation of duties)

Same as answer to No. 6 above.

The treasurer reconciles the bank statement. (Independent internal verification)

An internal auditor should reconcile the bank statement.

LO 2 BT: E Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 7-6 (a) Cash balance per bank statement ................... Add: Deposits in transit .................................

$3,677.20 590.00 4,267.20 770.00 $3,497.20

Less: Outstanding checks .............................. Adjusted cash balance per bank ..................... (b) Cash balance per books................................... Less: NSF check .............................................. Bank service charge.............................. Adjusted cash balance per books ...................

$3,975.20 $450.00 28.00

(c) Accounts Receivable........................................ Cash ...........................................................

450.00

Miscellaneous Expense.................................... Cash ...........................................................

28.00

450.00

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 7-7 The outstanding checks are as follows: No. 255 261 264

Amount $ 700 500 360 Total $1,560

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

478.00 $3,497.20

28.00

EXERCISE 7-8 (a)

LANCE COMPANY Bank Reconciliation July 31, 2017 Cash balance per bank statement ................................ Add: Deposits in transit ..............................................

$7,328 2,700 10,028 686 $9,342

Less: Outstanding checks ........................................... Adjusted cash balance per bank .................................. Cash balance per books................................................ Add: Electronic funds transfer received ....................

$7,364 2,016 9,380 38 $9,342

Less: Bank service charge........................................... Adjusted cash balance per books ................................ (b)

July 31 31

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

2,016

Bank Charges Expense ................................ Cash .......................................................

LO 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

2,016 38

EXERCISE 7-9 (a)

HOWARD COMPANY Bank Reconciliation September 30, 2017 Cash balance per bank statement ......................... Add: Deposits in transit .......................................

$16,500 4,738 21,238 2,383 $18,855

Less: Outstanding checks .................................... Adjusted cash balance per bank ........................... Cash balance per books......................................... Add: Electronic funds transfer received ............. Interest earned.............................................

$17,600 $1,830 45

Less: NSF check .................................................... Safety deposit box rent ............................... Adjusted cash balance per books ......................... (b) Sept. 30 30 30 30

560 60

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

1,830

Cash ...................................................... Interest Revenue ..........................

Accounts Receivable—H. Kane .......... Cash ..............................................

560

Bank Charges Expense ....................... Cash ..............................................

LO 3 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

1,875 19,475 620 $18,855

1,830 45 560 60

EXERCISE 7-10 (a) Deposits in transit: Deposits per books in July........................... Less: Deposits per bank in July.................. Deposits in transit, June 30............... July receipts deposited in July .................... Deposits in transit, July 31 ........................... (b) Outstanding checks: Checks per books in July ............................. Less: Checks clearing bank in July ............ Outstanding checks, June 30............ July checks cleared in July .......................... Outstanding checks, July 31 ........................

$16,900 $15,600 (580) 15,020 $ 1,880

$17,500 $16,400 (940)

(c) Deposits in transit: Deposits per bank statement in September.................................................. Add: Deposits in transit, September 30..... Total deposits to be accounted for .............. Less: Deposits per books............................ Deposits in transit, August 31 ...................... (d) Outstanding checks: Checks clearing bank in September ............ Add: Outstanding checks, September 30 ..................................... Total checks to be accounted for................. Less: Cash disbursements per books ........ Outstanding checks, August 31 ................... LO 3 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

15,460 $ 2,040

$25,900 2,200 28,100 26,400 $ 1,700

$24,000 2,100 26,100 23,500 $ 2,600

EXERCISE 7-11 (a) Deposits in transit = $74,000 – ($71,000 – $4,800) = $7,800 (b) Outstanding checks = ($73,570 + $360) – ($68,678 – $4,500) = $9,752 (c)

PERTH INC. Bank Reconciliation August 31, 2017 Cash balance per bank statement ...................... Add: Deposits in transit .....................................

$20,692* 7,800 28,492 9,752 $18,740

Less: Outstanding checks .................................. Adjusted cash balance per bank ........................ Cash balance per books...................................... Add: Interest earned .......................................... Less: Error in recording check ($400 – $40) ..... Service charge .......................................... Safety deposit box rent ............................ Adjusted cash balance per books ......................

$19,130** 45 19,175 $360 50 25

435 $18,740

*Proof of cash balance per bank statement: $18,400 + $71,000 – $68,678 + $45 – $25 – $50 = $20,692 **Proof of cash balance per books: $18,700 + $74,000 – $73,570 = $19,130 (d) Aug. 31 Cash........................................................... Interest Revenue ............................... 31 31

45 45

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

360

Bank Charges Expense ($50 + $25)......... Cash ...................................................

LO 3 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

360 75

EXERCISE 7-12 (a) Cash and Cash Equivalents 1. 2. 3. 5. 6.

Currency .......................................................................... U.S. Treasury bill............................................................. April checks .................................................................... Checking account ........................................................... Savings account ............................................................. Total ...........................................................................

$ 60 10,000 260 2,500 4,800 $17,620

(b) 4. Post-dated check—Accounts Receivable; Balance Sheet 7. Prepaid postage in postage meter—Prepaid Postage Expense; Balance Sheet, or Postage Expense; Income Statement 8. IOU from company receptionist—Accounts Receivable; Balance Sheet LO 4 BT: AP Difficulty: Medium TOT: 7 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 7-13 Suggestions to improve cash management practices for Lance, Art and Wayne: 1. 2. 3. 4.

Prepare a cash budget. Bill clients as work progresses. Establish a line of credit with bank. Arrange a long-term loan for renovations and equipment and plan the timing of major expenditures.

LO 4 BT: C Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 7-14 RIGLEY COMPANY Cash Budget For the Two Months Ending February 28, 2017

Beginning cash balance ........................................ Add: Cash receipts Collections from customers....................... Sale of short-term investments.................. Total receipts .............................................. Total available cash ............................................... Less: Cash disbursements Payments to suppliers................................ Wages .......................................................... Administrative expenses............................ Selling expenses......................................... Total disbursements ................................... Excess (deficiency) of available cash over disbursements..................................................... Financing Add: Borrowings.................................................. Less: Repayments ................................................ Ending cash balance..............................................

January

February

$ 46,000

$ 24,000

71,000 12,000 83,000 129,000

146,000 0 146,000 170,000

40,000 30,000 20,000 15,000 105,000

75,000 40,000 23,000 20,000 158,000

24,000

12,000

0 0 $ 24,000

8,000 0 $ 20,000

LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 7-15 Oct. 1 31

Petty Cash........................................................ Cash ..........................................................

150.00

Petty Cash........................................................ Postage Expense............................................. Supplies ........................................................... Miscellaneous Expense .................................. Freight-Out....................................................... Cash Over and Short ....................................... Cash ($200.00 – $59.70) ...........................

50.00 39.70 26.10 16.40 6.80 1.30

150.00

140.30

LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 7-16 (a)

Aug. 1 15

16 31

(b) 8/1 8/16 8/31 Bal.

Petty Cash ............................................... Cash..................................................

200.00

Freight-Out .............................................. Entertainment Expense .......................... Postage Expense .................................... Miscellaneous Expense .......................... Cash Over and Short............................... Cash..................................................

74.40 36.00 33.70 27.50 3.40

Petty Cash ............................................... Cash..................................................

200.00

Postage Expense .................................... Entertainment Expense .......................... Freight-Out .............................................. Cash Over and Short............................... Cash..................................................

145.00 90.60 46.40 1.00

Petty Cash 200 200 400

200.00

175.00 200.00

283.00

*EXERCISE 7-16 (Continued) (c) The internal control features of a petty cash fund include: (1) A custodian is responsible for the fund. (2) A pre-numbered petty cash receipt signed by the custodian and the individual receiving payment is required for each payment from the fund. (3) The treasurer’s office examines all payments and stamps supporting documents to indicate they were paid when the fund is replenished. (4) Surprise counts can be made at any time to determine whether the fund is intact. LO 5 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO PROBLEMS PROBLEM 7-1A (a) Principles

Application to Gary Theater

Establishment of responsibility.

Only cashiers are authorized to sell tickets. Only the manager and cashier can handle cash.

Segregation of duties.

The duties of receiving cash and admitting customers are assigned to the cashier and to the doorperson. The manager maintains custody of the cash, and the company accountant records the cash.

Documentation procedures.

Tickets are prenumbered. Cash count sheets are prepared. Deposit slips are prepared.

Physical controls.

A safe is used for the storage of cash and a machine is used to issue tickets.

Independent internal verification.

Cash counts are made by the manager at the end of each cashier’s shift. Daily comparisons are made by the company treasurer.

Human resource controls.

Cashiers are bonded.

(b) Actions by the doorperson and cashier to misappropriate cash include: (1) Instead of tearing the tickets, the doorperson could return the tickets to the cashier who could resell them, and the two could divide the cash. (2) The cashier could issue a lower price ticket than paid for and the doorperson would admit the customer. The difference between the price of the ticket issued and the cash received could be divided between the doorperson and cashier. LO 2 BT: C Difficulty: Medium TOT: 30 AACSB: None AICPA FC: Measurement

PROBLEM 7-2A

Grant has created a situation that leaves many opportunities for undetected theft. Here is a list of some of the weaknesses in internal control. You may find others. 1.

Documentation procedures. The tickets were unnumbered. By numbering the tickets, the students could have been held more accountable for the tickets. See number 3 below.

Physical controls and establishment of responsibility. The tickets were left in an unlocked box on his desk. Instead, Grant should have assigned control of the tickets to one individual, in a locked box which that student alone had control over.

Documentation procedures. No record was kept of which students took tickets to sell or how many they took. In combination with items 1 and 2 above, the student assigned control over the tickets should have kept a record of which tickets were issued to each student for resale. (Note: This problem could have been largely avoided if the tickets had only been sold at the door on the day of the dance.)

Documentation procedures. There was no control over unsold tickets. This deficiency made it possible for students to sell tickets, keep the cash, and tell Grant that they had disposed of the unsold tickets. Instead, students should have been required to return the unsold tickets to the student maintaining control over tickets, and the cash to Grant. In each case, the students should have been issued a receipt for the cash they turned in and the tickets they returned.

Establishment of responsibility. Inadequate control over the cash box. In effect, it was operated like a petty cash fund, but too many people had the key. Instead, Grant should have had the key and dispersed funds when necessary for purchases.

Documentation procedures. Instead of receipts, students simply wrote notes saying how they used the funds. Instead, it should have been required that they provided a valid receipt.

PROBLEM 7-2A (Continued) 7.

Segregation of duties. Lynn Dandi counted the funds, made out the deposit slip, and took the funds to the bank. This made it possible for Lynn Dandi to take some of the money and deposit the rest since there was no external check on his work. Grant should have counted the funds, with someone observing him. Then he could have made out the deposit slip and had Lynn Dandi deposit the funds.

Documentation procedures. Grant did not receive a receipt from Kray Zee. Without a receipt, there is no way to verify how much Kray Zee was actually paid. For example, it is possible that he was only paid $100 and that Grant took the rest.

Segregation of duties. Dana Uhler was collecting tickets and receiving cash for additional tickets sold. Instead, there should have been one person selling tickets at the door and a second person collecting tickets.

LO 2 BT: C Difficulty: Medium TOT: 30 AACSB: None AICPA FC: Measurement

PROBLEM 7-3A

(a)

KEEDS COMPANY Bank Reconciliation July 31, 2017 Cash balance per bank statement .................... Add: Deposits in transit ..................................

$7,690.80 1,193.30 8,884.10 1,860.10 $7,024.00

Less: Outstanding checks ............................... Adjusted cash balance per bank ...................... Cash balance per books.................................... Add: Electronic funds transfer received .................................... Less: NSF check ............................................... Error in recording check No. 2480 ........ Bank service charge............................... Adjusted cash balance per books ....................

(b) July 31 31 31 31

$6,140.00 1,520.00 7,660.00 $575.00 36.00 25.00

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

1,520

Accounts Receivable—W. Krueger... Cash ...........................................

575

Accounts Payable—L. Taylor........... Cash ...........................................

Bank Charges Expense .................... Cash ...........................................

LO 3 BT: AP Difficulty: Medium TOT: 30 AACSB: Analytic AICPA FC: Reporting

636.00 $7,024.00

1,520 575 36 25

PROBLEM 7-4A

(a)

BOGALUSA COMPANY Bank Reconciliation November 30, 2017 Cash Balance per bank statement............... Add: Deposits in transit ............................. Less: Outstanding checks No. 2451.......................................... No. 2472.......................................... No. 2478.......................................... No. 2482.......................................... No. 2484.......................................... No. 2485.......................................... No. 2487.......................................... No. 2488.......................................... Adjusted cash balance per bank .................

$17,712.50 1,304.00 19,016.50 $1,260.40 426.80 538.20 612.00 829.50 974.80 398.00 800.00

Cash Balance per books .............................. Add: Electronic funds transfer received................................ Less: Check printing charge ....................... Error in recording check No. 2479 ($1,750 – $1,705)............. Error in 11-21 deposit ($2,954 – $2,945) ............................ Adjusted cash balance per books ...............

5,839.70 $13,176.80 $11,073.80 2,242.00 13,315.80

85.00 45.00 9.00

139.00 $13,176.80

PROBLEM 7-4A (Continued) (b) Nov. 30 30 30 30

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

2,242

Bank Charges Expense ......................... Cash.................................................

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

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

LO 3 BT: AP Difficulty: Medium TOT: 50 AACSB: Analytic AICPA FC: Reporting

2,242 85 45 9

PROBLEM 7-5A

(a)

TIMMINS COMPANY Bank Reconciliation May 31, 2017 Cash balance per bank statement .................... Add: Deposits in transit .................................. Bank error—Tomins ...............................

$6,968.00 $1,880.15 360.00

Less: Outstanding checks ............................... Adjusted cash balance per bank ...................... Cash balance per books.................................... Add: Electronic funds transfer received ................................ Less: NSF check ............................................... Error in May 12 deposit .......................... Error in recording check No. 1181......... Check printing charge ............................ Adjusted cash balance per books .................... (b) May 31 31

31 31 31

2,240.15 9,208.15 276.25 $8,931.90 $6,738.90 2,690.00 9,428.90

$ 380.00 50.00 27.00 40.00

Cash ................................................... Notes Receivable ....................... Accounts Receivable— S. Ballard ........................................ Cash............................................

2,690 2,690 380 380

Sales Revenue................................... Cash............................................

Accounts Payable—H. Moses .......... Cash............................................

Bank Charges Expense .................... Cash............................................

LO 3 BT: AP Difficulty: Medium TOT: 40 AACSB: Analytic AICPA FC: Reporting

497.00 $8,931.90

50 27 40

PROBLEM 7-6A

(a)

DAISEY COMPANY Bank Reconciliation October 31, 2017 Balance per bank statement .............................................. Plus: Undeposited receipts..............................................

$18,380.00 3,795.51 22,175.51

Less: Outstanding checks No. 62 183 284

Amount $140.75 180.00 253.25

No. 862 863 864

Amount $190.71 226.80 165.28 ....................

1,156.79

Adjusted balance per bank ................................................

$21,018.72

Cash balance per books..................................................... Add: Bank credit (collection of note receivable) ............ Adjusted balance per books (before theft) ....................... Less: Theft ($22,062.72 – $21,018.72)............................... Adjusted balance per books ..............................................

$21,877.72 185.00 22,062.72 1,044.00 $21,018.72

(b) The cashier attempted to cover the theft of $1,044.00 by: 1. Not listing as outstanding three checks totaling $574.00 (No. 62, $140.75; No. 183, $180.00; and No. 284, $253.25). 2. Underfooting the outstanding checks listed by $100. (The correct total is $582.79.) 3. Subtracting the $185 credit from the bank balance instead of adding it to the book balance, thereby concealing $370 of the theft. (c) 1. The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation. 2. The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation. LO 1 - 3 BT: E Difficulty: Hard TOT: 50 AACSB: Analytic AICPA FC: Reporting

PROBLEM 7-7A

MOTNAHAN INC. Cash Budget For the Month Ending April 30, 2017 Beginning cash balance............................................. Add: Cash receipts Cash sales ....................................................... Collections from customers........................... Total receipts................................................. Total available cash.................................................... Less: Cash disbursements Payment of March purchases ........................ April cash purchases...................................... Cash operating costs...................................... Equipment purchase....................................... Total disbursements.................................... Excess (deficiency) of available cash over disbursements......................................................... Financing Add: Borrowings...................................................... Less: Repayments .................................................... Ending cash balance.................................................. LO 4 BT: AP Difficulty: Medium TOT: 35 AACSB: Analytic AICPA FC: Reporting

$11,000 42,000 18,400 60,400 71,400 22,400 28,100 11,200 2,500 64,200 7,200 1,800 0 $ 9,000

PROBLEM 7-8A

BASTILLE CORPORATION Cash Budget For the Two Months Ending February 28, 2017

Beginning cash balance ....................................... Add: Cash receipts Collections from customers ...................... Notes receivable......................................... Sale of securities........................................ Total receipts......................................................... Total available cash .............................................. Less: Cash disbursements Purchases ................................................... Salaries ....................................................... Administrative expenses (Jan. $72,000 – $1,000; Feb. $75,000 – $1,000) ................ Selling expenses ........................................ Dividends .................................................... Total disbursements ............................................. Excess (deficiency) of available cash over disbursements ................................................... Financing Add: Borrowings ................................................. Less: Repayments ................................................ Ending cash balance.............................................

January

February

$ 46,000

$ 43,000

326,000 15,000 0 341,000 387,000

378,000

110,000 84,000

135,000 81,000

71,000 79,000 0 344,000

74,000 88,000 10,000 388,000

43,000

37,000

0 0 $ 43,000

3,000 0 $ 40,000

LO 4 BT: AP Difficulty: Medium TOT: 35 AACSB: Analytic AICPA FC: Reporting

4,000 382,000 425,000

ACCOUNTING CYCLE REVIEW

(a)

Dec. 7 12 17

19 22

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

3,600

Inventory.................................................... Accounts Payable..............................

12,000

Accounts Receivable ................................ Sales Revenue ...................................

16,000

Cost of Goods Sold................................... Inventory ............................................

10,000

Salaries and Wages Expense ................... Cash ...................................................

2,200

Accounts Payable ..................................... Cash ($12,000 X .99) .......................... Inventory ............................................

12,000

Cash ($16,000 X .98).................................. Sales Discounts ........................................ Accounts Receivable.........................

15,680 320

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

2,700

3,600 12,000 16,000 10,000 2,200 11,880 120

16,000 2,700

Cash 12/1 Bal. 18,200 12/19 12/7 3,600 12/22 12/26 15,680 12/31 12/31 2,700 12/31 2,000 12/31 Bal. 27,420 Notes Receivable 12/1 Bal. 2,000 12/31 12/31 Bal. – 0 –

2,200 11,880 680

2,000

Accounts Receivable 12/1 Bal. 7,500 12/7 3,600 12/17 16,000 12/26 16,000 12/31 680 12/31 2,700 12/31 Bal. 1,880 Inventory 12/1 Bal. 16,000 12/17 12/12 12,000 12/22 12/31 Bal. 17,880 Prepaid Insurance 12/1 Bal. 1,600 12/31 12/31 Bal. 1,200

12/1 Bal.

10,000 120

400

Equipment 28,000

Accumulated Depreciation—Equipment 12/1 Bal. 3,000 12/31 200 12/31 Bal. 3,200 Income Taxes Payable 12/31 425 12/31 Bal. 425

12/22

Accounts Payable 12,000 12/1 Bal. 6,100 12/12 12,000 12/31 Bal. 6,100 Common Stock 12/1 Bal.

50,000

Retained Earnings 12/1 Bal.

14,200

Sales Revenue 12/17 16,000 12/31 Bal. 16,000 Sales Discounts 12/26 320 12/31 Bal. 320 Cost of Goods Sold 12/17 10,000 12/31 Bal. 10,000 Depreciation Expense 12/31 200 12/31 Bal. 200 Salaries and Wages Expense 12/19 2,200 12/31 Bal. 2,200 Insurance Expense 12/31 400 12/31 Bal. 400 Income Tax Expense 12/31 425 12/31 Bal. 425

ACR SOLUTION (Continued) (c)

HAVENHILL COMPANY Bank Reconciliation December 31, 2017 Cash balance per bank statement .......................... Add: Deposits in transit ..........................................

$25,930 2,700 28,630 1,210 $27,420

Less: Outstanding checks ...................................... Adjusted cash balance per bank ............................ Cash balance per books.......................................... Add: Electric funds transfer received ....................

26,100 2,000 28,100 680 $27,420

Less: NSF check ...................................................... Adjusted cash balance per books .......................... (d) Dec. 31 Cash........................................................... Notes Receivable ...............................

2,000

31 Accounts Receivable................................ Cash....................................................

680

31 Depreciation Expense .............................. Accumulated Depreciation— Equipment .......................................

200

Insurance Expense ................................... Prepaid Insurance..............................

400

Income Tax Expense ................................ Income Taxes Payable.......................

425

2,000 680

200

400 425

ACR SOLUTION (Continued) (f)

HAVENHILL COMPANY Adjusted Trial Balance December 31, 2017 Cash.............................................................. Accounts Receivable................................... Inventory ...................................................... Prepaid Insurance........................................ Equipment .................................................... Accumulated Depreciation—Equipment .... Accounts Payable ........................................ Income Taxes Payable................................. Common Stock ............................................ Retained Earnings ....................................... Sales Revenue ............................................. Sales Discounts ........................................... Cost of Goods Sold ..................................... Depreciation Expense ................................. Salaries and Wages Expense...................... Insurance Expense ...................................... Income Tax Expense ...................................

(g)

DR. $27,420 1,880 17,880 1,200 28,000

CR.

$ 3,200 6,100 425 50,000 14,200 16,000 320 10,000 200 2,200 400 425 $89,925

$89,925

HAVENHILL COMPANY Income Statement For the Month Ending December 31, 2017 Sales revenue.............................................. Less: Sales discounts ............................... Net sales...................................................... Cost of goods sold ..................................... Gross profit ................................................. Operating expenses Salaries and wages expense .............. Insurance expense .............................. Depreciation expense ......................... Income before income taxes ...................... Income tax expense.................................... Net income ..................................................

$16,000 320 15,680 10,000 5,680 $2,200 400 200

2,800 2,880 425 $ 2,455

ACR SOLUTION (Continued) (g)

HAVENHILL COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash........................................................ Accounts receivable.............................. Inventory ................................................ Prepaid insurance.................................. Total current assets ..........................

$27,420 1,880 17,880 1,200

Property, plant, and equipment Equipment .............................................. Less: Accumulated depreciation—Equipment .......... Total assets ...................................................

$48,380 28,000 3,200

24,800 $73,180

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................. Income taxes payable............................ Stockholders’ equity Common stock....................................... Retained earnings ($14,200 + $2,455)... Total stockholders’ equity............... Total liabilities and stockholders’ equity .... LO 3 BT: AP Difficulty: Hard TOT: 120 AACSB: Analytic AICPA FC: Reporting

$6,100 425

$6,525

50,000 16,655 66,655 $73,180

CT 7-1

FINANCIAL REPORTING PROBLEM

(a) The first paragraph of the independent registered public accounting firm’s report states that: We have audited the accompanying consolidated balance sheets of Apple Inc. as of September 27, 2014 and September 28, 2013, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended September 27, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The third paragraph of the report also states that: In our opinion, the financial statements referred to above present fairly, in all material respects the consolidated financial position of Apple Inc. at September 27, 2014 and September 28, 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 27, 2014, in conformity with U.S. generally accepted accounting principles. (b) The consolidated balance sheet shows the combined cash and cash equivalent balances (in millions) at September 27, 2014 and September 28, 2013: 2014—$13,844 and 2013—$14,259 (c) The consolidated statement of cash flows indicates that three activities are responsible for the change in cash in 2014: (1) operating, (2) investing, and (3) financing. (d) In Note 1 under cash equivalents and marketable securities, it states: All highly liquid investments with maturities of three months or less at the date of purchase are classified as cash equivalents.

(e) The management of Apple Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. After performing an evaluation of company procedures, management concluded that its internal control over financial reporting was effective. Management’s assessment of Apple’s internal control was audited by and addressed in the opinion of its public accounting firm, Ernst & Young, LLP. LO 4 BT: AN Difficulty: Hard TOT: 30 min. AACSB: Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 7-2

COMPARATIVE ANALYSIS PROBLEM

(In thousands) (a) Cash/cash equivalents balance (b) Cash as a percentage of total assets 2014: 2013:

Columbia Sportswear

VF Corporation

$413,558

$971,895

23.1%* 27.2%**

9.7%*** 7.5%****

Cash as a percentage of total assets decreased 15% for Columbia Sportswear and increased by 29% for VF Corporation. (c) Cash provided by operating activities

$185,783

$1,697,629

(d) The objective in cash management is to ensure that a company has sufficient cash to meet payments as they come due, yet minimize the amount of non-revenue-generating cash on hand. The decrease in cash as a percentage of total assets experienced by Columbia is a cause of concern only if it is missing opportunities to generate revenue. If not, Columbia could have probably done a better job managing cash in 2014 than 2013. Data from several years would be necessary to look for trends to draw more reliable conclusions. VF Corporation, on the other hand, has done an excellent job of managing its cash *$413,558/$1,792,209 **$437,489/$1,605,588 ***$971,895/$9,980,140 ****$776,403/$10,315,443 LO 4 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 7-3

COMPARATIVE ANALYSIS PROBLEM

Amazon. com

Wal-Mart Stores

(a) Cash/cash equivalents balance

$14,557

$9,135

(b) Cash as a percentage of total assets 2014: 2013:

26.7%* 21.6%**

4.5%*** 3.6%****

(In millions)

Cash as a percentage of total assets increased 23.6% for Amazon and increased 25% for Wal-Mart. (c) Cash provided by operating activities *$14,557/$54,505 **$8,658/$40,159

$6,842

$28,564

***$9,135/$203,706 ****$7,281/$204,751

(d) The percentage of cash to total assets for Wal-Mart was about 6 times lower than the percentage of cash to total assets for Amazon in both 2013 and 2014. However, Wal-Mart generated more than 4 times the operating cash flow during 2014 than did Amazon.com. This may be a somewhat troubling difference that Amazon faces in generating cash from operations (if it continues in the long-term), but perhaps it is part of the company’s shorter-term strategic plan to undercut Wal-Mart prices. Taken together with Amazon’s large percentage of cash to total assets, it seems as if the company is currently not in danger of having to borrow to meet temporary cash shortfalls, if this is its underlying strategic maneuver. LO 4 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 7-4

INTERPRETING FINANCIAL STATEMENTS

(a) The global percentage of companies that experienced a significant instance of fraud during the period covered by the survey was 12% and Egypt had the highest rate at 44%. (b) 35% of survey respondents were asked to participate in an ABAC risk assessment in the two years prior to the survey. (c) 61% of C-suite executives have not attended ABAC training. (d) Hackers and hacktivists are the source of Cyber crime that concerns respondents the most. LO 1 BT: AN Difficulty: Hard TOT: 30 min. AACSB: Technology, Communication, and Ethics AICPA FC: Reporting AICPA PC: Communication and Personal demeanor

CT 7-5

REAL-WORLD FOCUS

(a) The mission of the Financial Accounting Standards Board is to establish and improve standards of financial accounting and reporting that foster financial reporting by non-governmental entities that provides decision-useful information to investors and other users of financial reports. (b) The Chairman will consult with FASB members, staff directors, and others as appropriate before making a decision to add or remove a project from the FASB’s technical agenda or to change the priorities of existing projects. The FASB and its Chairman consult with FASAC concerning, among other things, major technical issues, the FASB’s agenda of projects and the priorities of the projects, and matters likely to require the attention of the FASB. The FASB also considers timely suggestions from other individuals and organizations. (c) The FASB is committed to following an open, orderly process for setting standards. The FASB designed its comprehensive due process procedures to permit timely, thorough, and open study of financial accounting and reporting issues and to encourage broad public participation in the standards-setting process by creating channels for the communication of all points of view and expressions of opinion at all stages of the process. The cooperation of all concerned with or affected by financial accounting and reporting is fundamental to the operation of the FASB. Of particular importance to the FASB is the receipt of thoughtful, reasoned, and timely input during the FASB’s research, discussion, and deliberative processes. The FASB recognizes that acceptance of its conclusions is enhanced by demonstrating that the comments received in due process are considered carefully. LO None BT: S Difficulty: Hard TOT: 40 min. AACSB: Technology and Communication AICPA FC: reporting AICPA PC: Communication

CT 7-6

REAL-WORLD FOCUS

(a) The PCAOB is a private-sector, non-profit corporation, created by the Sarbanes-Oxley Act of 2002 to oversee the auditors of public companies in order to protect investors and the public interest by promoting informative, fair, and independent audit reports. (b) The PCAOB is required to conduct inspections of public accounting firms to assess compliance with the Sarbanes-Oxley Act, the rules of the Board, the rules of the SEC, and professional standards in connection with the firm’s performance of audits, issuance of audit reports, and related matters involving U.S. public companies and other issuers. Inspections occur annually for larger firms and at least triennially for smaller firms. The PCAOB prepares written reports concerning each inspection for regulatory authorities and the public. (c) The PCAOB has authority to investigate and discipline registered public accounting firms and persons associated with those firms for noncompliance with the Sarbanes-Oxley Act of 2002, the rules of the PCAOB and the Securities and Exchange Commission, and other laws, rules, and professional standards governing the audits of public companies. When violations are found, the PCAOB can impose appropriate sanctions. As required by the Sarbanes-Oxley Act, the Board’s investigations are confidential and nonpublic. The SarbanesOxley Act also requires that disciplinary proceedings are confidential and nonpublic, unless and until there is a final decision imposing sanctions. LO 1 BT: S Difficulty: Hard TOT: 40 min. AACSB: Technology, Communication and Ethics AICPA FC: Measurement AICPA PC: Communication and Personal Demeanor AICPA BB: Legal/Regulatory Perspective

CT 7-7

REAL WORLD FOCUS

(a) The article lists 8 different forms of payment. They are: wire transfer, paper checks, automated clearing house (ACH) credits, ACH debits, purchasing cards (p-cards), paying from statements, petty cash, payment via travel and expense (T&E) reimbursement. (b) As more payment options become available, it is more likely that companies will pay the same bill twice. (c) The controls suggested in the article are: 1. 2. 3. 4. 5.

Limit payment type i.e. only p-card. Make sure purchase orders are extinguished whenever a payment is made. Make sure the invoice number is entered using the coding standard whenever payments are made. Make sure the same coding standards are used. Establish a payment timing policy adhered to by everyone.

LO 2 BT: S Difficulty: Hard TOT: 40 min. AACSB: Technology and Communication AICPA FC: Measurement AICPA PC: Communication

CT 7-8

DECISION MAKING ACROSS THE ORGANIZATION

(a) The material weaknesses and the related principle(s) of internal control that was violated are as follows: Material Weakness

Internal Control Principle



Non-timely deposit of cash receipts



Physical controls—cash should be deposited in total daily



Excessive past due accounts receivable



Establishment of responsibility



Disregard of advantages offered by vendors for prompt payment of invoices



Establishment of responsibility



Absence of segregation of duties



Segregation of duties



Inadequate procedures for applying accounting principles



Documentation procedures



Lack of qualified management personnel



Establishment of responsibility



Lack of supervision by outside board of directors



Establishment of responsibility; independent internal verification



Overall poor recordkeeping



Documentation procedures

(b) Under the Sarbanes-Oxley Act, publicly traded companies are required to maintain adequate systems of internal control. Failure to comply with the Act can result in fines and imprisonment of officers. Managers should recognize that good internal control is necessary to stay in business. In addition, good internal control principles should benefit the company by safeguarding its assets and enhancing the accuracy and reliability of accounting records. LO 1, 2 BT: E Difficulty: Hard TOT: 60 min. AACSB: Communication and Ethics AICPA PC: Communication and Personal Demeanor

CT 7-9

COMMUNICATION ACTIVITY

Mr. Frank Simon Simon Company Main Street, USA Dear Mr. Simon: During our audit of your financial statements, we reviewed the internal controls over cash receipts. The weaknesses we discovered and our suggested improvements are listed below. Weaknesses

Suggested Improvement

A list of checks received is not prepared by the person who opens the mail.

This list should be prepared so that it can later be compared with the daily cash summary. While this procedure does not assure that all checks will be listed, it does allow the company to verify that all checks on the list did get deposited.

Mail is opened by only one person.

When this occurs, there is no assurance that all incoming checks are forwarded to the cashier’s department.

The cashier is allowed to open the mail.

Under this arrangement, it is possible for the cashier to open the mail, prepare the cash summary and make the bank deposit. This involves no segregation of duties as the cashier controls the cash from the time it is received until it is deposited in the bank.

The accounts receivable clerk is allowed to open the mail.

Again, there is poor segregation of duties. In this case, the clerk could write off a customer’s account as uncollectible and then misappropriate the collection when it’s received.

CT 7-9 (Continued)

Weaknesses

Suggested Improvement

Mail receipts are deposited weekly.

This makes the receipts vulnerable to robbery and to misappropriation. The receipts should be deposited daily.

We would be pleased to discuss the weaknesses and our recommended improvements with you, at your convenience. Yours sincerely,

Blacke and Whyte Certified Public Accountants LO 2 BT: E Difficulty: Hard TOT: 40 min. AACSB: Communication and Reflective Thinking AICPA PC: Measurement and Reporting AICPA PC: Communication

CT 7-10

ETHICS CASE

(a) The amount of fee revenue depending on order of processing would be: (1) Largest to smallest: (2) Smallest to largest: (3) In order of check number:

5 bounced checks X $30 = $150 1 bounced check X $30 = $30 2 bounced checks X $30 = $60

(b) Whether this is ethical is subject to debate. On the one hand, it can be argued that customers have a responsibility to maintain an adequate balance in their accounts. Some customers are frequently overdrawn; thus only severe penalties will persuade them to maintain an adequate balance. However, it could be argued that charging $30 for something that has a cost to the bank of $1.50 is “gouging”—that is, taking unfair advantage of the customer. (c) In deciding what approach to take, the bank must consider its relationship with the customer. Clearly, by adopting a “largest to smallest” approach, it is going to anger some customers, who may well decide to leave the bank and go to a more customer-friendly bank. However, it could be argued that some of the customers the bank may lose are customers that are frequently overdrawn and therefore costly to the bank. Also, it can be time-consuming to change banks, and most people don’t have the spare time to change banks unless they really need to. (d) Answer will vary depending on student’s opinion. LO 2 BT: E Difficulty: Hard TOT: 40 AACSB: Communication, Reflective Thinking and Ethics AICPA FC: Measurement and Reporting AICPA PC: Communication and Personal Demeanor

CT 7-11

ETHICS CASE

Answers will vary depending on article chosen. LO 1 BT: S Difficulty: Hard TOT: 40 min. AACSB: Communication and Technology AICPA FC: Measurement and Reporting

CT 7-12

ALL ABOUT YOU

Answers are provided to students on the government website as they complete the ID Theft Faceoff quiz. LO 1 BT: S Difficulty: Hard TOT: 40 min. AACSB: Communication and Technology AICPA FC: Measurement and Reporting

CT 7-13

FASB CODIFICATION ACTIVITY

(a) Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made. Codification reference (305-10-20). (b) Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: a.

Readily convertible to known amounts of cash

So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a threemonth U.S. Treasury bill and a three-year Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). Codification reference (305-10-20).

CT 7-13 (Continued) (c) Cash and cash items. Separate disclosure shall be made of the cash and cash items which are restricted as to withdrawal or usage. The provisions of any restrictions shall be described in a note to the financial statements. Restrictions may include legally restricted deposits held as compensating balances against short-term borrowing arrangements, contracts entered into with others, or company statements of intention with regard to particular deposits; however, time deposits and short-term certificates of deposit are not generally included in legally restricted deposits. In cases where compensating balance arrangements exist but are not agreements which legally restrict the use of cash amounts shown on the balance sheet, describe in the notes to the financial statements these arrangements and the amount involved, if determinable, for the most recent audited balance sheet required and for any subsequent unaudited balance sheet required in the notes to the financial statements. Compensating balances that are maintained under an agreement to assure future credit availability shall be disclosed in the notes to the financial statements along with the amount and terms of such agreement. LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

IFRS CONCEPTS AND APPLICATION

IFRS7-1 Companies listed on U.S. stock exchanges must comply with the SarbanesOxley Act. This compliance gives investors greater assurance that these companies have adequate internal controls in place. In addition, the auditors for these publicly traded companies must attest to the effectiveness of such controls. This process can result in discovery of weaknesses that companies had previously overlooked. After correcting these weaknesses to satisfy auditors, investors may find such companies to be less risky and therefore better investments. In order to comply with SOX, a company must document its internal control procedures and have an auditor attest to their effectiveness. Doing so costs money. A recent study indicated that audit fees can double in the first year of a company’s compliance. Since this cost is incurred only if a company lists on U.S. exchanges, many investors see SOX compliance as a costly undertaking.

IFRS7-2

INTERNATIONAL FINANCIAL REPORTING PROBLEM

Note 1.18 Cash and cash equivalents state that: Cash and cash equivalents comprise cash and highly liquid money-market investments subject to an insignificant risk of changes in value over time. Money-market investments are measured at their market value, based on price quotations at the close of trading and on the exchange rate prevailing at the balance sheet date, with any changes in value recognized as part of net financial income/expense

CHAPTER 8 Reporting and Analyzing Receivables Learning Objectives 1. 2. 3. 4.

Explain how companies recognize accounts receivable. Describe how companies value accounts receivable and record their disposition. Explain how companies recognize, value, and dispose of notes receivable. Describe the statement presentation of receivables and the principles of receivables management.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

AP C K AP C

16. 17. 18. 19. 20.

4 4 4 4 4

K K C K C

21. 22. 23. 24.

4 4 4 4

C AP C C

Brief Exercises 8. 3 AP 9. 3 AP

10. 11.

2, 4 4

AP AP

12.

11. 12. 13. 14.

3 4 4 4

AP AP K AN

15. 16. 17.

4 4 4

AN C AN

4 C 1, 2, 3, 4 AP

Questions 1. 2. 3. 4. 5. 1. 2. 3. 4.

1 1 2 2 2 1 1 2 2

C K C C AP C AP AP AP

6. 7. 8. 9. 10. 5. 6. 7.

2 2 2 2 2 2 2 3

K C C K C AP AP AP

11. 12. 13. 14. 15.

2 3 3 3 3

Do It! Exercises 1. 1. 2. 3. 4. 1. 2.

1 1 1 1, 2 2 2 2, 4

AP AP AP AP AP AP AP

2a. 5. 6. 7. 8. 3. 4.

2 2 2 2 2 2 2

AP AP AP AP AP AP AP

2b.

Exercises 9. 2 AP 10. 3 AP

Problems: Set A 5. 2 AP 1, 3 AP 6.

7. 8.

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Journalize transactions related to bad debts.

Moderate

15–20

Prepare journal entries related to bad debt expense, and compute ratios.

Moderate

15–20

Journalize transactions related to bad debts.

Moderate

15–20

Compute bad debt amounts.

Moderate

15–20

Journalize entries to record transactions related to bad debts.

Moderate

20–30

Journalize various receivables transactions.

Moderate

25–30

Explain the impact of transactions on ratios.

Moderate

20–30

Prepare entries for various credit card and notes receivable transactions.

Moderate

20–30

Calculate and interpret various ratios.

Moderate

10–15

ANSWERS TO QUESTIONS 1.

Accounts receivable are amounts customers owe on account. They result from the sale of goods and services (i.e., in trade). Notes receivable represent claims that are evidenced by formal instruments of credit.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 2.

Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 3.

The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and matched against revenues in the same accounting period in which the revenues are recorded. (2) Estimated uncollectibles are debited to Bad Debt Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off as uncollectible.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 4.

Lance should realize that the decrease in cash realizable value occurs when estimated uncollectibles are recognized in an adjusting entry. The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, cash realizable value does not change.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACCSB: None AICPA FC: Reporting 5.

The adjusting entry under the percentage of receivables basis is: Bad Debt Expense .................................................................................. Allowance for Doubtful Accounts ($5,100 – $2,200) ..........................

2,900 2,900

LO 2 BT: AP Difficulty: Medium TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 6.

Apple reports two types of receivables on its balance sheet: Accounts receivable trade, and vendor non-trade receivables. Since Apple’s balance sheet reports allowance amounts for receivables, we know that Apple uses the allowance method rather than the direct write-off method.

LO 2 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 7.

Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debt Expense and credited to Accounts Receivable. The direct write-off method makes no attempt to match bad debts expense to revenues or to show the cash realizable value of the receivables in the balance sheet.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

Offering credit usually results in an increase in sales because customers prefer to “buy now and pay later”. If a company decides to extend credit to customers, it should also establish credit standards to determine if a particular customer is credit worthy. Standards that are easily met can result in additional sales being made to customers that may not be able to meet the “tighter” credit policies of competitors. If such customers fail to pay, the additional sales revenue will be offset by higher collection costs and bad debt expense.

LO 2 BT: E Difficulty: Hard TOT: 5 min. AACSB: Reflective Thinking AICPA FC: Reporting 9.

From its own credit cards, the JC Penney Company may realize financing charges from customers who do not pay the balance due within a specified grace period. National credit cards offer the following advantages: (1) The credit card issuer does the credit investigation of the customer. (2) The issuer maintains individual customer accounts. (3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts. (4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers. LO 2 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 10.

The reasons companies sell their receivables are: (1) For competitive reasons, companies often must provide financing to purchasers of their goods. Such financing can result in receivables balances that are larger than the company wishes to hold. Selling the receivables reduces the excessive balance. (2) Receivables may be sold because they may be the only reasonable source of cash. (3) Billing and collection are often time-consuming and costly. As a result, it is often easier for a retailer to sell the receivables to another party that has expertise in billing and collecting receivables.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: reporting 11.

Cash ................................................................................................................. 388,000 Service Charge Expense (3% X $400,000) ......................................................... 12,000 Accounts Receivable............................................................................... 400,000

LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 12.

A promissory note gives the holder a stronger legal claim than one on an account receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. The holder of a promissory note also can earn interest.

LO 3 BT: AN Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 13.

The maturity date of a promissory note may be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 14.

The missing amounts are: (a) $27,000, (b) 10%, (c) six months or 180 days, and (d) $7,200.

LO 3 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

15.

When Mendosa Company has dishonored a note, the lender can renegotiate new terms for the receivable which is equal to the full amount of the note plus the interest due. It will then try to collect the balance due, or as much as possible. If there is no hope of collection, it will write-off the note receivable.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 16.

Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts should be reported. If collectible within a year or the operating cycle, whichever is longer, these receivables are reported as current assets immediately below short-term investments. Notes receivables are usually listed before accounts receivable because notes are more easily converted to cash.

LO 4 BT: K Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 17.

The steps involved in receivables management are: (1) Determine to whom to extend credit. (2) Establish a payment period. (3) Monitor collections. (4) Evaluate the liquidity of receivables. (5) Accelerate cash receipts from receivables when necessary.

LO 4 BT: K Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 18.

A company can prepare an aging schedule to monitor collection success. An aging schedule provides information about the overall collection experience of a company and identifies problem accounts. LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

19.

A concentration of credit risk is a threat of nonpayment from either a single large customer or class of customers that could adversely affect the company’s financial health.

LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 20.

An increase in the current ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: accounts receivable turnover ratio and average collection period.

LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 21.

An increase of more than 100% in the average collection period is probably caused by the adoption of looser credit standards. The new sales director may have increased sales by extending credit to customers that did not meet the company’s previous credit standards. Management should try to determine if the longer collection period jeopardizes the company’s overall financial position. It should compare its collection period to that of its competitors to determine if it is reasonable. It should also monitor collections to see if the additional sales are producing significant increases in costs associated with collection and bad debts. To reduce the average collection period, management might consider offering a sales discount to encourage customers to pay sooner.

LO 4 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

22.

Net credit sales for the period are 9.05 X $3,424 million = $30,987.2 million. Average collection period in days = 365 days ÷ 9.05 = 40.3 days.

LO 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 23.

Sales revenue is recorded when goods or services are provided, even if cash is yet to be received. As a consequence, if sales are growing rapidly, cash collections are sometimes significantly lower than sales.

LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 24.

Cash collections can be determined by adjusting Sales Revenue for the net change in Accounts Receivable. An increase in the receivables balance is deducted from Sales Revenue, a decrease in the receivables balance is added to Sales Revenue.

LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) Other receivables. (b) Notes receivable. (c) Accounts receivable. LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 8-2 (a)

Accounts Receivable............................................... Sales Revenue .................................................

23,000

Sales Returns and Allowances ............................... Accounts Receivable ......................................

2,400

(c) Cash ($20,600 – $412).............................................. Sales Discounts ($20,600 X 2%) ............................. Accounts Receivable ($23,000 – $2,400) .......

20,188 412

(b)

23,000 2,400

20,600

LO 1 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-3 (a) Allowance for Doubtful Accounts .......................... Accounts Receivable ...................................... (b) Accounts receivable Less: Allowance for doubtful accounts Cash realizable value

(1) Before Write-Off $700,000

4,300 4,300 (2) After Write-Off $695,700

25,000 $675,000

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

20,700 $675,000

BRIEF EXERCISE 8-4 Accounts Receivable ...................................................... Allowance for Doubtful Accounts ..........................

4,300

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

4,300

4,300 4,300

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-5 (a) Bad Debt Expense [($400,000 X 2%) – $2,800].................................... Allowance for Doubtful Accounts ..................

5,200

(b) Bad Debt Expense [($400,000 X 2%) + $900]....................................... Allowance for Doubtful Accounts ..................

8,900

5,200

8,900

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-6 (a) Cash ($200 – $6)....................................................... Service Charge Expense ($200 X 3%) .................... Sales Revenue..................................................

194 6

(b) Cash ($65,000 – $1,950) ........................................... Service Charge Expense ($65,000 X 3%)................ Accounts Receivable .......................................

63,050 1,950

200

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-7 Interest Maturity Date (a) $800 August 9 (Omit the date the note is issued but include the due date) (b) $875 October 12 (Omit the date the note is issued but include the due date) (c) $200 July 11 (Omit the date the note is issued but include the due date) LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

65,000

BRIEF EXERCISE 8-8 Maturity Date Annual Interest Rate Total Interest (a) May 31 9% $9,000 (The computation of interest assumes 360 days for the year) (b) August 1 8% $ 600 (The computation of interest assumes 360 days for the year) (c) September 7 10% $6,000 LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-9 Jan. 10 Feb. 9

Accounts Receivable ...................................... Sales Revenue........................................

8,000

Notes Receivable............................................. Accounts Receivable .............................

8,000

8,000 8,000

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 8-10 (a) Bad Debt Expense .................................................. Allowance for Doubtful Accounts ..................

18,000

(b) Current assets Cash ................................................................. Accounts receivable ....................................... $400,000 Less: Allowance for doubtful accounts........ 18,000 Inventory.......................................................... Supplies ...........................................................

18,000 $ 90,000 382,000 180,000 13,000 $665,000

$3, 000, 000

= 10 times $300, 000 365 days Average collection period = = 36.5 days 10 The accounts receivable turnover is a liquidity measure. The average collection period indicates the effectiveness of a company’s credit and collection policies. To evaluate Fertig’s liquidity and credit policies, these measures should be compared to the same measures for competitors.

LO 2, 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 8-11 Accounts Receivable Turnover: $23.1B = 7.2 times $23.1B = ($3.2B + 3.25B) ÷ 2 $3.225B Average Collection Period: 365 days

= 50.7 days

7.2 times LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 8-12 Accounts Receivable

Beg. Sales End

70,000 598,000 577,000 91,000

Collections or

Sales – Increase in Receivables = Cash Collections $598,000 – ($91,000 – $70,000) = $577,000 (Collections reduce the accounts receivable balance) LO 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 8-1 Mar. 1 Mar. 6 Mar. 11

Accounts Receivable ...................................... Sales Revenue ..........................................

28,000

Sales Returns and Allowances....................... Accounts Receivable................................

1,000

Cash ($27,000 – $270) ..................................... Sales Discounts ($27,000 X 1%) ..................... Accounts Receivable................................

26,730 270

28,000 1,000

27,000

LO 1 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 8-2a The following entry should be prepared to bring the balance in the Allowance for Doubtful Accounts up from $5,700 credit to $21,700 credit (7% X $310,000): Bad Debt Expense .................................................................... 16,000 Allowance for Doubtful Accounts............................... (To record estimate of uncollectible accounts)

16,000

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 8-2b To speed up the collection of cash, Neumann sells $170,000 of its accounts receivable to a factor. Assuming the factor charges Neumann a 2% service charge, it would make the following entry: Cash ..................................................................................... 166,600 Service Charge Expense ($170,000 X 2%) ..................... 3,400 Accounts Receivable ............................................. (To record sale of receivables to factor)

170,000

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 8-3 The interest payable at maturity is $186: Face X Rate X Time = Income $6,200 X 9% X 4/12 = $186 The entry recorded by Buffet Wholesalers at the maturity date is: Cash ................................................................................. 6,386 Notes Receivable...................................................... Interest Revenue....................................................... (To record collection of Gates note and interest) LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

6,200 186

DO IT! 8-4 (a)

Net credit sales ÷

Average net accounts receivable

(b)

$1,600,000

Days in year

365

$108,000 + $120,000 2

Accounts receivable turnover ÷ 14.0 times

Accounts receivable turnover

14.0 times

= =

Average collection period in days 26.1 days

LO 4 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Measurement

SOLUTIONS TO EXERCISES EXERCISE 8-1 Jan. 6 16

Accounts Receivable—Harley Inc.................. Sales Revenue ..........................................

9,200

Cash ($9,200 – $92) ......................................... Sales Discounts (1% X $9,200) ....................... Accounts Receivable—Harley Inc ...........

9,108 92

9,200

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-2 Jan. 10 Feb. 12 Mar. 10

Accounts Receivable—Amise ........................ Sales Revenue ..........................................

1,700

Cash ................................................................. Accounts Receivable—Amise .................

1,100

Accounts Receivable—Amise ........................ Interest Revenue [1% X ($1,700 – $1,100)] ........................

1,700 1,100

LO 1 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-3 (a)

(b)

Accounts Receivable ........................................... Sales Revenue .................................................

800,000

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

763,000

Allowance for Doubtful Accounts ....................... Accounts Receivable ......................................

7,300

800,000 763,000 7,300

EXERCISE 8-3 (Continued) (c)

(d)

Accounts Receivable............................................ Allowance for Doubtful Accounts ..................

3,100

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

3,100

Bad Debt Expense ................................................ Allowance for Doubtful Accounts ..............

20,200

3,100 3,100 20,200

Allowance for Doubtful Accounts Beg. Bal. 9,000 Write-off 7,300 Recovery 3,100 Bad Debts 20,200 [$25,000 – ($9,000 + $3,100 – $7,300)] End Bal. 25,000

(e)

Accounts Receivable Beg. Bal. 200,000 Collections 763,000 Sales 800,000 Write-off 7,300 Recovery 3,100 Collections 3,100 End Bal. 229,700

(f)

Net realizable value of receivables is $204,700 ($229,700 – $25,000)

Allowance for Doubtful Accounts Beg. Bal. 9,000 Write-off 7,300 Recovery 3,100 Bad Debts 20,200 End Bal. 25,000

LO 1, 2 BT: AP Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-4 (a) Dec. 31

(b) Dec. 31

Bad Debt Expense ........................................... Accounts Receivable—Matisse ...............

900 900

Bad Debt Expense .............................................. 6,700 Allowance for Doubtful Accounts [($78,000 X 10%) – $1,100]..................... 6,700 (Bad Debt Expense takes into account any existing balance in the allowance account)

EXERCISE 8-4 (Continued) (c) Dec. 31

Bad Debt Expense .............................................. 6,740 Allowance for Doubtful Accounts [($78,000 X 8%) + $500] ......................... 6,740 (Bad Debt Expense takes into account any existing balance in the allowance account)

LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-5 (a)

Accounts Receivable Current 1–30 days past due 31–90 days past due Over 90 days past due

Amount $65,000 12,900 10,100 7,400

% Estimated Uncollectible 2 $1,300 5 645 30 3,030 50 3,700 $8,675

(b) Mar. 31

Bad Debt Expense........................................... 6,575 Allowance for Doubtful Accounts 6,575 ($8,675 – $2,100) .................................... (Bad Debt Expense takes into account any existing balance in the allowance account)

(c) The total balance of receivables increased from 2016 to 2017. However, of concern is the fact that each of the three categories of older accounts increased substantially during 2017. That is, customers are taking longer to pay and bad debts are likely to increase. Management needs to investigate the causes of this change. LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-6 December 31, 2016 Bad Debt Expense .......................................................... 9,500 Allowance for Doubtful Accounts [(9% X $90,000) + $1,400]...................................... (Bad Debt Expense takes into account any existing balance in the allowance account)

9,500

EXERCISE 8-6 (Continued) May 11, 2017 Allowance for Doubtful Accounts .................................. Accounts Receivable—Jared ..................................

1,200

June 12, 2017 Accounts Receivable—Jared ......................................... Allowance for Doubtful Accounts...........................

1,200

Cash ................................................................................. Accounts Receivable—Jared ..................................

1,200

1,200 1,200 1,200

LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-7 Mar. 3

Cash ($710,000 – $28,400) ................................... 681,600 Service Charge Expense (4% X $710,000) ..... 28,400 Accounts Receivable................................

710,000

LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-8 May 10

Cash ($4,000 – $152) ....................................... Service Charge Expense (3.8% X $4,000) ...... Sales Revenue ..........................................

3,848 152 4,000

LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-9 July 4

Cash ($250 – $10) ............................................ Service Charge Expense (4% X $250) ............ Sales Revenue ..........................................

LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

240 10 250

EXERCISE 8-10 Nov. 1 Dec. 11 16 31

Notes Receivable............................................. Cash ..........................................................

60,000

Notes Receivable............................................. Sales Revenue ..........................................

3,600

Notes Receivable............................................. Accounts Receivable—A. Murdock.........

12,000

Interest Receivable.......................................... Interest Revenue* .....................................

761

60,000 3,600 12,000 761

*Calculation of interest revenue: Bohr’s note: $60,000 X 7% X 2/12 = $700 Pine’s note: 3,600 X 8% X 20/360 = 16 Murdock’s note: 12,000 X 9% X 15/360 = 45 Total accrued interest = $761 (The computation of interest assumes a 360 day year) LO 3 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-11 May

Dec. 31

2016 Notes Receivable............................................. Accounts Receivable—R. Stoney............ Interest Receivable.......................................... Interest Revenue ($5,000 X 6% X 8/12) ..............................

5,000 5,000 200 200

(At the end of each year, interest is accrued for the time elapsed since the date of a note.) May

2017 1 Cash ................................................................. Notes Receivable...................................... Interest Receivable ................................... Interest Revenue ($5,000 X 6% X 4/12) ..............................

LO 3 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

5,300 5,000 200 100

EXERCISE 8-12 EILEEN CORP. Balance Sheet (Partial) October 31, 2017 (in thousands) Receivables Notes receivable ........................................................ Accounts receivable .................................................. Other receivables....................................................... Total receivables........................................................ Less: Allowance for doubtful accounts ........................ Net receivables ................................................................

$1,353 2,910 189 $4,452 52 $4,400

LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 8-13 (a) 2. Reviewing company ratings in the Dun and Bradstreet Reference Book of American Business. (b) 3. Collecting information on competitors’ payment period policies. (c) 4. Preparing monthly accounts receivable aging schedule and investigating problem accounts. (d) 5. Calculating the accounts receivable turnover ratio and average collection period. (e) 1. Selling receivables to a factor. LO 4 BT: K Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement

EXERCISE 8-14 (a)

$35,497 Accounts receivable = = 9.2 times turnover ($3,391 + $4,359)/2 Average collection = 365 days = 39.7 days period 9.2

EXERCISE 8-14 (Continued) (b)

Accounts receivable comprise 48% ($3,391/$7,116) of the company’s total current assets. This is certainly a material component.

(c)

The balance in the allowance account increased $38 million ($196 – $158) while its accounts receivable decreased $930 million ($3,587 – $4,517). As a result, the allowance for uncollectible accounts increased from 3.5% of accounts receivable in 2016 to 5.5% in 2017.

LO 4 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 8-15 (a) At first glance it appears that Ming’s liquidity had deteriorated over the past year since the company’s current ratio has fallen from 1.5:1 to 1.3:1. However, it is taking the company less time to collect its accounts receivable as evidenced by the higher accounts receivable turnover. The company also appears to be moving its inventory more quickly as evidenced by the higher inventory turnover. It is possible that the lower current ratio is due to the fact that with improved collections and inventory turnover, the company is carrying fewer current assets and not because the company’s liquidity has deteriorated. (b) Changes in the turnover ratios do not directly affect profitability. However, improvements in turnover generally indicate that the company is better able to convert sales to cash. Improved liquidity could allow the company to better manage its cash flows and therefore, indirectly improve profitability. (c) There are several steps that Ming might have taken to improve its receivables and inventory turnover: Receivables -

The company could limit credit to only the best customers, however, this could negatively affect sales.

The company could initiate the use of a cash discount to encourage early payment of receivables.

EXERCISE 8-15 (Continued) -

The company could more aggressively monitor collections to encourage customers to pay on time.

The company could sell its receivables to a factor to accelerate cash receipts.

Inventory -

The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, required inventory levels could be reduced.

Improvements in production processes could reduce the amount of work in process, thereby reducing inventory and improving the turnover ratio.

Moving to a system whereby inventory is only produced as needed, will reduce the amount of finished goods inventory and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.

LO 4 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 8-16 One possible reason Office Depot chose to sell its receivables may have been to improve its financial ratios. Other reasons include not wanting to deal with the administration of collecting accounts or the desire to accelerate cash receipts. LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

EXERCISE 8-17 (a)

Accounts Receivable

Beg 38,000 Sales 380,000 227,000 End 191,000

Collections or

Sales – Increase in Receivables = Cash Collections $380,000 – ($191,000 – $38,000) = $227,000 (Collections reduce the accounts receivable balance)

EXERCISE 8-17 (Continued) (b) The quality of earnings ratio is net cash provided by operating activities divided by net income. If accrual sales exceed cash collections, then net income will exceed net cash provided by operating activities, all else being equal. Therefore, this would cause a drop in the quality of earnings ratio. (c) If the company relaxed its credit requirements it should increase its estimated bad debts expense. If it doesn’t do this, net income in the current period will likely be overstated. LO 4 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO PROBLEMS PROBLEM 8-1A

(a)

Total estimated bad debts Number of Days Outstanding 31–60 61–90 91–120

Over 120

$377,000 $222,000 1%

$90,000 4%

$38,000 5%

$15,000 8%

$12,000 10%

$10,120

$3,600

$1,900

$1,200

(b) Bad Debt Expense .......................................... 14,120 Allowance for Doubtful Accounts ($10,120 + $4,000) ................................. (Bad Debt Expense takes into account any existing balance in the allowance account.)

14,120

Total Accounts receivable % uncollectible Estimated bad debts

(e)

0–30

$2,220

Allowance for Doubtful Accounts ................. Accounts Receivable...............................

5,000

Accounts Receivable ..................................... Allowance for Doubtful Accounts ..........

5,000

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

5,000

5,000 5,000 5,000

If Rianna.com used 3% of total accounts receivable rather than aging the individual accounts, the bad debt expense adjustment would be $15,310 [($377,000 X 3%) + $4,000]. Aging the individual accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance account and bad debts expense.

LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

PROBLEM 8-2A

(a)

Accounts Receivable........................................ 2,500,000 Sales Revenue ......................................... 2,500,000

Sales Returns and Allowances...................... Accounts Receivable ..............................

Cash .................................................................. 2,200,000 Accounts Receivable .............................. 2,200,000

Allowance for Doubtful Accounts ................. Accounts Receivable ..............................

41,000

Accounts Receivable ..................................... Allowance for Doubtful Accounts ..........

15,000

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

15,000

Accounts Receivable Bal. 600,000 (1) 2,500,000 (5) 15,000 Bal.

(c)

50,000

(b)

50,000

(2) 50,000 (3) 2,200,000 (4) 41,000 (5) 15,000

41,000 15,000 15,000

Allowance for Doubtful Accounts (4)

41,000

809,000

Bal. (5)

37,000 15,000

Bal.

11,000

Balance needed...................................................... Balance before adjustment [See (b)] .................... Adjustment required ..............................................

$46,000 (11,000) $35,000

The journal entry would therefore be as follows: Bad Debt Expense.................................................. 35,000 Allowance for Doubtful Accounts............... (Bad Debt Expense takes into account any existing balance in the allowance account.)

35,000

PROBLEM 8-2A (Continued) (d)

$2,500, 000 – $50,000 $2,450,000 = = 3.7 times ($563,000* + $763,000**) ÷ 2 $663,000 *$600,000 – $37,000 **$809,000 – $46,000 The average collection period is: 365 days

= 98.6 days

3.7 LO 2, 4 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 8-3A

(a) Dec. 31

Bad Debt Expense .......................................... 34,400 Allowance for Doubtful Accounts ($42,400 – $8,000) ............................. (Bad Debt Expense takes into account any existing balance in the allowance account.)

34,400

(a) & (b) 12/31 12/31

Bad Debt Expense

Allowance for Doubtful Accounts

34,400 Bal. 34,400

2016

2017 3/1

(b) (1)

(2)

May 1

Dec. 31

600 5/1

2017 Allowance for Doubtful Accounts ....... Accounts Receivable....................

Mar. 1

(c)

12/31 Bal. 8,000 12/31 34,400 12/31 Bal. 42,400 600

600 600

Accounts Receivable............................ Allowance for Doubtful Accounts ....................................

600

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

600

2017 Bad Debt Expense...................................... Allowance for Doubtful Accounts ($36,700 + $1,400) ..............................

LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

600

600 38,100 38,100

PROBLEM 8-4A

(a) $37,000. (b) $30,600 [($840,000 X 4%) – $3,000]. (Bad Debt Expense takes into account any existing balance in the allowance account.) (c) $34,600 [(840,000 X 4%) + $1,000]. (d) The are two major weaknesses with the direct write-off method. First, it does not match expenses with revenues. Second, the accounts receivable are not stated at cash realizable value at the balance sheet date. LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 8-5A

Bad Debt Expense ($10,200 – $1,500) ..... 8,700 Allowance for Doubtful Accounts ..... (Bad Debt Expense takes into account any existing balance in the allowance account.) (a) Dec. 31

(b) Dec. 31

(c)

(d)

(e)

Bad Debt Expense ($10,200 + $1,500) ......... 11,700 Allowance for Doubtful Accounts .....

Allowance for Doubtful Accounts ........................... Accounts Receivable ........................................

2,100

Bad Debt Expense.................................................... Accounts Receivable ........................................

2,100

8,700

11,700

2,100

The advantages of the allowance method over the direct write-off method are: 1.

It attempts to match bad debts expense related to uncollectible accounts receivable with sales revenues on the income statement.

It attempts to show the cash realizable value of the accounts receivable on the balance sheet.

LO 2 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 8-6A

Jan. 5 Feb. 2 12 26 Apr.

Accounts Receivable—Rian Company.......... Sales Revenue ..........................................

4,000

Notes Receivable............................................. Accounts Receivable—Rian Company ...

4,000

Notes Receivable............................................. Sales Revenue ..........................................

12,000

Accounts Receivable—Malcolm Co ............... Sales Revenue ..........................................

5,200

Notes Receivable............................................. Accounts Receivable—Malcolm Co ........

5,200

4,000 4,000 12,000 5,200 5,200

Cash ($12,000 + $200) ..................................... 12,200 Notes Receivable...................................... 12,000 Interest Revenue ($12,000 X 10% X 2/12) .......................... 200 (When the terms of a note are expressed in months, the time element is based on 12 months) June 2

Cash ($4,000 + $120) ....................................... 4,120 Notes Receivable...................................... 4,000 Interest Revenue ($4,000 X 9% X 4/12).... 120 (When the terms of a note are expressed in months, the time element is based on 12 months) June 15

Notes Receivable............................................. Sales Revenue ..........................................

2,000

LO 1, 3 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

2,000

PROBLEM 8-7A

Transaction 1. Recorded cash sale. 2. Recorded bad debts expense. Use allowance method 3. Wrote off an account receivable as uncollectible. Use allowance method 4. Recorded sales on account.

Current Ratio (2:1) I

Accounts Receivable Turnover (10X) NE

Average Collection Period (36.5 days) NE

LO 4 BT: C Difficulty: Medium TOT: 20 min. AACSB: None AICPA FC: Measurement

PROBLEM 8-8A

(a) July

Accounts Receivable ............................... Sales Revenue ....................................

4,500

Cash ($600 – $18) ..................................... Service Charge Expense ($600 X 3%) ..... Sales Revenue ....................................

582 18

Cash ......................................................... Notes Receivable ................................ Interest Revenue ($6,000 X 8% X 90/360)..................... (The interest computation assumes a 360-day year)

6,120

Cash ......................................................... Notes Receivable ................................ Interest Revenue ($7,800 X 10% X 60/360)................... (The interest computation assumes a 360-day year) 31

4,500

600

6,000 120

7,930 7,800 130

Interest Receivable .................................. Interest Revenue ($10,000 X 6% X 1/12).......................

50 50

(b) Notes Receivable 7/1 Bal. 23,800 7/20 7/24 7/31 Bal. 10,000

6,000 7,800

Accounts Receivable 7/5 4,500 7/31 Bal. 4,500

7/31

Interest Receivable 50

7/31 Bal.

PROBLEM 8-8A (Continued) MILTON COMPANY Balance Sheet (Partial) July 31, 201X (c) Current assets Notes receivable............................................... Accounts receivable ........................................ Interest receivable............................................ Total receivables ........................................ LO 1 - 4 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

$10,000 4,500 50 $14,550

PROBLEM 8-9A

Nike Accounts receivable turnover

adidas

$19,176.1 a

$10,381 b

($2,795.3 + $2,883.9 )/2 $19,176.1 $2,839.6

= 6.8 times

($1,624c + $1,429d )/2 $10,381 = 6.8 times $1,526.5

a2,873.7 – 78.4 b2,994.7 – 110.8 c1,743 – 119 d1,553 – 124

Average collection period

365 6.8

= 53.7 days

365

= 53.7 days

6.8

Both companies have the same turnover ratios and average collection periods. LO 4 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement

ACCOUNTING CYCLE REVIEW (a) Jan. 1

3 8 11

17 21 24

27 31

Notes Receivable........................................... Accounts Receivable— Betheny Company ..............................

1,200

Allowance for Doubtful Accounts ................ Accounts Receivable.............................

730

Inventory ........................................................ Accounts Payable ..................................

17,200

Accounts Receivable .................................... Sales Revenue .......................................

25,000

Cost of Goods Sold ....................................... Inventory ................................................

17,500

Cash ............................................................... Service Charge Expense............................... Sales Revenue .......................................

970 30

Cost of Goods Sold ....................................... Inventory ................................................

700

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

22,900

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

16,300

Accounts Receivable .................................... Allowance for Doubtful Accounts.........

280

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

280

Supplies ......................................................... Cash........................................................

1,400

Other Operating Expenses ........................... Cash........................................................

3,218

1,200 730 17,200 25,000 17,500

1,000 700 22,900 16,300 280 280 1,400 3,218

ACR SOLUTION (Continued) Adjusting Entries Jan. 31 31

31 31

(b)

Interest Receivable ........................................ Interest Revenue ($1,200 X 8% X 1/12) ....... Bad Debt Expense [($19,950 X 6%) – ($800 – $730 + $280)] .................................. Allowance for Doubtful Accounts..........

8 8

847 847

Supplies Expense .......................................... Supplies ($1,400 – $560) ........................

840

Income Tax Expense...................................... Income Taxes Payable [$2,873 (See c) X 30%].........................

862

840

862

HUDSON CORPORATION Adjusted Trial Balance January 31, 2017 Cash ............................................................ Notes Receivable ....................................... Accounts Receivable ................................. Allowance for Doubtful Accounts............. Interest Receivable .................................... Inventory..................................................... Supplies...................................................... Accounts Payable ...................................... Income Taxes Payable ............................... Common Stock........................................... Retained Earnings...................................... Sales Revenue............................................ Cost of Goods Sold.................................... Supplies Expense ...................................... Bad Debt Expense...................................... Service Charge Expense ........................... Other Operating Expenses ........................ Interest Revenue ........................................ Income Tax Expense..................................

Debit $16,332 1,200 19,950

Credit

$ 1,197 8 8,400 560 9,650 862 20,000 12,730 26,000 18,200 840 847 30 3,218 8 862 $70,447

$70,447

ACR SOLUTION (Continued) (b)

Optional T accounts for accounts with multiple transactions

Cash 1/1 Bal. 13,100 1/21 1/15 970 1/27 1/17 22,900 1/31 1/24 280 1/31 Bal. 16,332

16,300 1,400 3,218

1/21

Accounts Receivable 1/1 Bal. 19,780 1/1 1,200 1/11 25,000 1/3 730 1/24 280 1/17 22,900 1/24 280 1/31 Bal. 19,950

Allowance for Doubtful Accounts 1/3 730 1/1 Bal. 800 1/24 280 1/31 847 1/31 Bal. 1,197

Inventory 1/1 Bal. 9,400 1/11 1/8 17,200 1/15 1/31 Bal. 8,400

1/27 1/31 Bal.

17,500 700

Supplies 1,400 1/31 560

840

Accounts Payable 16,300 1/1 Bal. 8,750 1/8 17,200 1/31 Bal. 9,650 Sales Revenue 1/11 25,000 1/15 1,000 1/31 Bal. 26,000

Cost of Goods Sold 1/11 17,500 1/15 700 1/31 Bal. 18,200

ACR SOLUTION (Continued) (c)

HUDSON CORPORATION Income Statement For the Month Ending January 31, 2017 Sales revenue................................................. Cost of goods sold......................................... Gross profit .................................................... Operating expenses....................................... Other operating expenses...................... Bad debt expense ................................... Supplies expense ................................... Service charge expense ......................... Total operating expenses .............................. Income from operations ................................ Other revenues and gains ............................. Interest revenue ...................................... Income before taxes ...................................... Income tax expense ($2,873 X 30%) ...... Net income......................................................

$26,000 18,200 7,800 $3,218 847 840 30 4,935 2,865 8 2,873 862 $ 2,011

ACR SOLUTION (Continued) HUDSON CORPORATION Retained Earnings Statement For the Month Ending January 31, 2017 Retained earnings, January 1 .......................................... Add: Net income ............................................................... Retained earnings, January 31 ........................................

$12,730 2,011 $14,741

HUDSON CORPORATION Balance Sheet January 31, 2017 Assets Current assets Cash ........................................................ Notes receivable ..................................... Accounts receivable............................... Less: Allowance for doubtful accounts ...................................... Interest receivable .................................. Inventory ................................................. Supplies .................................................. Total assets ....................................................

$16,332 1,200 $19,950 1,197

18,753 8 8,400 560 $45,253

Liabilities and Stockholders’ Equity Current liabilities Accounts payable................................... Income taxes payable ............................ Total liabilities................................................ Stockholders’ equity Common stock ....................................... Retained earnings .................................. Total stockholders’ equity ..................... Total liabilities and stockholders’ equity .....

$ 9,650 862 $10,512 $20,000 14,741

LO 1 – 4 BT: AP Difficulty: Hard TOT: 120 min. AACSB: Analytic AICPA FC: Reporting

34,741 $45,253

CT 8-1

(a)

FINANCIAL REPORTING PROBLEM

Accounts receivable turnover

2014 $182,795 ($17, 460 + $13,102) ÷ 2

$182, 795 = 12.0 times $15, 281 365 Average collection period = = 30.4 days 12.0 =

(b)

Note 2 under Accounts Receivable states that As of September 27, 2014, the Company had two customers that represented 10% or more of total trade receivables, one of which accounted for 16% and the other 13%. As of September 28, 2013, the Company had two customers that represented 10% or more of total trade receivables, one of which accounted for 13% and the other 10%. The Company's cellular network carriers accounted for 72% and 68% of trade receivables as of September 27, 2014 and September 28, 2013, respectively. The additions and write-offs to the Company's allowance for doubtful accounts during 2014, 2013 and 2012 were not significant.

(c)

At 30.4 days, Apple’s average collection period appears reasonable. It should be compared to its credit terms (normally 30 days) and to previous years to determine whether it is of concern.

LO 4 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 8-2

(a) (1)

COMPARATIVE ANALYSIS PROBLEM

Accounts receivable turnover ratio Columbia Sportswear $2,100, 590 ($344, 390 + $306, 878) ÷ 2 $2,100, 590 = 6.5 times $325, 634

(2)

VF Corporation $12,154, 784 ($1, 276, 224 + $1, 360, 443) ÷ 2 $12,154, 784 = 9.2 times $1, 318, 333.5

Average collection period 365 6.5

= 56.2 days

365

= 39.7 days

9.2

(b) The general rule for the average collection period is that it should not greatly exceed the credit term period. VFC’s average collection period (approximately 40 days) is longer than the normal credit term period of 30 days but is better than Columbia's 56 day average collection period. LO 4 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 8-3

(a) (1)

COMPARATIVE ANALYSIS PROBLEM

Accounts receivable turnover Amazon.com $70, 080 ($5, 612 + $4,767) ÷ 2 $70, 080

= 13.5 times

$5,189.5 (2)

Wal-Mart stores $485,651 ($6,778 + $6,677) ÷ 2 $485,651

= 72.2 times

$6,727.5

Average collection period 365 13.5

= 27.0 days

365

= 5.1 days

72.2

(b) The general rule for the average collection period is that it should not greatly exceed the credit term period. Amazon’s average collection period (approximately 27 days) is shorter than the normal credit term period of 30 days but is much longer than Wal-Mart’s 5.1 days. LO 4 BT: AN Difficulty: Hard TOT: 20 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 8-4 (a)

INTERPRETING FINANCIAL STATEMENTS

Accounts receivable turnover

$2,981.8 = 11.7 times ($259.8* + $248.3**)/2

*$270.4 – $10.6 **$259.7 – $11.4 Average collection period =

365 days

= 31.2 days

11.7 (b)

Accounts receivable represent 24.9% [($270.4 – $10.6)/$1,044.9] of the company’s current assets. This is a material amount of the current assets.

(c)

The ratios would probably vary throughout the year as receivables increase during the busy season and decrease in the “off” season. To improve the accuracy of the ratio, average receivables should be calculated using monthly or quarterly data, rather than just the beginning and ending balance.

(d)

It is difficult to evaluate Scotts’ credit risk with only a single year’s data and no industry norms. An average collection period of 31.2 days may be reasonable for the type of customers that make up Scotts’ receivables. Scotts explained that a majority of its receivables were from its North American Consumer segment. Within this segment, there were several subgroups (i.e., home centers, mass merchandisers, hardware stores). The note explains that its top 3 customers accounted for 48% of its total receivables from the North American consumer business. In addition its two largest customers accounted for more than 34% of its net sales. These facts indicate a higher degree of credit risk than having numerous smaller customers.

CT 8-4 (Continued) (e)

Note 19 addressed the issues that surround credit risk. It provided the reader with at least a moderate degree of “comfort” that Scotts’ accounts receivable and allowance policies were acceptable. The note also appears to comply with the full disclosure principle required under GAAP. It does not, however, disclose what the company’s credit exposure is to any individual customers. This would be of interest, since some of its customers are probably very large. As noted in part (d), having the receivables balance spread across multiple customers is usually less risky than having a few large customers.

LO 4 BT: AN Difficulty: Hard TOT: 25 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 8-5 (a)

REAL-WORLD FOCUS

Factoring invoices enhances cash flow and allows a company to meet business expenses and take on new opportunities. The benefits of factoring include:    

Predictable cash flow and elimination of slow payments Flexible financing, as factoring line is tied to sales. It’s the ideal tool for growth Factoring is easy to obtain. Works well with startups and established companies Factoring financing lines can be setup in a few days

(b)

Factoring rates range between 1.5% and 3.5% per month. The two major variables considered when determining the rate are: (1) the size of the transaction, and (2) the credit quality of the company’s clients .

(c)

The first installment is paid within a couple of days and is typically 90% of the invoice amount. After customers pay the invoice amount to the factor, the second installment (10%) is paid, less a fee for the transaction.

LO 2, 4 BT: S Difficulty: Hard TOT: 20 min. AACSB: Analytic, Communication and Technology AICPA FC: Reporting AICPA PC: Communication

CT 8-6

RESEARCH CASE

(a) InBev told its suppliers that it would take up to 120 days to pay. This is compared to 30 days previously. (b) To free up cash, General Electric shortened collection times, collected on past-due accounts, and stretched out its payments to suppliers. By doing this the company says that it freed up $3.8 billion. (c) Companies with sales of more than $5 billion took an average of 55.8 days to pay suppliers and they took an average of 41 days to collect from customers. Companies with sales of less than $500 million took an average of 40.1 days to pay suppliers and they took an average of 58.9 days to collect from customers. (d) If a company negotiates payment terms that are too severe for its suppliers, the suppliers may be forced out of business. This can then disrupt the company’s operations as it searches for substitute suppliers. LO 4 BT: S Difficulty: Hard TOT: 25 min. AACSB: Analytic, Communication and Technology AICPA FC: Reporting AICPA PC: Communication

CT 8-7

DECISION MAKING ACROSS THE ORGANIZATION

(a) Net credit sales .................................

2017 $500,000

Credit and collection expenses Collection agency fees ............. $ 2,900 Salary of accounts receivable clerk ..................................... 4,400 Uncollectible accounts ............. 8,000 Billing and mailing costs .......... 2,500 Credit investigation fees........... 1,000 Total..................................... $ 18,800 Total expenses as a percentage of net credit sales...................... 3.8% (b)

2016 $600,000

2015 $400,000

$ 2,600

$ 1,600

4,400 9,600 3,000 1,200 $ 20,800

4,400 6,400 2,000 800 $ 15,200

3.5%

3.8%

Average accounts receivable (5%) ...

$ 25,000

$ 30,000

$ 20,000

Investment earnings (10%) ..............

2,500

$ 3,000

$ 2,000

Total credit and collection expense per above .................................. Add: Investment earnings* ............. Net credit and collection expense ....

$ 18,800 2,500 $ 21,300

$ 20,800 3,000 $ 23,800

$ 15,200 2,000 $ 17,200

Net expenses as a percentage of net sales ...............................

4.3%

4.0%

4.3%

*The investment earnings on the cash tied up in accounts receivables is an additional expense of continuing the existing credit policies. (c) The analysis shows that the credit card fee of 4% of net credit sales will be higher than the percentage cost of credit and collection expenses in each year before considering the effect of earnings from other investment opportunities. However, after considering investment earnings, the credit card fee of 4% will be less than or equal to the company’s percentage cost.

CT 8-7 (Continued) Finally, the decision hinges on (1) the accuracy of investment earnings, (2) the expected trend in credit sales, and (3) the effect the new policy will have on sales. Nonfinancial factors include the effects on customer relationships of the alternative credit policies and whether the Santos want to continue with the handling of their own accounts receivable. LO 4 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Interaction, Leadership and Communication

CT 8-8

COMMUNICATION ACTIVITY

To:

John Doe, President

From:

Mary Jane, Student

Re:

Improving debt-paying ability

Date:

September 14, 2017

The first step that should be taken to improve your company’s debt-paying ability is to accelerate collections of your accounts receivable. The current credit policy (i.e., “pay when they can”) encourages slow payment from credit customers. Most companies have a 30-day credit period with finance charges applied on late payments. You may also want to consider adopting a discount period which allows customers a reduction in the amount owed if payment is made within a specified time period. Measuring success in improving collections can be done by monitoring collections and evaluating the receivables balance. Monitoring collections is done by preparing an accounts receivable aging schedule on a monthly basis. Evaluating receivables is accomplished by computing an accounts receivable turnover and an average collection period. Another step that can be taken with receivables to ease your company’s liquidity problems is to sell the receivables to another company for cash. Selling receivables to another company (called a factor) shortens the cashto-cash operating cycle. It should be pointed out that factors normally charge a commission of 1% to 3%. Hopefully this memo addresses the questions you have on improving your company’s debt-paying ability. Please contact me if you have any questions or need additional information. LO 4 BT: S Difficulty: Hard TOT: 30 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 8-9

(a)

ETHICS CASE

The stakeholders in this situation are: The president of Mendez Corp. The controller of Mendez Corp. The stockholders of Mendez Corp.

(b)

Yes. The controller is posed with an ethical dilemma—should he/she follow the president’s “suggestion” and prepare misleading financial statements (understated net income) or should he/she attempt to stand up to and possibly anger the president by preparing a fair (realistic) income statement.

(c)

No. Mendez Corp.’s growth rate should be a product of fair and accurate financial statements, not vice versa. That is, one should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of creative accounting.

LO 2 BT: E Difficulty: Hard TOT: 30 min. Communication and Professional Demeanor

AACSB: Analytic, Communication and Ethics

AICPA PC:

CT 8-10

ALL ABOUT YOU

(a) There are a number of sources that compare features of credit cards. Here are three: www.creditcards.com/, www.federalreserve.gov/pubs/shop/, and www.creditorweb.com/. (b) Here are some of the features you should consider: annual percentage rate, credit limit, annual fees, billing and due dates, minimum payment, penalties and fees, premiums received (airlines miles, hotel discounts etc.), and cash rebates. (c) Answer depends on present credit card and student’s personal situation. LO 2 BT: S Difficulty: Hard TOT: 30 min. AACSB: Analytic, Communication and Technology AICPA PC: Communication AICPA BB: Critical Thinking

CT 8-11

FASB CODIFICATION ACTIVITY

(a) Receivables represent contractual rights to receive money on fixed or determinable dates, whether or not there is any stated provision for interest. Receivables may arise from credit sales, loans, or other transactions. Receivables may be in the form of loans, notes, and other types of financial instruments and may be originated by an entity or purchased from another entity. (Codification reference 310-10-05-4). (b) The conditions under which receivables exist usually involve some degree of uncertainty about their collectibility, in which case a contingency exists. Subtopic 450-20 requires recognition of a loss when both of the following conditions are met: a. Information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired at the date of the financial statements. b. The amount of the loss can be reasonably estimated. Losses from uncollectible receivables shall be accrued when both the preceding conditions are met. Those conditions may be considered in relation to individual receivables or in relation to groups of similar types of receivables. If the conditions are met, accrual shall be made even though the particular receivables that are uncollectible may not be identifiable. (Codification reference 310-10-35-7, 35-8-35-9). LO 1, 2 BT: S Difficulty: Hard TOT: 40 min. AACSB: Analytic, Communication and Technology AICPA FC: Measurement AICPA PC: Communication

IFRS 8-1

INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a)

Note 1.17 states: Trade accounts receivable are recorded at their face value. A provision for impairment is recorded if their net realizable value, based on the probability of their collection, is less than their carrying amount.

(b)

Note 11 indicates that provisions for impairment and product returns accounted for the difference between gross and net trade accounts receivable.

(c)

According to Note 11, the primary reason for the increase in gross accounts receivable was an increase in trade receivables.

(d)

2014 :

€66 = 2.59% €2, 546

2013 :

€67 = 2.77% €2, 416

The provision for impairment as a percentage of trade receivables decrease from 2.76% to 2.59%. This decrease indicates that Louis Vuitton is doing a better job collecting its receivables. LO 2, 4 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic, Communication, Technology and Diversity AICPA: FC: Measurement and Reporting AICPA PC: International/Global Perspective

CHAPTER 9 Reporting and Analyzing Long-Lived Assets Learning Objectives 1. Explain the accounting for plant asset expenditures. 2. Apply depreciation methods to plant assets. 3. Explain how to account for the disposal of plant assets. 4. Identify the basic issues related to reporting intangible assets. 5. Discuss how long-lived assets are reported and analyzed. *6. Compute periodic depreciation using the declining-balance method and the units- of-activity method.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO

Item

19. 20. 21. 22. 23. 24.

4 4 5 5 5 5

K C AP C C C

25. 26. 27.

5 5 5

C C C.

10. 11. 12.

5 5 5

AP AP AP

13. 14.

6* 6*

AP AP

13. 14.

4 2, 4

C C

17. 18.

5 5

AP AN

15. 16.

5 5

AP AP

19. 20.

6* 6*

AP AP

7. 8.

5 2, 6*

AN AP

2, 6*

Questions 1. 2. 3. 4. 5. 6.

1 1 1 1 1 1

C K C C C K

7. 8. 9. 10. 11. 12.

2 2 2 2 3 3, 5

K C C C K C

1. 2. 3.

1 1 1

AP AP AP

4. 5. 6.

2 2 2

AP AN AP

1. 2a.

1 2

C AP

2b. 3.

2 3

AP AP

1. 2.

1 1

C C

5. 6.

2 2

AP AN

3. 4.

1 2

AP C

7. 8

3 3

AP AP

1. 1 2. 2, 3, 5

C AP

3. 3 AP 4. 1, 2, 3, AP 5

13. 14. 15. 16. 17. 18.

5 4 4 4 4 4

K C C C C C

Brief Exercises 7. 3 AP 8. 3 AP 9. 4 AP Do It! Exercises 4. 4 C 5. 5 AP Exercises 9. 1, 2, 3 AN 10. 1, 2, 3, C 4 11. 4 AN 12. 4 AN Problems: Set A 5. 4, 5 AP 6. 4 AP

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CLASSIFICATION TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine acquisition costs of land and building.

Simple

20–30

Journalize equipment transactions related to purchase, sale, retirement, and depreciation.

Moderate

40–50

Journalize entries for disposal of plant assets.

Moderate

20–30

Record property, plant and equipment transactions; prepare partial balance sheet

Moderate

40–50

Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section and note.

Moderate

30–40

Prepare entries to correct errors in recording and amortizing intangible assets.

Moderate

15–20

Calculate and comment on return on assets, profit margin, and asset turnover.

Moderate

15–20

*8A

Compute depreciation under different methods.

Simple

30–40

*9A

Compute depreciation under different methods.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

For plant assets, the historical cost principle states that plant assets are recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 2.

In a cash transaction, cost is equal to the cash paid. In a noncash transaction, cost is equal to the cash equivalent price paid, which is the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 3.

When only the land is to be used, all demolition and removal costs of the building less any proceeds from salvaged materials are necessary expenditures to make the land ready for its intended use. Any costs for clearing, draining, filling, and grading are also part of the cost of the land. Also any back taxes are also included in the cost of the land. When both the land and building are to be used, necessary costs of the building include remodeling expenditures and the cost of replacing or repairing the roofs, floors, wiring, and plumbing.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 4.

Ordinary repairs are made to maintain the operating efficiency and expected productive life of the asset. Capital expenditures are additions and improvements made to increase efficiency, productive capacity, or expected useful life of the asset. Ordinary repairs are recognized as expenses when incurred; capital expenditures are generally debited to the plant asset affected.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 5.

The potential benefits of leasing are (1) reduced risk of obsolescence (an obvious concern to Nolan), (2) little or no required down payment, (3) shared tax advantages, (4) assets and liabilities may not reported on the balance sheet.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 6.

You should explain to the president that depreciation is a process of allocating the cost of a plant asset to expense over its service (useful) life in a rational and systematic manner. Recognition of depreciation is not intended to result in the accumulation of cash for replacement of the asset.

LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 7.

(a) Salvage value is the expected cash value of the asset at the end of its useful life. (b) Salvage value is used in determining depreciable cost in the straight-line method by subtracting it from the plant asset’s cost.

LO 2 BT: C Difficulty: Essy TOT: 2 min. AACSB: None AICPA FC: Reporting

(a) Useful life is expressed in years under the straight-line method and in units of activity under the units-of-activity method. (b) The pattern of periodic depreciation expense over an asset’s useful life is constant under the straight-line method and variable under the units-of-activity method.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 9.

The effects of the three depreciation methods on annual depreciation expense are: Straightline—constant amount; units-of-activity—varying amounts; declining-balance—decreasing amounts.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 10.

A revision of depreciation is made in current and future years but not retroactively. The rationale is that continual restatement of prior periods would adversely affect the reader’s confidence in the financial statements.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 11.

In a sale of plant assets, the book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC; Reporting 12.

The plant asset and related accumulated depreciation should continue to be reported on the balance sheet without further depreciation or adjustment until the asset is retired. Reporting the asset and related accumulated depreciation on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset. In no situation can the depreciation on the plant asset exceed the cost of the plant asset.

LO 2, 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 13.

Apple depreciates its buildings over the lesser of 30 years or the remaining life of the underlying building, and its machinery and equipment between 2 to 5 years.

LO 5 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic & Technology AICPA FC: Reporting & Technology 14.

Depreciation and amortization are both concerned with writing off the cost of an asset to expense over the periods benefited. Depreciation refers to allocating the cost of a plant asset to expense and amortization to allocating the cost of an intangible asset to expense.

LO 2, 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

15.

It is true that successful marketing campaigns often benefit multiple accounting periods in the future, enhancing the company’s value, and potentially creating goodwill. However, from an accounting perspective Bruce’s proposal is unacceptable. First of all, accounting standards only allow the recording of “purchased goodwill” that results from the purchase of another business. Internally created goodwill is not allowed to be recorded. Second, marketing expenditures are to be treated as expenses of the period in which they are incurred. They cannot be capitalized. It is unethical to capitalize costs simply to boost reported income by spreading the cost over multiple periods.

LO 4 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 16.

The intern is not correct. If an intangible asset has a limited life, the cost of the asset should be amortized over that asset’s useful life (the period of time when operations are benefited by use of the asset) or its legal life, whichever is shorter. The cost of intangible assets with indefinite lives should not be amortized.

LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 17.

The favorable attributes which could result in goodwill include exceptional management, desirable location, good customer relations, skilled employees, high quality products, fair pricing policies, and harmonious relations with labor unions.

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 18.

Goodwill is the value of many favorable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold.

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 19.

Goodwill is recorded only when there is an exchange transaction that involves the purchase of an entire business. Goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired. The recognition of goodwill without an exchange transaction would lead to subjective valuations which would reduce the reliability of financial statements. Goodwill is not amortized because it has an indefinite life. It remains at its original value as an intangible asset unless it is considered to be impaired. If it is impaired, it is written down.

LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

Questions Chapter 9 (Continued) 20.

Research and development costs present several accounting problems. It is sometimes difficult to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, research and development costs are usually recorded as an expense when incurred.

LO 4 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 21.

Campbell Soup Company’s return on assets is computed as follows: Net Income Average Total Assets

$736

= 11.7%

$6,265

LO 5 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 22.

The return on assets is closely monitored by management. It is the product of the profit margin and the asset turnover. At first glance, if this new product line has a lower profit margin, then it will reduce the company’s asset turnover. However, it is likely that it will have a higher turnover than the company’s more expensive offerings. As a consequence, it is not possible to know what effect the new product line will have on the company’s return on assets without knowing the expected effect on the company’s asset turnover.

LO 5 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 23.

(a) Grocery stores usually have a high asset turnover and a low profit margin. (b) Car dealerships normally have a low asset turnover and a high profit margin.

LO 5 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

24.

Since Peyton uses the straight-line depreciation method, its depreciation expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method. Rogers’ depreciation expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Peyton’s net income will be higher than Rogers’ in the first few years of the asset’s useful life.

LO 2 BT: AN Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 25.

Yes, the tax regulations of the IRS allow a company to use a different depreciation method on the tax return than is used in preparing financial statements. Mesa Corporation uses an accelerated depreciation method for tax purposes to minimize its income taxes in the early years of the assets’ lives.

LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

26.

By selecting a higher estimated useful life, Gore Corp. is spreading the plant assets’ cost over a longer period of time. The depreciation expense reported in each period is lower and net income is higher. Ross’s choice of a shorter estimated useful life will result in higher depreciation expense reported in each period and lower net income.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 27.

In the operating activities section of the statement of cash flows, depreciation expense (from plant assets) and amortization expense (from intangible assets) are added back to net income in the determination of net cash provided by operating activities. In the investing section, cash paid to purchase plant assets or intangible assets is shown as a use of cash. If the company sells any of its used plant assets, or if it sells intangibles, it would report the amount of cash received as a source of cash from investing activities.

LO 5 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures should be included in the cost of the land. Therefore, the cost of the land is $73,900 ($60,000 + $5,000 + $2,100 + $3,300 + $3,500). LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-2 The cost of the truck is $26,780 (cash price $24,000 + sales taxes $1,080 + painting and lettering $1,700). The expenditures for insurance and motor vehicle license should not be added to the cost of the truck. LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-3 (a) Maintenance and Repairs Expense ........................ Cash ....................................................................

(b) Equipment ................................................................ Cash ....................................................................

400

LO 2 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-4 The depreciable cost is $27,000 ($31,000 – $4,000). With a 4-year useful life, annual depreciation is $6,750 ($27,000 ÷ 4). Under the straight-line method, depreciation is the same each year. Thus, depreciation is $6,750 for both the first and second years. LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-5 It is likely that management requested this accounting treatment to boost reported net income. Land is not depreciated; thus, by reporting land at $130,000 above its actual value the company increased yearly income by   $6,500  $130,000  or the reduction in depreciation expense. This practice  20 years  is not ethical because management is knowingly misstating asset values. LO 2 BT: AN Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-6 Book value, 1/1/17 ($36,000 – $13,600) ........................................... Less: Salvage value ........................................................................ Depreciable cost .............................................................................. Remaining useful life ....................................................................... Revised annual depreciation ($20,400 ÷ 2) .....................................

$22,400 2,000 $20,400 2 years $10,200

LO 2 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-7 (a) Accumulated Depreciation—Equipment................ Equipment...........................................................

41,000

(b) Accumulated Depreciation—Equipment................ Loss on Disposal of Plant Assets .......................... Equipment ..........................................................

37,200 3,800

Cost of delivery equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal

41,000

$41,000 37,200 3,800 0 $ 3,800

LO 3 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

41,000

BRIEF EXERCISE 9-8 (a) 7/31/17 Depreciation Expense .............................. Accumulated Depreciation— Equipment ........................................

4,600

(b) 7/31/17

46,600 21,000 4,400

Accumulated Depreciation—Equipment .... Cash........................................................... Loss on Disposal of Plant Assets ........... Equipment .......................................... Cost of office equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal

4,600

72,000

$72,000 46,600* 25,400 21,000 $ 4,400

*$42,000 + $4,600 LO 3 BT: AP Difficulty: Medium TOT: 7 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-9 (a) Amortization Expense ($156,000 ÷ 6) ..................... Patents ..............................................................

26,000

(b) Intangible Assets Patents (Net of $26,000 of amortization).........

26,000

$130,000

LO 4 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-10 (a)

Return on assets =

$4.55

= 15.5%

($28.46 + $30.22)÷2

(b)

Asset turnover =

$22.74

= .78 times

($28.46 + $30.22) ÷ 2

LO 5 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 9-11 NIKE, INC. Partial Balance Sheet As of May 31, 2017 (in millions) Property, plant, and equipment Land........................................................ Buildings ................................................ Machinery and equipment..................... Other plant assets ................................. Less: Accumulated depreciation......... Total property, plant, and equip. .. Intangible assets Goodwill ................................................. Patents and trademarks ........................ $515.1 Less: Accumulated amortization ......... 47.7 Total intangible assets...................

$ 221.6 $ 974.0 2,094.3 965.8 2,298.0

1,736.1 1,957.7

193.5 467.4 660.9*

*Alternatively, many companies would simply show a single line for net intangibles. LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 9-12 In the determination of net cash provided by operating activities, add depreciation expense and amortization expense to net income: Net cash provided by = $157,000 + $12,000 + $8,000 = $177,000 operating activities LO 5 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 9-13 The declining-balance rate is 50% (1/4 X 2) and this rate is applied to the book value at the beginning of the year. The computations are: Book Value Year 1 Year 2

$31,000 ($31,000 – $15,500)

Rate

Depreciation

50% 50%

$15,500 $ 7,750

LO 6 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 9-14 The depreciation cost per unit is 18 cents per mile computed as follows: Depreciable cost ($27,500 – $500) ÷ 150,000 = $.18 Depreciation expense for each year is as follows: 2016 32,000 miles X $.18 = $5,760 2017 33,000 miles X $.18 = $5,940 LO 6 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 9-1 The following four items are expenditures necessary to acquire the truck and get it ready for use: Negotiated purchase price ........................................ Installation of special shelving.................................. Painting and lettering................................................. Sales tax ..................................................................... Total paid.........................................................

$24,000 1,100 900 1,440 $27,440

Thus, the cost of the truck is $27,440. The cost of the motor vehicle license is an operating cost and is expensed. The annual insurance policy would be recorded as prepaid insurance and then expensed over the year. LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

DO IT! 9-2a Depreciation expense = Cost – Salvage = $15,000 – $1,000 = $1,400 Useful life 10 years The entry to record the first year’s depreciation would be: Depreciation Expense .......................................................... Accumulated Depreciation—Equipment....................

1,400 1,400

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 9-2b Original depreciation expense = ($50,000 – $2,000) ÷ 8 years = $6,000 Accumulated depreciation after three years = 3 X $6,000 = $18,000 Book value, $50,000 – $18,000 ............................................ Less: Salvage value ............................................................ Depreciable cost .................................................................. Remaining useful life ........................................................... Revised annual depreciation ($28,000 ÷ 7) ......................... LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

$32,000 4,000 $28,000 7 years $ 4,000

DO IT! 9-3 (a)

(b)

Sale of machine for cash at a gain: Accumulated Depreciation—Equipment.................... Cash.............................................................................. Equipment ............................................................. Gain on Disposal of Plant Assets ........................ Sale of machine for cash at a loss: Accumulated Depreciation—Equipment.................... Cash.............................................................................. Loss on Disposal of Plant Assets .............................. Equipment..............................................................

28,000 25,000 50,000 3,000 28,000 15,000 7,000 50,000

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 9-4 1. 2. 3. 4. 5.

Intangible assets Amortization Franchise Research and development costs Goodwill

LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement

DO IT! 9-5 Asset turnover = $400,000/[($300,000 + $340,000)/2] = 1.25 times LO 5 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO EXERCISES EXERCISE 9-1 (a)

The following points explain the application of the historical cost principle to plant assets. 1.

(b)

Under the historical cost principle, the acquisition cost for a plant asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. Cost is measured by the cash paid in a cash transaction, or by the cash equivalent price paid when noncash assets are used in payment. The cash equivalent price is equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.

1. Land 2. Equipment 3. Equipment 4. Land Improvements

5. 6. 7. 8.

Equipment Equipment Prepaid Insurance License Expense

LO 1 BT: C Difficulty: Medium TOT: 10 min AACSB: None AICPA FC: Measurement

EXERCISE 9-2 1. 2. 3. 4. 5. 6. 7. 8. 9.

Equipment Equipment Equipment Land Prepaid Insurance Land Improvements Land Improvements Land Building

LO 1 BT: C Difficulty: Medium TOT: 4 min AACSB: None AICPA FC: Measurement

EXERCISE 9-3 (a)

(b)

Cost of land Cash paid .................................................................. Net cost of removing warehouse ($8,200 – $1,700)... Attorney’s fee ........................................................... Real estate broker’s fee ........................................... Total....................................................................

$80,000 6,500 1,900 5,200 $93,600

The architect’s fee ($9,100) should be debited to the building account. The cost of the driveways and parking lot ($14,000) should be debited to Land Improvements.

LO 1 BT: AP Difficulty: Medium TOT: 5 min AACSB: None AICPA FC: Measurement and Reporting

EXERCISE 9-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

False. Depreciation is a process of cost allocation, not asset valuation. True. False. The book value of a plant asset may be quite different from its market value. False. Depreciation applies to three classes of plant assets: land improvements, building, and equipment. False. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time. True. False. Recognizing depreciation on an asset does not result in an accumulation of cash for replacement of the asset. True. False. Depreciation expense is reported on the income statement, and accumulated depreciation is reported as a deduction from plant assets on the balance sheet. True.

LO 2 BT: C Difficulty: Medium TOT: 10 min AACSB: None AICPA FC: Measurement

EXERCISE 9-5 Straight-line method:

 $90,000 – $8,000  = $10,250 per year.   8  

2017 depreciation = $10,250 X 3/12 = $2,562.50 2018 depreciation = $10,250. LO 2 BT: AP Difficulty: Medium TOT: 5 min AACSB: Analytic AICPA FC: Reporting

EXERCISE 9-6 (a)

Type of Asset Cost........................................................ Less: Accumulated depreciation ......... Book value, 1/1/17 ................................. Less: Salvage value ............................. Depreciable cost (1) ..............................

Building $700,000 130,000 570,000 35,000 $535,000

Warehouse $120,000 23,000 97,000 3,600 $ 93,400

40*

15**

Revised remaining useful life in years (2) *(48 – 8)

**(20 – 5)

Revised annual depreciation (1) ÷ (2) (b) Dec. 31

$13,375

Depreciation Expense ............................ Accumulated Depreciation— Buildings .......................................

$6,227 13,375 13,375

LO 2 BT: AN Difficulty: Hard TOT: 15 min AACSB: Analytic AICPA FC: Reporting

EXERCISE 9-7 (a) Loss on Disposal of Plant Assets .......................... Accumulated Depreciation—Equipment.................. Equipment ........................................................

26,000 24,000

(b) Cash.......................................................................... Accumulated Depreciation—Equipment................ Equipment ........................................................ Gain on Disposal of Plant Assets ...................

37,000 24,000

(c) Accumulated Depreciation—Equipment................ Cash.......................................................................... Loss on Disposal of Plant Assets .......................... Equipment ........................................................

24,000 20,000 6,000

50,000

50,000 11,000

LO 3 BT: AP Difficulty: Medium TOT: 8 min AACSB: Analytic AICPA FC: Reporting

50,000

EXERCISE 9-8 Jan.

1 Accumulated Depreciation—Equipment........... Equipment .....................................................

62,000

June 30 Depreciation Expense ........................................ Accum. Depreciation—Equipment ($36,000 X 1/3 X 6/12) .................................

6,000

Accumulated Depreciation—Equipment ($36,000 X 2/3 = $24,000; $24,000 + $6,000) ..... Cash .................................................................... Loss on Disposal of Plant Assets [$5,000 – ($36,000 – $30,000)] ......................... Equipment ..................................................... Dec. 31 Depreciation Expense ........................................ Accumulated Depreciation—Equipment [($25,000 – $4,000) X 1/5] ........................... 31 Accumulated Depreciation—Equipment [($25,000 – $4,000) X 4/5]................................. Cash .................................................................... Equipment ..................................................... Gain on Disposal of Plant Assets ................

62,000

6,000 30,000 5,000 1,000 36,000 4,200 4,200 16,800 9,000 25,000 800

LO 3 BT: AP Difficulty: Hard TOT: 15 min AACSB: Analytic AICPA FC: Reporting

Exercise 9-9 (a) The amount paid for the equipment is $1, 100 Jan.1

Equipment........................................................... Cash...............................................................

1,100 1,100

(b) The amount of depreciation expense is $100 Dec. 31

Depreciation Expense ........................................ Accumulated Depreciation—Equipment.....

100 100

EXERCISE 9-9 (Continued) (c) The amount of the gain on disposal is $50 and is derived from the disposal entry that follows. Dec. 31

Cash ..................................................................... Accumulated Depreciation—Equipment ........... Gain on Disposal ........................................... Equipment ......................................................

450 40 50 440

LO 1 – 3 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 9-10 1.

Depreciation is the process of allocating the cost of a long-lived asset to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and revenue producing ability does not decline. In addition, the useful life of land is indefinite. Therefore, it would be incorrect for the student to depreciate the land.

Goodwill is an intangible asset with an indefinite life. According to generally accepted accounting principles, goodwill is not amortized but reviewed annually for impairment. If a permanent decline in value has occurred the goodwill is written down and an impairment loss is recorded on the income statement. Therefore the amortization entry should be reversed and no decline in value recorded until an impairment in value occurs.

This is a violation of the historical cost principle. Because current market values are subjective and not reliable, they are not used to increase the recorded value of an asset after acquisition. The appropriate accounting treatment is to leave the building on the books at its zero book value.

LO 1, 2, 3, 4 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement

EXERCISE 9-11 Dec. 31

Amortization Expense ..................................... Copyright ($120,000 X 1/6) .......................

20,000

31 Amortization Expense ..................................... Patents ($54,000 X 1/4 X 10/12) ................

11,250

20,000 11,250

The goodwill would not require an adjusting entry because it has an indefinite life. LO 4 BT: AN Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 9-12 (a)

1/2/17

Patents ...................................................... Cash....................................................

280,000

Franchise................................................... Cash....................................................

540,000

Research and Development Expense ..... Cash....................................................

185,000

Amortization Expense............................................ Patents ($280,000 ÷ 5) ..................................... Franchise [($540,000 ÷ 9) X 6/12] ....................

86,000

7/1/17 9/1/17

(b)

(c)

280,000 540,000 185,000

Ending balances, 12/31/17: Patents = $224,000 ($280,000 – $56,000) Franchise = $510,000 ($540,000 – $30,000)

LO 4 BT: AN Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

56,000 30,000

EXERCISE 9-13 Alliance Atlantis Communications Inc.’s change of accounting policy to amortize broadcast rights will probably increase its reported income. Prior to the change, Alliance Atlantis had amortized broadcast rights over a maximum of two years. Their new policy calls for amortization over the contracted exhibition period. If this is greater than two years, annual amortization expense will decrease and income will increase. A change of this nature will make comparison of financial results with previous years’ difficult. To evaluate the company’s performance one will need to make an adjustment for such changes in estimated lives. LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Measurement

EXERCISE 9-14 (a)

A company should depreciate its buildings because depreciation is necessary in order to allocate the cost of the buildings to the periods in which they are in use. This allows the cost of the buildings to be matched against the revenues generated each year in accordance with the expense recognition principle.

(b)

A building can have a zero book value if it has no salvage value and it is fully depreciated—that is, if it has been used for a period at least as long as its expected life. Because depreciation is used to allocate cost rather than to reflect actual value, it is not at all unlikely that a building could have a low or zero book value, but a substantial fair value.

(c)

Examples of intangibles that might be found on a college campus are a franchise of a bookstore chain, the license to operate a radio station, a patent developed by professors, and a permit to operate a bus service.

(d)

Typical company or product trade names are: Clothes—Gap, Gitano, Dockers, Calvin Klein, Chaus, Guess. Perfume—Passion, Ruffles, Chanel No. 5, Diamonds. Cars—Accord, Charger, Mustang, Corvette. Shoes— Nike, Florsheim, L.A. Gear, adidas. Breakfast cereals—Cheerios, Wheaties, Frosted Mini-Wheats, Rice Krispies.

EXERCISE 9-14 (Continued) Trade names and trademarks are reported on a balance sheet if there is a cost attached to them. If the trade name or trademark is purchased, the cost is the purchase price. If it is developed by the enterprise, the cost includes attorney’s fees, registration fees, design costs, successful legal defense costs, and other expenditures directly related to securing the trade name or trademark. LO 2, 4 BT: C Difficulty: Medium TOT: 15 min. AACSB: None AICPA FC: Measurement and Reporting

EXERCISE 9-15 $35,497 = 1.42 times ($25,633 + $24,244) ÷ 2

(a)

Asset turnover =

(b)

Return on assets =

$98 = .4% ($25,633 + $24,244) ÷ 2

LO 5 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 9-16 (a)

Without new products

With new products

Return on assets

$500,000 = 10% $5,000,000

$960,000 = 8% $12,000,000

Profit margin

$500,000 = 5% $10,000,000

$960,000 = 6% $16,000,000

Asset turnover

$10,000,000 = 2.0 $5,000,000

$16,000,000 = 1.3 $12,000,000

(b) The return on assets declined from 10% to 8%. This means that the company is not generating as much income from each dollar invested in assets. It is common for companies to try to maximize their return on assets, thus top management might not find this proposal very desirable. The new product line would increase the company’s profit margin (the amount of net income generated from each dollar of sales) from 5% to 6%. However, because of the huge investment in new assets that the proposal requires, the asset turnover plummets from 2.0 times down to 1.3 times. LO 5 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 9-17 (a) ($ in millions) 1. Return on assets

$264.8

= 6.2%

($4,312.6 + $4,254.3) ÷ 2 2. Asset turnover

$11,408.5

= 2.7 times

($4,312.6 + $4,254.3) ÷ 2 3. Profit margin

$264.8

= 2.3%

$11,408.5 (b) Profit Margin X Asset Turnover = Return on Assets = 2.3% X 2.7 times = 6.2% (c) Asset turnover and profit margin vary considerably across industries. Therefore, when you have a diverse group of businesses from several industry types combined into one company, such as in Linley Company, the ability to compare these ratios to other businesses becomes very difficult. Linley Company would almost need to calculate ratios for each of the separate industry segments to allow for a meaningful analysis. LO 5 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 9-18 Net Income

10-year life $58,000

15-year life $102,000*

*$58,000 + ($132,000 – $88,000) Calculation of net cash provided by operating activities: 10-year Net income $ 58,000 Plus: depreciation expense 132,000 Net cash provided by operating activities $190,000

15-year $102,000 88,000 $190,000

EXERCISE 9-18 (Continued) The CEO is correct regarding the impact on net income. By increasing the expected useful life depreciation, expense would be lowered and net income would increase. However, this move would be appropriate only if, in fact, a 15-year life was a better estimate of the expected period of use. The CEO is incorrect in stating that cash provided by operating activities would be increased. Depreciation expense does not use up cash. Therefore, net cash provided by operating activities would be the same no matter what expected life was used. LO 5 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 9-19 (a)

Depreciation cost per unit is $.575 per mile [($100,000 – $8,000) ÷ 160,000].

(b)

Computation

Years

Units of Activity

2017 2018 2019 2020

40,000 52,000 41,000 27,000

End of Year

Annual Depreciation Depreciation Accumulated Depreciation X Cost/Unit = Expense $.575 .575 .575 .575

$23,000 29,900 23,575 15,525

$23,000 52,900 76,475 92,000

LO 6 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 9-20 (a)

Declining-balance method: 2017 depreciation = $90,000 X 25%* X 3/12 = $5,625 Book value January 1, 2018 = $90,000 – $5,625 = $84,375 2018 depreciation = $84,375 X 25% = $21,093.75. *(1/8) X 2 = 25%

Book Value $77,000 47,100 23,525 8,000

EXERCISE 9-20 (Continued) (b)

Units-of-activity method:  $90,000 – $8,000  70,000 = $1.17 per hour  

2017 depreciation = 480 hours X $1.17 = $562 (rounded). LO 6 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO PROBLEMS PROBLEM 9-1A

Item 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Land

Building

Other Accounts

$ 23,000 33,000 640,000 $280,000 $29,000

Land Improvements

6,800

Land Improvements

6,400

Property Tax Expense

3,170 31,000 (12,000) $302,170

$696,000

LO 1 BT: C Difficulty: Easy TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 9-2A (a) April May

Land ...................................................... 2,200,000 Cash ............................................... 2,200,000

1 Depreciation Expense .......................... Accumulated Depreciation— Equipment ($600,000 X 1/10 X 4/12).............. 1 Accumulated Depreciation— Equipment.......................................... Cash ...................................................... Equipment...................................... Gain on Disposal of Plant Assets .........................................

20,000 20,000 440,000 170,000 600,000 10,000

Cost .......................................... $600,000 Accum. depr.—Equipment...... (440,000) [($600,000 X 1/10) X 7 + $20,000)]

Book value ............................... 160,000 Cash proceeds ........................ 170,000 Gain on disposal ..................... $ 10,000 June

Cash ...................................................... 1,600,000 Land................................................ 1,000,000 Gain on Disposal of Plant Assets ......................................... 600,000

July

Equipment............................................. 1,100,000 Cash ............................................... 1,100,000

Dec. 31

Depreciation Expense .......................... Accumulated Depreciation— Equipment ($700,000 X 1/10) ..... Accumulated Depreciation— Equipment.......................................... Equipment......................................

70,000 70,000 700,000 700,000

PROBLEM 9-2A (Continued) Cost ........................................ Accum. depr.—Equipment ($700,000 X 1/10 X 10) ........ Book value .............................

(b) Dec. 31

$700,000 (700,000) $ 0

Depreciation Expense ............................ Accumulated Depreciation— Buildings ($26,500,000 X 1/40) .....

662,500 662,500

Depreciation Expense .............................. 3,925,000 Accumulated Depreciation— Equipment ..................................... 3,925,000 $38,700,000* X 1/10 ................... $3,870,000 $ 1,100,000 X 1/10 X 6/12 ......... 55,000 $3,925,000 *($40,000,000 – $600,000 – $700,000)

(c)

ARNOLD CORPORATION Partial Balance Sheet December 31, 2018 Plant Assets* Land ......................................................... Buildings ................................................. Less: Accumulated depreciation— buildings ...................................... Equipment ............................................... Less: Accumulated depreciation— equipment .................................... Total plant assets.............................. *See T-accounts which follow.

$ 4,200,000 $26,500,000 12,587,500 39,800,000

13,912,500

7,875,000

31,925,000 $50,037,500

PROBLEM 9-2A (Continued) Land 12/31/17 04/01/18

3,000,000 2,200,000

12/31/18

Bal. 4,200,000

6/1/17

1,000,000

Buildings 12/31/17

26,500,000

12/31/18

Bal. 26,500,000

Equipment 12/31/17 07/01/18

40,000,000 1,100,000

12/31/18

Bal. 39,800,000

05/01/18 12/31/18

600,000 700,000

Accumulated Depreciation—Buildings 12/31/17 12/31/18

11,925,000 662,500

12/31/18

Bal. 12,587,500

Accumulated Depreciation—Equipment 05/01/18 12/31/18

440,000 700,000

12/31/17 5/1/18 12/31/18 12/31/18

5,000,000 20,000 70,000 3,925,000

12/31/18

Bal. 7,875,000

LO 2, 3, 5 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 9-3A Jan.

June 30

Dec. 31

Accumulated Depreciation—Equipment....... Equipment................................................

71,000

Depreciation Expense .................................... Accum. Depreciation—Equipment ($30,000 X 1/5 X 6/12)............................

3,000

Cash ................................................................ Accumulated Depreciation—Equipment....... Equipment................................................ Gain on Disposal of Plant Assets...........

12,000 21,000

Cost ................................................................. Accumulated Depreciation—Equipment [($30,000 X 1/5) X 3 + $3,000] ...................... Book Value...................................................... Cash Proceeds ............................................... Gain on Disposal ............................................

$30,000

Depreciation Expense .................................... Accumulated Depreciation—Equipment [($33,400 – $3,000) X 1/8]......................

3,800

Loss on Disposal of Plant Assets ................. Accumulated Depreciation—Equipment....... Equipment................................................

10,600 22,800

71,000

3,000

30,000 3,000

(21,000) 9,000 12,000 $ 3,000

3,800

Cost ..................................................................... $33,400 Accumulated Depreciation—Equipment [($33,400 – $3,000) X 1/8 X 6]........................... (22,800) Book Value...................................................... 10,600 Proceeds ............................................................ 0 Loss on Disposal ................................................ $10,600 LO 3 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

33,400

PROBLEM 9-4A (a)

April

May

June

July

Dec. 31

Land............................................................... Cash ...................................................... Mortgage Payable.................................

4,400,000 1,100,000 3,300,000

Depreciation Expense .................................. Accumulated Depreciation—Equipment. ($2,800,000 ÷ 10 × 4/12 = $93,333)

93,333

Cash............................................................... Accumulated Depreciation—Equipment .... Loss on Disposal.......................................... Equipment.............................................

300,000 2,333,333 166,667

Cost Accumulated depreciation—equipment [($2,800,000 ÷ 10) × 8 + $93,333)] Carrying amount Cash proceeds Loss on disposal

$2,800,000

93,333

2,800,000

2,333,333 466,667 300,000 $ (166,667)

Cash............................................................... Notes Receivable.......................................... Land....................................................... Gain on Disposal ..................................

900,000 2,700,000

Equipment..................................................... Cash ......................................................

2,200,000

Depreciation Expense .................................. Accumulated Depreciation—Equipment ($1,000,000 ÷ 10 = $100,000)

100,000

Accumulated Depreciation—Equipment .... Equipment................................................

1,000,000

1,400,000 2,200,000

2,200,000

100,000

1,000,000

PROBLEM 9-4A (Continued) (b)

Dec.

Depreciation Expense .................................... Accumulated Depreciation—Buildings. ($97,400,000 ÷ 40 = $2,435,000)

2,435,000 2,435,000

Depreciation Expense ......................................... 14,730,000 Accumulated Depreciation—Equipment $146,200,000* ÷ 10 $2,200,000 ÷ 10 × 6/12

14,730,000

$14,620,000 110,000 $14,730,000

* $150,000,000 – $2,800,000 – $1,000,000 = $146,200,000 31

Interest Expense ............................................. Interest Payable ...................................... ($3,300,000 × 6% × 9/12 = $148,500)

148,500

Interest Receivable ......................................... Interest Revenue ..................................... ($2,700,000 × 5% × 7/12 = $78,750)

78,750

148,500

78,750

(c) YOUNGSTOWN Company Statement of Financial Position (Partial) December 31, 2017 Property, plant, and equipment1 Land.................................................................. Buildings.......................................................... Less: Accumulated depreciation ................... Equipment........................................................ Less: Accumulated depreciation ................... Total property, plant, and equipment ..... 1 See T accounts on the following page.

$ 23,000,000 $97,400,000 64,635,000 $148,400,000 65,590,000

32,765,000 82,810,000 $138,575,000

PROBLEM 9-4A (Continued) (c) (Continued) Land Jan. 1, 2017 April 1, 2017

20,000,000 4,400,000

Dec. 31, 2017

Bal. 23,000,000

June 1, 2017

1,400,000

Buildings Jan. 1, 2017

97,400,000

Dec. 31, 2017

Bal. 97,400,000

Equipment Jan. 1, 2017 July 1, 2017

150,000,000 2,200,000

Dec. 31, 2017

Bal. 148,400,000

May 1, 2017 Dec. 31, 2017

2,800,000 1,000,000

Accumulated Depreciation—Buildings Jan. 1, 2017 Dec. 31, 2017

62,200,000 2,435,000

Dec. 31, 2017

Bal. 64,635,000

Accumulated Depreciation—Equipment May 1, 2017 Dec. 31, 2017

2,333,333 1,000,000

Jan. 1, 2017 May 1, 2017 Dec. 31, 2017 Dec. 31, 2017

54,000,000 93,333 100,000 14,730,000

Dec. 31, 2017

Bal. 65,590,000

LO 1, 2, 3, 5 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 9-5A Patents ........................................................ Cash.......................................................

46,800

Jan.– June

Research and Development Expense ....... Cash.......................................................

230,000

July 1

Patents ........................................................ Cash.......................................................

20,000

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

40,000

(a) Jan. 2

Sept. 1 Oct. 1 (b) Dec. 31

46,800 230,000 20,000 40,000

Copyright .................................................... 200,000 Cash....................................................... Amortization Expense ................................ Patents................................................... [($60,000 X 1/10) + ($46,800 X 1/9) + ($20,000 X 1/20 X 6/12)]

11,700

Amortization Expense ................................ Copyrights............................................. [($36,000 X 1/10) + ($200,000 X 1/50 X 3/12)]

4,600

11,700

(c) Intangible Assets Patents ($126,800 cost less $17,700 amortization) (1) ......... Copyrights ($236,000 cost less $29,800 amortization) (2)..... Total intangible assets .................................................. (1) (2) (d)

200,000

4,600

$109,100 206,200 $315,300

Cost ($60,000 + $46,800 + $20,000); amortization ($6,000 + $11,700). Cost ($36,000 + $200,000); amortization ($25,200 + $4,600).

The intangible assets of Amato Corporation consist of two patents and two copyrights. One patent with a cost of $60,000 is being amortized over 10 years. In addition, legal costs of $46,800 incurred in the successful defense of this patent are being amortized over the remaining useful life, 9 years. The other patent with a cost of $20,000 is being amortized over 20 years. A copyright with a cost of $36,000 is being amortized over 10 years; the other copyright with a cost of $200,000 is being amortized over 50 years.

LO 4, 5 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 9-6A

Research and Development Expense ....................... 160,000 Patents ................................................................ Patents ........................................................................ Amortization Expense [$10,000 – ($40,000 X 1/20)].............................

8,000

Goodwill ...................................................................... Amortization Expense ........................................

2,000

160,000

8,000

LO 4 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

2,000

PROBLEM 9-7A

(a)

Blythe

Jacke

Return on assets

$240,000 = 7.5% $3,200,000

$300,000 = 10.0% $3,000,000

Profit margin

$240,000 = 20.9% $1,150,000

$300,000 = 25.0% $1,200,000

Asset turnover

$1,150,000 = .36 times $3,200,000

$1,200,000 = .40 times $3,000,000

(b) Based on the asset turnover, Jacke Corp. is more effective in using assets to generate sales. Its asset turnover is 11% higher than Blythe’s ratio. A factor that inhibits comparing the two companies is the differing composition of total assets for each company. Eighty-four percent [($2,400,000 + $300,000) ÷ $3,200,000] of Blythe’s total assets are plant or intangible assets compared to only sixty percent ($1,800,000 ÷ $3,000,000) for Jacke. Also, Jacke reports no intangible assets. LO 5 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 9-8A

(a) Year

Computation

Accumulated Depreciation 12/31

2015 2016 2017 2018

MACHINE 1 $84,000* X 1/8 = $10,500 $84,000 X 1/8 = $10,500 $84,000 X 1/8 = $10,500 $84,000 X 1/8 = $10,500

$10,500 21,000 31,500 42,000

*($96,000 – $12,000) 2016 2017 2018

MACHINE 2 $85,000 X 40%* X 6/12 = $17,000 $68,000 X 40% = $27,200 $40,800 X 40% = $16,320

$17,000 44,200 60,520

*(1/5) X 2 2016 2017 2018 a

(b)

MACHINE 3 800 X $2.00a = $ 1,600 4,500 X $2.00 = 9,000 6,000 X $2.00 = 12,000

($66,000 – $6,000) ÷ 30,000 Year 2016

Depreciation Expense MACHINE 2 $85,000 X 40% X 9/12 = $25,500

2017

$59,500 X 40%

= $23,800

LO 2, 6 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

$ 1,600 10,600 22,600

*PROBLEM 9-9A (a)

STRAIGHT-LINE DEPRECIATION Computation Depreciable Years Cost X

End of Year

Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation

2017 $220,000* 2018 220,000 2019 220,000 2020 220,000

25%** 25% 25% 25%

$ 55,000 55,000 55,000 55,000 $220,000

$ 55,000 110,000 165,000 220,000

Book Value $195,000 140,000 85,000 30,000

*($250,000 – $30,000) **1/4 = 25% DOUBLE-DECLINING-BALANCE DEPRECIATION Computation Book Value Beginning of Year Years X 2017 2018 2019 2020

$250,000 125,000 62,500 31,250

End of Year

Annual Depreciation Accumulated Depreciation Rate Depreciation = Expense 50%* 50% 50% 50%

$125,000 62,500 31,250 1,250** $220,000

$125,000 187,500 218,750 220,000

Book Value $125,000 62,500 31,250 30,000

*(1/4) X 2 = 50% **Adjusted so ending book value will equal salvage value.

(b)

Straight-line depreciation provides the lower amount for 2017 depreciation expense ($55,000) and, therefore, the higher 2017 income. Over the four-year period, both methods result in the same total depreciation expense ($220,000) and, therefore, the same total income.

(c)

Double-declining-balance depreciation provides the higher amount for 2017 depreciation expense ($125,000) and, therefore, the lower 2017 income. Both methods result in the same total income over the four-year period.

LO 2, 6 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

ACR9-1 (a)

ACCOUNTING CYCLE REVIEW

Dec. 2 2

Equipment ................................................... 16,800 Cash........................................................ Depreciation Expense................................. Accumulated Depreciation— Equipment ...........................................

825

Cash ............................................................. Accumulated Depreciation—Equipment ... Equipment .............................................. Gain on Disposal of Plant Assets [$3,500 – ($5,000 – $2,250)] ................

3,500 2,625

15 Accounts Receivable .................................. Sales Revenue .......................................

5,000

Cost of Goods Sold..................................... Inventory ................................................

3,500

23 Salaries and Wages Expense ..................... Cash........................................................

6,600

31 Bad Debt Expense ($4,000 – $500)............. Allowance for Doubtful Accounts ........

3,500

Interest Receivable ($10,000 X .08 X 9/12) ............................... Interest Revenue....................................

600

16,800

825

5,000 1,125 5,000 3,500 6,600 3,500

600

Insurance Expense ($3,600 X 4/6) .............. Prepaid Insurance..................................

2,400

Depreciation Expense................................. Accumulated Depreciation—Building [($150,000 – $30,000) ÷ 30] .................

4,000

Depreciation Expense................................. Accumulated Depreciation— Equipment [($55,000 – $5,500) ÷ 5] ....

9,900

2,400

4,000

9,900

ACR 9-1 (Continued) Depreciation Expense .................................... Accumulated Depreciation—Equipment [($16,800 – $1,800) ÷ 5] X 1/12 ...............

250

Amortization Expense ($9,000 ÷ 9)................ Patent.........................................................

1,000

Salaries and Wages Expense ........................ Salaries and Wages Payable ....................

2,200

Interest Expense............................................. Interest Payable [($11,000 + $35,000) X .10] .....................

4,600

Income Tax Expense ...................................... Income Taxes Payable..............................

15,000

250 1,000 2,200

4,600 15,000

ACR 9-1 (Continued) (b)

MILO CORPORATION Adjusted Trial Balance December 31, 2017 Debits $ 2,100 41,800 10,000 600 32,700 1,200 20,000 150,000 71,800 8,000

Cash ................................................................. Accounts Receivable ...................................... Notes Receivable ............................................ Interest Receivable.......................................... Inventory.......................................................... Prepaid Insurance ........................................... Land ................................................................. Buildings.......................................................... Equipment ....................................................... Patent ............................................................... Allowance for Doubtful Accounts .................. Accumulated Depreciation—Buildings.......... Accumulated Depreciation—Equipment ....... Accounts Payable ........................................... Salaries and Wages Payable .......................... Notes Payable (due April 30, 2018) ................ Interest Payable............................................... Notes Payable (due in 2023) ........................... Income Taxes Payable .................................... Common Stock................................................ Retained Earnings........................................... Dividends......................................................... 12,000 Sales Revenue................................................. Interest Revenue ............................................. Gain on Disposal of Plant Assets .................. Bad Debt Expense........................................... 3,500 Cost of Goods Sold......................................... 633,500 Depreciation Expense..................................... 14,975 Insurance Expense.......................................... 2,400 Interest Expense ............................................. 4,600 Other Operating Expenses ............................. 61,800 Amortization Expense..................................... 1,000 Salaries and Wages Expense ......................... 118,800 Income Tax Expense....................................... 15,000 Total.......................................................... $1,205,775

Credits

4,000 54,000 32,350 27,300 2,200 11,000 4,600 35,000 15,000 50,000 63,600 905,000 600 1,125

$1,205,775

ACR 9-1 (Continued) (c)

MILO CORPORATION Income Statement For the Year Ended December 31, 2017 Sales revenue ....................................... Cost of goods sold ............................... Gross profit ........................................... Operating expenses Salaries and wages expense.......... Other operating expenses.............. Depreciation expense ......................... Bad debt expense ........................... Insurance expense ......................... Amortization expense..................... Total operating expenses..................... Income from operations....................... Other revenues and gains Gain on disposal of plant assets ... Interest revenue .............................. Other expenses and losses Interest expense ............................. Income before income taxes................ Income tax expense.............................. Net income ............................................

$905,000 633,500 271,500 $118,800 61,800 14,975 3,500 2,400 1,000 202,475 69,025 1,125 600

1,725 (4,600) 66,150 15,000 $ 51,150

MILO CORPORATION Retained Earnings Statement For the Year Ending December 31, 2017 Retained earnings, 1/1/17.......................................... Add: Net income ...................................................... Less: Dividends ........................................................ Retained earnings, 12/31/17......................................

$ 63,600 51,150 114,750 12,000 $102,750

ACR 9-1 (Continued) (d)

MILO CORPORATION Balance Sheet December 31, 2017

Current assets Cash ........................................................... $ 2,100 Accounts receivable ................................. $ 41,800 Less: Allowance for doubtful accounts.... 4,000 37,800 Notes receivable........................................ 10,000 Interest receivable..................................... 600 Inventory.................................................... 32,700 Prepaid insurance ..................................... 1,200 Total current assets............................. 84,400 Property, plant, and equipment Land ........................................................... 20,000 Buildings.................................................... $150,000 Less: Accum. depr.—buildings............... 54,000 96,000 Equipment.................................................. 71,800 Less: Accum. depr.—equipment............. 32,350 39,450 Total property, plant, and equipment... 155,450 Intangible assets Patents ....................................................... 8,000 Total assets ..................................................... $247,850 Current liabilities Notes payable (due April 30, 2018) .......... Accounts payable...................................... Income taxes payable ............................... Interest payable ......................................... Salaries and wages payable ..................... Total current liabilities......................... Long-term liabilities Notes payable (due in 2023) ..................... Total liabilities ................................................. Stockholders’ equity Common stock .......................................... Retained earnings ..................................... Total liabilities and stockholders’ equity ......

$ 11,000 27,300 15,000 4,600 2,200 60,100 35,000 95,100 50,000 102,750

LO 1 – 5 BT: AP Difficulty: Hard TOT: 120 min. AACSB: Analytic AICPA FC: Reporting

152,750 $247,850

ACR9-2

ACCOUNTING CYCLE REVIEW

(a) Date 2/1/2017

3/1/2017

3/28/2017

3/29/2017

3/31/2017

Account Titles Cash Unearned Service Revenue

Debit Credit 12,000 12,000

Equipment Cash Accounts Payable

9,600

Patents Cash

9,600

3,000 6,600

9,600

Account Receivable Service Revenue

140,000

Cash Accounts Receivable

133,000

Accounts Payable Cash

16,370

Operating Expenses Cash

97,525

140,000

133,000

16,370

97,525

Allowance for Doubtful Accounts Accounts Receivable

200

Depreciation Expense Accumulated Depreciation - Equipment [(11,000–1,000)/5) × (3/12)]

500

Cash Accumulated Depreciation - Equipment Loss on Disposal of Plant Assets Equipment

1,620 8,500 880

200

500

11,000

ACR 9-2 (Continued) (b), (c), and (f) Bal. Feb. 1 Mar. 29 Mar. 31

Cash 24,300 12,000 3,000 133,000 9,600 1,620 16,370 97,525 100

Feb. 1 Mar. 1 Mar. 29 Mar. 29 Adj Mar. 31

44,325

Bal. Mar. 28

Accounts Receivable 22,400 140,000 133,000 200

Mar. 29 Mar. 31

29,200 Allowance for Doubtful Accts 1,200 Bal. Mar. 31 200 800 Adj Mar. 31

1,800

Bal. Feb. 1

Equipment 20,000 9,600 11,000 Mar. 31 18,600

Accum Depreciation—Equipment 15,000 Bal. 500 Mar. 31 505 Adj Mar. 31 Mar. 31 8,500 7,505

Land Bal.

20,000

Bal.

Buildings 100,000 100,000

Accum Depreciation—Buildings 15,000 Bal. 750 Adj Mar. 31 15,750

Patents Mar. 1

9,600 80

Adj Mar. 31

9,520

Mar. 29

Accounts Payable 16,370 12,370 6,600 2,600

Bal. Feb. 1

Unearned Service Revenue 12,000 Feb. 1 Adj Mar. 31 2,000 10,000

Income Taxes Payable 12,258 Mar. 31 Adj. 12,258

Common Stock 90,000

Bal.

90,000

Retained Earnings 53,130

Bal.

53,130

Service Revenue 140,000 Mar. 28 2,000 Mar. 31 Adj. 142,000

Operating Expenses Mar. 29 97,525 Mar. 31 Adj. 100 97,625

Depreciation Expense Mar. 31 500 Mar. 31 Adj. 505 Mar. 31 Adj. 750 1,755

31-Mar

Loss on Disposal of Equip 880 880

Patent Amortization Exp Mar. 31 Adj. 80 80

Bad Debt Expense Mar. 31 Adj. 800 800

Income Tax Expense Mar. 31 Adj. 12,258 12,258

(d) and (g)

Accounts

Aberkonkie Corporation Trial Balance 3/31/17

Adjusted Trial Balance

Debit

Credit

Cash

44,425

44,325

Accounts receivable

29,200

Allowance for doubtful accounts

1,000

1,800

Land

20,000

Buildings

100,000

Acc. depreciation-buildings Equipment

15,000 18,600

Acc depreciation-equipment Patents

15,750 18,600

7,000 9,600

7,505 9,520

Accounts payable

2,600

Unearned service revenue

12,000

10,000

Income taxes payable

12,258

Common stock

90,000

Retained earnings

53,130

Service revenue

140,000

142,000

Operating expenses Depreciation expense

97,525

97,625

500

1,755

Patent amortization expense

Bad debt expense

800

Loss on disp. of plant assets

880

Income tax expense Total

12,258 320,730

320,730

335,043

(e) BANK RECONCILIATION Balance per Bank .......................................................... Add: Deposits in Transit 3/31/17 .................................. Less: Outstanding Checks ................................... #440 #454 #455 #456 Adjusted balance per bank Balance per books ........................................................ Less: Bank Service Charge .......................................... Adjusted balance per books

$64,594 1,620 $3,444 5,845 3,000 9,600

21,889 $44,325 $44,425 100 $44,325

Date Account titles 3/31/2017 Operating Expense Cash Unearned Service Revenue Service Revenue ($12,000/12×2)

Debit 100

100 2,000 2,000

Bad Debt Expense Allowance for Doubtful Accounts {($26,000 × .04 = $1,040) + [($29,200 – $26,000) × .2375 = $760]} – $1,000

800

Depreciation Expense Accumulated Depreciation - Equipment (($9,000/10) × (3/12) = $225 + [($9,600 – $1,200)/5) × (2/12) = $280]

505

Depreciation Expense Accumulated Depreciation – Buildings (($100,000 – $10,000)/30) × (3/12)

750

Patent Amortization Expense Patents [($9,600/10) × (1/12)]

Income Tax Expense Income Taxes Payable

Credit

800

505

750

12,258 12,258

Aberkonkie Corporation Income Statement For the Quarter Ended 3/31/17 Service Revenue ........................................................... Operating expenses Operating Expenses .................................................. Depreciation Expense ............................................... Bad Debt Expense ..................................................... Amortization Expense ............................................... Total Expenses .............................................................. Income from Operations ............................................... Other Expenses and Losses Loss on Disposal ....................................................... Income before Taxes..................................................... Income Tax Expense ................................................. Net Income.....................................................................

$142,000 $97,625 1,755 800 80 100,260 41,740 880 40,860 12,258 $28,602

Aberkonkie Corporation Retained Earnings Statement For the Quarter Ended 3/31/17 Retained Earnings, 1/1/17 ............................................. Add: Net Income ........................................................... Retained Earnings, 3/31/17 ...........................................

$53,130 28,602 $81,732

Aberkonkie Corporation Balance Sheet 3/31/2017 Assets Current Assets Cash ............................................................... Accounts Receivable .................................... Less: Allowance for Doubtful Accounts ...... Total Current Assets .................... Property, Plant, and Equipment Land................................................................ Equipment...................................................... Less: Accumulated Depreciation—Equip.... Buildings........................................................ Less: Accumulated Depreciation—Build..... Total property, plant, & equip....................... Patents, less amortization ............................ Total Assets..................................

$44,325 $29,200 1,800

27,400 71,725

20,000 $ 18,600 7,505 100,000 15,750

11,095 84,250 115,345 9,520 $196,590

Liabilities & Stockholder’s Equity Current Liabilities Accounts Payable ............................................. Unearned Revenue............................................. Income Taxes Payable ....................................... Total Liabilities ............................................ Stockholders’ Equity Common Stock................................................... Retained Earnings.............................................. Total Liabilities and Stockholders’ Equity.

$ 2,600 10,000 12,258 $24,858 90,000 81,732

LO 1 – 5 BT: AP Difficulty: Hard TOT: 120 min. AACSB: Analytic AICPA FC: Reporting

171,732 $196,590

CT 9-1

FINANCIAL REPORTING PROBLEM

(All amounts are in millions) (a)

At September 27, 2014, total cost of property, plant and equipment was $39,015; book value was $20,624.

(b)

Depreciation is computed by use of the straight-line method over the estimated useful lives of the assets.

(c)

Depreciation and amortization was: 2014, $7,946; 2013, $6,757; 2012, $3,277.

(d)

Apple’s purchases of property, plant, and equipment were: 2014, $9,571; 2013, $8,165.

(e)

Goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment annually. The company did not have any goodwill impairments during 2014, 2013, or 2012.

LO 1, 2, 4, 5 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic, Communication and Technology AICPA FC: Reporting AICPA PC: Communication

CT 9-2

COMPARATIVE ANALYSIS PROBLEM

(a)

1. Return on assets 2. Profit margin 3. Asset turnover

Columbia Sports Wear

$141,859

= 8.4%

VF Corporation

$1,047,505

= 10.3%

($1, 792,209 + $1,605,588) / 2

($9,980,140 + $10,315,443) / 2

$141,859

$1,047,505

$2,100,590

= 6.8%

$2,100,590 ($1,792, 809 + $1,605,588) ÷ 2

$12,154,784 = 1.24 times

= 8.6%

$12,154,784

= 1.20 times

($9,980,140 + 10,315,443) ÷ 2

(b) The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Both companies generated roughly the same asset turnover. However, VF Corporation was more effective in generating profit from its sales (8.6%) than Columbia Sportswear (6.8%). This resulted in VF Corporation generating a 22.6% higher return on assets than Columbia Sports Wear. LO 5 BT: AN Difficulty: Medium TOT: 25 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CT 9-3

COMPARATIVE ANALYSIS PROBLEM

(a) 1.

Amazon.com $(241)

Return on assets

= (0.5)%

($54,505 + $40,159) / 2

Profit margin

$(241)

Asset turnover

($54, 505 + $40,159) ÷ 2

= 8.0%

$16,363 = 3.4%

= (0.3)% $88,988

$16,363 ($204,751+ $203,706) ÷ 2

$88,988 3.

Wal-Mart Stores

$485,651 = 1.88 times

$485,651

= 2.38 times

($204,751 + $203,706) ÷ 2

(b) The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Both companies generated an acceptable asset turnover. However, Wal-Mart was much more effective in generating profit from its sales (3.4) than Amazon (–0.3). This resulted in Wal-Mart generating a substantially higher return on assets than Amazon. LO 5 BT: AN Difficulty: Medium TOT: 25 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CT 9-4 (a)

INTERPRETING FINANCIAL STATEMENTS

Online retailers, such as Amazon, have large investments in sophisticated warehouses, but they have no money tied up in massive stores, such as those of Best Buy. This is would mean that, all else equal, an online retailer would have lower total assets, which would increase the asset turnover as well as the return on assets. We would also expect that the online retailer’s operating costs would be lower since it doesn’t incur salary and other costs of running a store. This should increase its net income, which would increase the profit margin ratio. 2017

(b)

$1, 277

Profit Margin

2012 $1,140

= 2.5%

$30, 848

$50, 272 $50, 272

Asset Turnover

$30, 848

= 2.78 times

(c)

$1,140

$1, 277

= 7.1% ($17, 849 + $18, 302) / 2

Profit Margin 2012 3.7% 2017 2.5%

× × ×

Asset Turnover 2.78 2.78

= 2.78 times

($11, 864 + $10, 294) / 2

($17, 849 + $18, 302) / 2 Return on Assets

= 3.7%

($11, 864 + $10, 294) / 2 = = =

= 10.3

Return on Assets 10.3 7.1%*

*Difference due to rounding. (d)

It is interesting to note that the asset turnover stayed the same, at 2.78 times between 2012 and 2017. This means that the company generates the same amount of sales per dollar invested in assets. However, the profit margin declined from 3.7% down to 2.5%. This means that the company previously generated 3.7 cents on each dollar of sales, but it now only generates only 2.5 cents. From the presentation in part (c) we can clearly see that the decline in the return on assets is due to the decline in the profit margin. This is consistent with the suggestion that the company is having a hard time competing with online retailers. The online retailers can offer lower prices because they have lower operating costs. Best Buy lowers its prices to meet the competitive, which then cuts into its profit margin.

LO 5 BT: AN Difficulty: Hard TOT: 30 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 9-5

REAL-WORLD FOCUS

Answers will vary depending on the company chosen by student. LO 2, 5 BT: AN Difficulty: Medium TOT: 25 min. AACSB: Analytic, Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 9-6

RESEARCH CASE

(a)

All of the companies have market values (that is, the total market price of all of their shares) that is less than the shareholders’ equity on their balance sheet. This means that the reported value of the company’s assets exceeds the fair value of those assets.

(b)

In most instances, when a company’s market value is less than its book value, the company needs to consider writing down its goodwill. It is hard to argue that a company has goodwill (which represents the amount by which fair value of a purchased asset exceeds its recorded value) when its market value is below its book value.

(c)

In order for goodwill to be present on a company’s balance sheet, that company must have purchased another business. If the amount paid for that other business exceeds the fair value of the identifiable assets acquired, then the difference is debited to goodwill.

(d)

The write-down of goodwill as part of an impairment adjustment (or the write-down of any asset) does not affect cash.

LO 4, 5 BT: S Difficulty: Hard TOT: 40 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 9-7

DECISION MAKING ACROSS THE ORGANIZATION

(a) (in thousands)

Proposed results Proposed results Current results without cannibalization with cannibalization

Return on assets

$12,000 $100,000 = .12

$13,500 $100,000 = .135

$12,000 $100,000 = .12

$12,000

$13,500

$12,000

Profit margin

= .27

$45,000 Asset turnover

$45,000 $100,000

= .225

$60,000 = .45

$60,000 $100,000

= .24

$50,000 = .60

$50,000

= .50

$100,000

(b)

If there is no cannibalization, return on assets increases from 12% to 13.5%. This occurs even though the profit margin decreases from 27% to 22.5% because the asset turnover increases significantly, from .45 times to .60 times. However, if there is cannibalization, the return on assets remains unchanged at 12% because the increase in the asset turnover is offset by the decrease in the profit margin.

(c)

Yes, there are other alternatives. Here are some examples. 1.

Increase spending on marketing in an effort to increase sales of the high end product, without offering the new, low-end product line. If this was successful it would increase the asset utilization, thus increasing the asset turnover and return on assets.

Consider marketing the new line under a different name, so as to minimize the cannibalization. This might substantially increase the marketing costs, and therefore reduce the profit margin. But the benefit of reducing cannibalization might make up for the increased marketing costs.

If neither of 1. or 2. seem feasible, they should consider closing a plant. This would increase the asset turnover and return on assets.

LO 5 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 9-8

COMMUNICATION ACTIVITY

Answers will depend on the position selected by the student. Some points that should be considered include: 1.

Some relatively small companies may spend less on R&D because they must expense these costs. However, the vast majority of companies realize that for continued growth and stability, R&D expenditures are a high priority regardless of how they are recorded for accounting purposes. Requiring companies to expense R&D costs instead of allowing them to be capitalized could leave U.S. companies at a competitive disadvantage as compared to non-U.S. companies. U.S. companies may be more reluctant to invest millions of dollars on research and development since the costs would negatively impact their financial statements in the short-run.

The tangible future benefits of R&D costs may not be realized for several years, if ever. Conversely, the purchase of a long-lived asset (i.e., equipment, building) will provide benefits immediately as well as in future years. Accountants often employ an approach called conservatism which dictates that when reasonable doubt exists, a company should choose the option that has the least favorable affect on income. Expensing R&D costs is an example of applying conservatism.

LO 4 BT: AN Difficulty: Medium TOT: 30 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CT 9-9

ETHICS CASE

(a)

The stakeholders in this situation are: Wade Truman, president of Clean Aire Anti-Pollution Company. Kate Rollins, controller. The stockholders of Clean Aire Anti-Pollution Company. Potential investors in Clean Aire Anti-Pollution Company.

(b)

The intentional misstatement of the life of an asset or the amount of the salvage value is unethical for whatever the reason. There is nothing unethical per se about changing the estimates used for the life of an asset or of an asset’s salvage value if the change is an attempt to better match cost and revenues and is a better allocation of the asset’s depreciable cost over the asset’s useful life. In this case, it appears from the controller’s reaction that the revision in the life is intended only to improve earnings which would be unethical. The fact that the competition uses a longer life for its equipment is not necessarily relevant. The competition’s maintenance and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Clean Aire Anti-Pollution Company.

(c)

Income before income taxes in the year of change is increased $155,000 ($387,500 – $232,500) by implementing the president’s proposed changes. Old Estimates Asset cost............................................................. Estimated salvage................................................ Depreciable cost .................................................. Depreciation per year (1/8) ..................................

$3,500,000 400,000 3,100,000 $ 387,500 Revised Estimates

Asset cost............................................................. Estimated salvage................................................ Depreciable cost .................................................. Depreciation taken to date ($387,500 X 2) .......... Remaining life in years ........................................ Depreciation per year ($2,325,000 ÷ 10)..............

$3,500,000 400,000 3,100,000 775,000 2,325,000 10 years $ 232,500

LO 2 BT: E Difficulty: Hard TOT: 50 min. AACSB: Analytic, Communication and Ethics AICPA FC: Reporting AICPA PC: Communication and Personal Demeanor

CT 9-10

(a) 1 c

ALL ABOUT YOU

3a 4d

(b) For the most part, the value of a brand is not reported on a company’s balance sheet. Most companies are required to expense all costs related to the maintenance of a brand name. Also any research and development that went into the development of the related product is generally expensed. The only way significant costs related to the value of the brand are reported on the balance sheet is when a company purchases another company that has a significant tradename (brand). In that case, given an objective transaction, companies are able to assign value to the brand and report it on the balance sheet. A conservative approach is used in this area because the value of the brand can be extremely difficult to determine. It should be noted that international rules permit companies to report brand values on their balance sheets. LO 4, 5 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 9-11

FASB CODIFICATION ACTIVITY

(a) Capitalize is a term used to indicate that the cost would be recorded as the cost of an asset. That procedure is often referred to as deferring a cost, and the resulting asset is sometimes described as a deferred cost. (b)

Intangible assets are assets that lack physical substance. (The term intangible asset is used to refer to intangible assets other than goodwill.)

(c)

Codification reference 360-10-35-2 addresses the concept of depreciation accounting and the various factors to consider in selecting the related periods and methods to be used in such accounting. Generally accepted accounting principles (GAAP) require that the cost of a productive facility be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility (Codification reference 360-10-35-4).

LO 1, 2, 4 BT: S Difficulty: Medium TOT: 30 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement AICPA PC: Communication

CT 9-12

CONSIDERING PEOPLE, PLANET AND PROFIT

(a)

Airbus developed a wing attachment called a Sharklet that is designed to reduce fuel consumption. It is quite similar to a device that is sold by Aviation Partners called a Winglet. Aviation Partners has a patent on the device. Airbus filed a lawsuit against Aviation Partners claiming that the patent should be declared invalid.

(b)

Aviation Partners says that its Winglets will reduce fuel consumption by 5 to 7 percent. It says that the total amount of jet fuel that its device has saved is approximately 3 billion gallons.

(c)

Airbus and Aviation Partners were involved in discussions for about 5 years before they reached a memorandum of understanding to form a joint venture to design a device for use on Airbus aircraft. However, Airbus then developed the Sharklet, which Aviation Partners says violates its patent.

(d)

If Aviation Partners loses the lawsuit it would have to expense the cost of the lawsuit. It would also have to review the recorded value of its patent to determine whether the loss of the lawsuit has caused the value of the patent to be impaired.

LO 4 BT: S Difficulty: Medium TOT: 45 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement AICPA BB: Critical Thinking

IFRS CONCEPTS AND APPLICATION IFRS9-1 Component depreciation is a method of allocating the cost of a plant asset into separate parts based on the estimated useful lives of each component. IFRS requires an entity to use component depreciation whenever significant parts of a plant asset have significantly different useful lives. LO 7 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS9-2 Revaluation is an accounting procedure that adjusts plant assets to fair value at the reporting date. Revaluation must be applied annually to assets that are experiencing rapid price changes. LO 7 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS9-3 Both types of development expenditures relate to the creation of new products but one is expensed and the other is capitalized. Development costs incurred before a new product achieves technological feasibility are recorded as development expenses and appear as part of operating expenses on the income statement. Costs incurred after technological feasibility are recorded as development costs and appear as an intangible asset on the statement of financial position. LO 7 BT: C Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS9-4

(a)

INTERNATIONAL FINANCIAL STATEMENT ANALYSIS

Note 1.13 indicates that “Property, Plant and equipment is depreciated on a straight-line basis over its estimated useful life; the estimated useful lives are as follows: Buildings including investment property Machinery and equipment Leasehold improvements Producing vineyards

20 to 50 years 3 to 25 years 3 to 10 years 18 to 25 years

(b)

Note 5 indicates that “Brands, trade names and other intangible assets with indefinite useful lives as well as goodwill arising from acquisition have been subject to annual impairment testing. No significant impairment expense has been recognized in respect to these items during the course of fiscal year 2014.”

(c)

(1) Per Note 3.1, the balance of Accumulated amortization and impairment as of December 31, 2014 was 3,506 (EUR millions). (2) Per Note 6.1 the balance of Depreciation and impairment as of December 31, 2014 was 7,379 (EUR millions).

LO 7 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic, Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CHAPTER 10 Reporting and Analyzing Liabilities Learning Objectives 1. Explain how to account for current liabilities. 2. Describe the major characteristics of bonds. 3. Explain how to account for bond transactions 4. Discuss how liabilities are reported and analyzed. *5. Apply the straight-line method of amortizing bond discount and bond premium. *6. Apply the effective-interest method of amortizing bond discount and bond premium. *7. Describe the accounting for long-term notes payable.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

C C AP AP AP C

19. 20. 21. 22. 23. 24.

4 4 4 4 4 4

K C C C C C

25. 26. 27. 28. 29. 30. 31.

4 5* 5* 6* 6* 7* 7*

C C AP C C C C

13. 14. 15. 16.

4 4 4 5*

AP AP AN AP

17. 18. 19.

5* 6* 7*

AP AP AP

16. 17. 18. 19. 20.

4 4 4 4 3, 5

AP AN AN C AP

21. 22. 23. 24. 25.

3, 5 3, 6* 5, 6* 7* 7*

AP AP AP AP AP

11. 12.

3, 4, 6* 4, 7*

AP AP

13.

4, 7*

Questions 1. 2. 3. 4. 5. 6.

1 1 1 1 1 1

C C AP AP K C

7. 8. 9. 10. 11. 12.

1 2 2 2 2 2

K C AN C C K

13. 14. 15. 16. 17. 18.

2, 3 3 3 3 3 4

Brief Exercises 1. 2. 3. 4.

1 1 1 1

C AP AP AP

5. 6. 7. 8.

1 1 1 3

AP AP AP AP

9. 10. 11. 12.

3 3 3 4

AP AP AP AP

Do It! Exercises 1a. 1b.

1 1

AP AP

2. 3a.

2 3

C AP

3b. 4.

3 4

AP AN

Exercises 1. 2. 3. 4. 5.

1 1 1 1 1

AP AP AP AP AP

6. 7. 8. 9. 10.

1 1 3 3 3

AP AP AP AP AP

11. 12. 13. 14. 15.

3 3 3 3 4

AP AN AP AP AP

Problems: Set A 1.

1, 4

3, 4

1, 4

3, 4, 5* 3, 4, 5*

AP 3. 3 AP 7. 3, 5 AP 4. 3, 4 AP 10. 3, 6* AP *Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description

Difficulty Level

Time Allotted (min.)

Prepare current liability entries, adjusting entries, and current liabilities section.

Moderate

30–40

Journalize and post note transactions; show balance sheet presentation.

Moderate

30–40

Prepare journal entries to record interest payments and redemption of bonds.

Moderate

30–40

Prepare journal entries to record issuance of bonds, interest, balance sheet presentation, and bond redemption.

Moderate

30–40

Prepare journal entries to record issuance of bonds, show balance sheet presentation, and record bond redemption.

Simple

30–40

Calculate and comment on ratios.

Moderate

30–40

*7A

Prepare journal entries to record interest payments, straight-line discount amortization, and redemption of bonds.

Moderate

30–40

*8A

Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.

Simple

30–40

*9A

Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.

Moderate

30–40

*10A

Prepare journal entries to record issuance of bonds, payment of interest, and amortization of bond discount using effective-interest method.

Moderate

30–40

*11A

Prepare journal entries to record issuance of bonds, payment of interest, effective-interest amortization, and balance sheet presentation.

Moderate

30–40

*12A

Prepare installment payments schedule, journal entries, and balance sheet presentation for a mortgage note payable.

Moderate

30–40

*13A

Prepare journal entries to record payments for long-term note payable, and balance sheet presentation.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

While this is generally true, more precisely a current liability is a debt that can reasonably be expected to be paid: (a) from existing current assets or through the creation of other current liabilities and (2) within one year or the operating cycle, whichever is longer.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 2.

In the balance sheet, Notes Payable of $20,000 and Interest Payable of $450 ($20,000 X 9% X 3/12) should be reported as current liabilities. In the income statement, Interest Expense of $450 should be reported under other expenses and losses.

LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 3.

(a) Disagree. The company only serves as a collection agent for the taxing authority. It does not report sales taxes as an expense; it merely forwards the amount paid by the customer to the government. (b) The entry to record the proceeds is: Cash ........................................................................................ Sales Revenue ................................................................. Sales Taxes Payable........................................................

8,550 8,000 550

LO 1 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 4.

(a) The entry when the tickets are sold is: Cash ........................................................................................ Unearned Ticket Revenue ................................................

900,000

(b) The entry after each game is: Unearned Ticket Revenue........................................................ Ticket Revenue ................................................................

180,000

900,000

180,000

LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 5.

Three taxes commonly withheld by employers from employees’ gross pay are (1) federal income taxes, (2) state income taxes, and (3) social security (FICA) taxes.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 6.

(a) Three taxes commonly paid by employers on employees’ salaries and wages are (1) social security (FICA) taxes, (2) state unemployment taxes, and (3) federal unemployment taxes. (b) Taxes withheld from employees’ gross pay and not yet remitted to the appropriate government agency are reported in the balance sheet as current liabilities.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

The liabilities that Apple identified as current are: Accounts payable, Accrued expenses, Deferred revenue, and Commercial paper.

LO 1 BT: AN Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 8.

(a)

Long-term liabilities are obligations that are expected to be paid after one year. Examples include bonds and long-term notes.

(b) Bonds are a form of interest-bearing notes payable used by corporations, universities, and governmental agencies. LO 2 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 9.

(a)

Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured bonds are issued against the general credit of the borrower.

(b) Convertible bonds permit bondholders to convert them into common stock at their option. In contrast, callable bonds are subject to call and redemption at a stated dollar amount prior to maturity at the option of the issuer. LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 10.

(a)

Face value is the amount of principal due at the maturity date.

(b) The contractual interest rate is the rate used to determine the amount of cash interest the borrower pays and the investor receives. This rate is also called the stated interest rate because it is the rate stated on the bonds. (c) A bond certificate is a legal document that indicates the name of the issuer, the face value of the bonds, and such other information as the contractual interest rate and maturity date of the bonds. LO 2 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 11.

(a)

A convertible bond permits bondholders to convert it into common stock at the option of the bondholders.

(b) For bondholders, the conversion option gives an opportunity to benefit if the market price of the common stock increases substantially. For the issuer, convertible bonds usually have: (1) a lower rate of interest than other debt securities, (2) a higher selling price. LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 12.

The two major obligations incurred by a company when bonds are issued are the interest payments due on a periodic basis and the principal which must be paid at maturity.

LO 2 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 13.

Less than. Investors were required to pay more than the face value; therefore, the market interest rate is less than the contractual rate.

LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

14.

No, Lee is not right. The market price on any bond is a function of three factors: (1) the dollar amounts to be received by the investor (interest and principal), (2) the length of time until the amounts are received (interest payment dates and maturity date), and (3) the market interest rate.

LO 3 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 15.

$48,000. $800,000 X 6% X 1 year = $48,000.

LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 16.

$664,000. The balance of the Bonds Payable account minus the balance of the Discount on Bonds Payable account (or plus the balance of the Premium on Bonds Payable account) equals the carrying value of the bonds.

LO 4 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 17.

Debits: Credits:

Bonds Payable (for the face value) and Premium on Bonds Payable (for the unamortized balance). Cash (for 97% of the face value) and Gain on Bond Redemption (to balance entry).

LO 4 BT: AN Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 18.

Two issues need to be considered. First, by financing a major purchase such as this with shortterm financing the company will reduce its liquidity. In the case of Johnson Inc., its current ratio will decrease from 2.2:1 to a less acceptable level of 1.5:1. However, of equal concern is that by financing a long-term project with short-term financing the company is exposing itself to interest rate risk. The company has the choice of locking in a long-term rate of 8%, or continually refinancing at whatever the short-term rate is when its short-term debt matures. If short-term rates increase substantially the increase in interest expense could significantly reduce the company’s profitability.

LO 4 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

Questions Chapter 10 (Continued) 19. (a) The nature and the amount of each long-term liability should be presented in the balance sheet or in schedules in the accompanying notes to the financial statements. The notes should also indicate the interest rates, maturity dates, conversion privileges, and assets pledged as collateral. (b) To evaluate liquidity a company may compute working capital and the current ratio. To evaluate long-run solvency a company may compute a debt to assets ratio, and a times interest earned ratio. LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 20. No, Ernie is not correct. Liquidity involves measuring the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency involves measuring the ability of a company to survive over a long period of time. LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 21. When companies are trying to overcome customer skepticism about the quality of their product they often consider providing a more generous warranty. While this may be effective in increasing sales, it is not without costs. Clearly a longer warranty will usually result in more warranty claims. Warranties are a contingent liability that must be accrued for each year. If the warranty period is extended, the size of this accrual could increase significantly. If the quality of the company’s product is not improved at the same time that the warranty is extended, it is quite possible that the increase in the estimated warranty accrual could exceed the increase in net income from expanded sales from the more generous warranty. LO 4 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 22. One alternative to purchasing the assets is to lease them through an operating lease agreement. In an operating lease, the lease payments are recorded as an expense. This allows the lessee to keep the leased assets and, more importantly, lease liabilities off the balance sheet (referred to as off-balance-sheet financing). Keeping lease liabilities off the balance sheet will have a favorable impact on the lessee’s liquidity and solvency ratios. Another option is to lease the assets through a capital lease agreement. However, in a capital lease the lessee must record the asset and a related liability for the lease payments. This treatment would impact liquidity and solvency ratios the same way the purchase of assets would. LO 4 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 23. Jon is not correct. In order to reduce costs, many companies today keep low amounts of inventory on hand. Consequently, liquidity ratios are generally lower than they used to be. Companies that keep fewer liquid assets on hand frequently rely on a bank line of credit. A line of credit allows a company to borrow money on a short-term basis to meet any cash shortfalls caused by a low amount of liquid assets. LO 4 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

24.

If a company has significant operating leases, most analysts would argue that its recorded assets and liabilities understate their true values. These analysts will increase the company’s liabilities and assets for the unrecorded operating leases. LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

25. Two criteria must be met: (1) the contingency must be probable and (2) the company must be able to arrive at a reasonable estimate. If these criteria are not met, the company should disclose the major facts concerning the contingency in the notes to its financial statements. LO 4 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting *26.

The straight-line method of amortization results in the same amortized amount being assigned to Interest Expense each interest period. This amount is determined by dividing the total bond discount or premium by the number of interest periods the bonds will be outstanding.

LO 5 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA: Reporting *27. The total amount of interest expense is $10,800. Interest expense is the interest to be paid in cash less the premium amortization for the year. Cash to be paid equals 6% X $200,000 or $12,000. Total premium equals 3% of $200,000 or $6,000. Since this is to be amortized over 5 years (the life of the bonds) in equal amounts, the amortization amount is $6,000 ÷ 5 = $1,200. Thus, $12,000 – $1,200 or $10,800 is the interest expense for 2017. LO 5 BT: AP Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting *28. Honore is probably indicating that since the borrower has the use of the bond proceeds over the term of the bonds, the borrowing rate in each period should be the same. The effective-interest method results in a varying amount of interest expense but a constant rate of interest on the balance outstanding. Accordingly, it results in a better matching of expenses with revenues than the straight-line method. LO 6 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting *29.

Decrease. Under the effective-interest method the interest expense per period is determined by multiplying the carrying value of the bonds by the effective-interest rate. When bonds are issued at a premium, the carrying value decreases over the life of the bonds. As a result, the interest expense will also decrease over the life of the bonds because it is determined by multiplying the decreasing carrying value of the bonds at the beginning of the period by the effective-interest rate.

LO 6 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting *30. The installment note requires equal payments. Each payment will pay any interest that has been incurred during the time that has past since the previous payment. The remaining amount of the payment will pay off part of the principal balance owed. Over time, as the principal is payed down, the amount of interest owed will decline, so that the principal payed off by each payment will increase. LO 7 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting *31. No, Tim is not right. Each payment by Tim consists of: (1) interest on the unpaid balance of the loan and (2) a reduction of loan principal. The interest decreases each period while the portion applied to the loan principal increases each period. LO 7 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) A note payable due in two years is a long-term liability, not a current liability. (b) $20,000 of the mortgage payable is a current maturity of long-term debt. This amount should be reported as a current liability. (c) Interest payable is a current liability because it will be paid out of current assets in the near future. (d) Accounts payable is a current liability because it will be paid out of current assets in the near future. LO 1 BT: C Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

BRIEF EXERCISE 10-2 (a) July 1 (b) Dec. 31

Cash.......................................................... Notes Payable ..................................

90,000

Interest Expense ...................................... Interest Payable ($90,000 X 7% X 6/12) ...................

3,150

90,000

3,150

LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-3 Sales tax payable (1) Sales = ($10,388 ÷ 1.06) = $9,800 (2) Sales taxes payable = ($9,800 X 6%) = $588 or $10,388 – $9,800 = $588 Mar. 16

Cash ................................................................. Sales Revenue.......................................... Sales Taxes Payable ................................

10,388

(Sales revenue = Total receipts ÷ (1 + sales tax rate)) LO 1 BT: AP Difficulty: Medium TOT: 7 min. AACSB: Analytic AICPA FC: Reporting

9,800 588

BRIEF EXERCISE 10-4 (a) Cash (3,500 X $80) .................................................. Unearned Ticket Revenue .............................. (To record sale of 3,500 season tickets)

280,000

(b) Unearned Ticket Revenue ...................................... Ticket Revenue ($280,000 ÷ 10)....................... (To record basketball ticket revenue earned)

28,000

280,000

28,000

LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-5 Gross earnings: Regular pay (40 X $16) ........................................... Overtime pay (7 X $24) ........................................... Gross earnings ............................................................... Less: FICA taxes payable ($808 X 7.65%).................... Federal income taxes payable ........................... Net pay ............................................................................

$640.00 168.00

$808.00 $808.00

$ 61.81 95.00

156.81 $651.19

LO 1 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-6 Jan.

Jan.

Salaries and Wages Expense.................... FICA Taxes Payable ($808 X 7.65%) Federal Income Taxes Payable ........ Salaries and Wages Payable............

808.00

Salaries and Wages Payable..................... Cash...................................................

651.19

61.81 95.00 651.19 651.19

LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-7 Jan.

Payroll Tax Expense .................................. FICA Taxes Payable ($808 X 7.65%)

LO 1 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

61.81 61.81

BRIEF EXERCISE 10-8 Cash ($300,000 X .98)................................. Discount on Bonds Payable...................... Bonds Payable .................................. (Cash received = Face value of bond X. 98)

294,000 6,000 300,000

LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-9 Cash ($400,000 X 1.01) ................................................... Bonds Payable .................................................. Premium on Bonds Payable............................. (Cash received = Face value of bond X 1.01)

404,000 400,000 4,000

LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-10 2017 (a) Jan. 1

(b) Dec. 31

2018 (c) Jan. 1

Cash ..................................................... 3,000,000 Bonds Payable (3,000 X $1,000) ..................... 3,000,000 Interest Expense ....................... 210,000 Interest Payable ($3,000,000 X 7%) ............ 210,000 (Interest expense = Face value of bond X stated interest rate) Interest Payable ........................ Cash .....................................

210,000

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

210,000

BRIEF EXERCISE 10-11 Bonds Payable ......................................................... Loss on Bond Redemption ($2,040,000 – $1,955,000) ..................................... Cash ($2,000,000 X 1.02) .................................. Discount on Bonds Payable ............................ (Cash paid = Face value of bond X 1.02)

2,000,000 85,000 2,040,000 45,000

LO 3 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-12 Long-term liabilities Bonds payable (due 2021)................................ Less: Discount on bonds payable .................. Notes payable (due 2019)................................. Total long-term liabilities..........................

$700,000 28,000

$672,000 80,000 $752,000

LO 4 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 10-13 O’BRIAN INC. Balance Sheet (Partial) December 31, 2017 Current liabilities Notes payable ............................................ Accounts payable...................................... Unearned rent revenue ............................. Interest payable ......................................... FICA taxes payable.................................... Income taxes payable ............................... Sales taxes payable................................... Total current liabilities.......................... Long-term liabilities Bonds payable (due 2021) ........................ Less: Discount on bonds payable........... Notes payable (due 2019).......................... Total long-term liabilities .................... Total liabilities...................................................

$ 20,000 157,000 240,000 40,000 7,800 3,500 1,700 $ 470,000 900,000 41,000

LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

859,000 80,000 939,000 $1,409,000

BRIEF EXERCISE 10-14 (a) Working capital = $4,485 – $2,836 = $1,649 (b) Current ratio = $4,485 ÷ $2,836 = 1.58:1 (c) Debt to assets = $5,099 ÷ $8,875 = 57% (d) Times interest earned = ($245 + $113 + $169) ÷ $169 = 3.12 times (Times interest earned = (Net income + Income taxes + Interest expense) ÷ Interest expense) Working capital and the current ratio measure a company’s ability to pay maturing obligations and meet cash needs. adidas’s current assets are 58% larger than the amount of its current liabilities which indicates a relatively high degree of liquidity. Debt to assets and times interest earned measure a company’s ability to survive over a long period of time. adidas’s debt to assets ratio indicates that approximately $.57 of every dollar invested in assets was provided by creditors. adidas’s times interest earned ratio of 3.12 indicates that its earnings are adequate to make interest payments as they come due. LO 4 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 10-15 (a) Debt to assets: Without operating leases

$14,180

= 59%

$24,004 With operating leases

$14,180 + $740

= 60%

$24,004 + $740 (b) CN does not have significant operating leases, therefore its assets and liabilities reflect its true financial position. By increasing its assets and liabilities for these operating leases we see that its debt to assets ratio increases only slightly from 59% to 60%. LO 4 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*BRIEF EXERCISE 10-16 (a) Jan. 1

Cash (99% X $2,000,000) ................. Discount on Bonds Payable............ Bonds Payable .........................

1,980,000 20,000 2,000,000

(b) Dec. 31

Interest Expense .............................. 142,000 140,000 Cash ($2,000,000 X 7%)............ Discount on Bonds Payable ($20,000 ÷ 10) ......... 2,000 (Bond discount amortization = Discount ÷ Number of interest periods) LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 10-17 (a) Jan.

Cash (102% X $4,000,000)............... Bonds Payable.......................... Premium on Bonds Payable ....

4,080,000 4,000,000 80,000

(b) Dec. 31

Interest Expense ............................. 304,000 Premium on Bonds Payable ($80,000 ÷ 5)............................. 16,000 Interest Payable ($4,000,000 X 8%)...................... 320,000 (Bond premium amortization = Premium ÷ Number of interest periods) LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 10-18 (a) Interest Expense ............................................... Discount on Bonds Payable ..................... Cash ...........................................................

48,070 3,070 45,000

(b) Interest expense is greater than interest paid because the bonds sold at a discount. The bonds sold at a discount because investors demanded a market interest rate higher than the contractual interest rate. Interest expense is calculated using the effective interest rate which is higher than the stated rate used to compute the cash payment.

*BRIEF EXERCISE 10-18 (Continued) (c) Interest expense increases each period because the bond carrying value increases each period. As the market interest rate is applied to this bond carrying value, interest expense will increase. LO 6 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 10-19 (A) Interest Period Issue Date 1 2017 Dec. 31

2018 June 30

Cash Payment

(B) Interest Expense (D) X 10%

$130,196

$80,000

$50,196

(D) Principal Balance (D) – (C) $800,000 749,804

Cash ...................................................... Mortgage Payable .......................

800,000

Interest Expense .................................. Mortgage Payable ................................ Cash .............................................

80,000 50,196

800,000

(See Illustration 10C-1) LO 7 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

130,196

SOLUTIONS TO DO IT! EXERCISES DO IT! 10-1a 1. $60,000 X 10% X 5/12 = $2,500 2. $42,000/1.05 = $40,000; $40,000 X 5% = $2,000 (Sales revenue = Total receipts ÷ (1 + sales tax rate)) 3. $42,000 X 2/6 = $14,000 LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Reporting

DO IT! 10-1b (a) To determine wages payable, reduce wages expense by the withholdings for FICA, federal income tax, and state income tax. Feb. 28 Salaries and Wages Expense ....................... FICA Taxes Payable .................................. Federal Income Taxes Payable ................ State Income Taxes Payable .................... Salaries and Wages Payable ....................

74,000 5,661 7,100 1,900 59,339

(b) Payroll taxes would be for the company’s share of FICA, as well as for federal and state unemployment tax. Feb. 28 Payroll Tax Expense ..................................... FICA Taxes Payable .................................. Federal Unemployment Taxes Payable ... State Unemployment Taxes Payable .......

5,931 5,661 110 160

LO 1 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 10-2 1. 2. 3. 4.

False. Convertible bonds can be converted into common stock at the bondholder’s option; callable bonds can be redeemed by the issuer at a set amount prior to maturity. True. True. True.

LO 2 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement

DO IT! 10-3a (a)

(b)

Cash ..................................................................... Bonds Payable ................................................ Premium on Bonds Payable........................... (To record sale of bonds at a premium)

315,000 300,000 15,000

Long-term liabilities Bonds payable ................................................ Plus: Premium on bonds payable.................

$300,000 15,000 $315,000

LO 3 BT: AP Difficulty: 5 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 10-3b Bonds Payable..................................................... Loss on Bond Redemption ................................. Cash ($400,000 X 99%) ................................... Discount on Bonds Payable........................... (To record redemption of bonds at 99)

400,000 8,000 396,000 12,000

(Carrying value of the bond = Face value of the bond – Bond discount) LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 10–4 (a) Current ratio $11,500 ÷ $12,000 = .96:1 Working capital $11,500 – $12,000 = ($500) (b) Current ratio $8,500 ÷ $9,000 = .94:1 Working capital $8,500 –$9,000 = ($500) (c) Debt to assets ratio $26,000 ÷$38,000 = .68:1 Times interest earned ratio ($16,000 + $3,200 + $1,300) ÷$1,300 = 15.8 LO 4 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO EXERCISES EXERCISE 10-1 2017 (a) June 1

Cash ........................................................... Notes Payable....................................

15,000 15,000

(b) June 30

Interest Expense ($15,000 X .08 X 1/12) ............................ 100 Interest Payable................................. (Monthly interest = Face value of note X interest rate X 1/12)

(c) Interest payable accrued each month ...................... Number of months from borrowing to year end ............................................................. Balance in interest payable account ........................ 2018 (d) Jan. 1

Notes Payable ........................................... Interest Payable ........................................ Cash ...................................................

100

$100 X 7 $700 15,000 700 15,700

LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-2 (a) Principal X .08 X 4/12 = $480 Principal = $480 ÷ (.08 X 4/12) Principal = $18,000 ($480 = Face value of note X .08 X 4/12) (b) $18,500 X Interest Rate X 4/12 = $555 Interest Rate = $555 ÷ ($18,500 X 4/12) Interest Rate = 9 percent ($555 = $18,500 X Interest rate X 4/12) (c) Initial Borrowing: May 15

Cash ......................................................... Notes Payable ..................................

18,000 18,000

EXERCISE 10-2 (Continued) Repayment: Sept. 15

Notes Payable......................................... Interest Expense..................................... Cash.................................................

18,000 480 18,480

LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-3 (a) June 1

Cash............................................................... 60,000 Notes Payable .....................................

Interest Expense ($60,000 X .08 X 1/12) .... 400 Interest Payable .................................. (Interest expense = Face value of note X interest rate X 1/12)

60,000

(b) June 30

Notes Payable ............................................... 60,000 Interest Payable ($60,000 X .08 X 6/12) .......... 2,400 Cash..................................................... (Interest payable = Face value of note X interest rate X 6/12)

400

62,400

(d) Interest expense accrued each month ........................ $ 400 Number of months of loan ........................................... X 6 Total interest expense .................................................... $2,400 LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-4 Apr. 10

CERVIQ COMPANY Cash........................................................................ 23,100 Sales Revenue.............................................. Sales Taxes Payable .................................... QUARTZ COMPANY Cash........................................................................ 13,780 Sales Revenue ($13,780 ÷ 1.06)................... Sales Taxes Payable ($13,780 – $13,000) ... (Sales revenue = Total receipts ÷ (1 + sales tax rate))

LO 1 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

22,000 1,100

13,000 780

EXERCISE 10-5 (a) Mar. 31

(b) Mar. 31

Salaries and Wages Expense ............... FICA Taxes Payable....................... Federal Income Taxes Payable ..... State Income Taxes Payable ......... Union Dues Payable ...................... Salaries and Wages Payable.........

64,000

Payroll Tax Expense ............................. FICA Taxes Payable....................... State Unemployment Taxes Payable .......................................

5,596

4,896 7,500 3,100 400 48,104 4,896 700

LO 1 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-6 (a) $1,728,000 ÷ $320 = 5,400 season tickets sold. (b) $1,728,000 ÷ 16 home games = $108,000 revenue recognized per home game. $1,188,000 ÷ $108,000 = 11 home games already played. (c) Cash......................................................................... 1,728,000 Unearned Ticket Revenue .............................. 1,728,000 (d) Unearned Ticket Revenue ...................................... Ticket Revenue................................................

108,000 108,000

LO 1 BT: AP Difficulty: Easy TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-7 (a) Nov. (b) Dec. 31

Cash (6,300 X $28)................................. Unearned Subscription Revenue..

176,400

Unearned Subscription Revenue ......... Subscription Revenue ($176,400 X 1/12) .........................

14,700

176,400

14,700

EXERCISE 10-7 (Continued) (c) Mar. 31

Unearned Subscription Revenue ........ Subscription Revenue ($176,400 X 3/12) ........................

44,100 44,100

LO 1 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-8 2017 (a) Aug. 1

Cash ...................................................... Bonds Payable ..............................

600,000 600,000

(b) Dec. 31

Interest Expense................................... 17,500 Interest Payable ($600,000 X 7% X 5/12)............... 17,500 (Interest expense = Face value of bond X stated interest rate X 5/12)

2018 (c) Aug. 1

Interest Expense ($600,000 X 7% X 7/12) ...................... 24,500 Interest Payable .................................... 17,500 Cash ($600,000 X 7% X 12/12) ...... 42,000 (Interest expense = Face value of bond X stated interest rate X 7/12)

LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-9 (a) Jan. 1

(b) Dec. 31

Cash....................................................... Bonds Payable ..............................

300,000

Interest Expense ................................... Interest Payable ($300,000 X 8% X 12/12) .............

24,000

Interest Payable .................................... Cash ...............................................

24,000

300,000

24,000

LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

24,000

EXERCISE 10-10 Cash ($600,000  1.03)................................ 618,000 Bonds Payable ................................ Premium on Bonds Payable......... (Cash received = Face value of bond  1.03)

(a) Jan.

600,000 18,000

(b) Long-term Liabilities Bonds Payable, due 2027 .................................. $600,000 Add: Premium on Bonds Payable ................ 10,800 $610,800 (c) The bonds sold for more than their face amount because the contract interest rate (6%) was higher than the market interest rate. When the contract rate is higher than the market rate, bonds will sell at a premium. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-11 Cash ($500,000  .96) ........................... Discount on Bonds Payable ................. Bonds Payable ............................... (Cash received = Face value of bond  .96)

(a) Jan.

(b) Long-term Liabilities Bonds Payable, due 2032 .............................. Less: Discount on Bonds Payable ................

480,000 20,000 500,000

$500,000 12,000 $488,000

(c) The bonds sold for less than their face value because the contract interest rate (7%) was lower than the market interest rate. When the contract rate is lower than the market rate, the bonds will sell at a discount. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-12 (a) The General Electric bonds were issued at a premium and the Boeing bonds were issued at a discount.

EXERCISE 10-12 (Continued) (b) The prices of the two bonds differed because bond price is based on the market rate of interest not the stated rate of interest. Market interest rates must have been different when the two bonds were issued causing the selling prices to differ. (c)

Cash (111.12% X $800,000) ................................... Bonds Payable ................................................. Premium on Bonds Payable............................

888,960 800,000 88,960

Cash (99.08% X $800,000) ..................................... 792,640 7,360 Discount on Bonds Payable.................................. Bonds Payable ................................................. (Cash received = Face value of bond X Issue price)

800,000

LO 3 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-13 2017 (a) Jan. 1 (b) Dec. 31

2018 (c) Jan. 1 2037 (d) Jan. 1

Cash....................................................... Bonds Payable ..............................

350,000

Interest Expense ................................... Interest Payable ($350,000 X 8% X 12/12) .............

28,000

Interest Payable .................................... Cash ...............................................

28,000

Bonds Payable ...................................... Cash ...............................................

350,000

28,000

350,000

LO 3 BT: AP Difficulty: Easy TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-14 (a) April 30

Bonds Payable ..................................... 140,000 Loss on Bond Redemption ................. 14,900* Cash ($140,000 X 101%)............... 141,400 Discount on Bonds Payable ($140,000 – $126,500) ............... 13,500 (Loss on redemption = Carrying value of bond – (face value of bond X 1.01))

EXERCISE 10-14 (Continued) (b) June 30

Bonds Payable..................................... 170,000 Premium on Bonds Payable ............... 14,000 Cash ($170,000 X 98%) ................ 166,600 Gain on Bond Redemption.......... 17,400** (Gain on redemption = Carrying value of bond – (face value of bond X .98)) *$126,500 – (101% X $140,000) **$184,000 – (98% X $170,000) LO 3 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-15 (a)

Account

Classification

Accounts payable Accrued pension liability

Current liability Long-term liability

Unearned rent revenue Bonds payable Current portion of mortgage payable Income taxes payable Mortgage payable Operating leases

Current liability Long-term liability Current liability

Notes payable (due in 2020) Salaries and wages payable Notes payable (due in 2018) Unused operating line of credit

Long-term liability

Warranty liability—current

Current liability

Current liability Long-term liability N/A

Current liability Current liability N/A

Reason Due within one year Relates to pensions. Not due within one year Due within one year Not due within one year Due within one year Due within one year Not due within one year Not a balance sheet item—may be disclosed in notes Not due within one year Due within one year Due within one year Not a balance sheet item as unused—may be disclosed in notes Can be current and/or long-term depending on the length of the warranty. Given as current

EXERCISE 10-15 (Continued) (b)

SANCHEZ INC. Balance Sheet (Partial) December 31, 2017 (in thousands) Current liabilities Notes payable ............................................ Accounts payable ...................................... Current portion of mortgage payable....... Warranty liability........................................ Unearned rent revenue.............................. Salaries and wages payable ..................... Income taxes payable................................ Total current liabilities .......................... Long-term liabilities Mortgage payable ...................................... Bonds payable ........................................... Accrued pension liability .......................... Notes payable ............................................ Total long-term liabilities..................... Total liabilities ...................................................

$2,563.6 4,263.9 1,992.2 1,417.3 1,058.1 858.1 265.2 $12,418.4 $6,746.7 1,961.2 1,115.2 335.6 10,158.7 $22,577.1

LO 4 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 10-16 Working capital = $3,416.3 – $2,988.7 = $427.6 Current ratio = $3,416.3 ÷ $2,988.7 = 1.14:1 Debt to assets ratio = $16,191.0 ÷ $30,224.9 = 54% Times interest earned = ($4,551.0 + $1,936.0 + $473.2) ÷ $473.2 = 14.71 times (Times interest earned = (Net income + Interest expense + Income taxes) ÷ Interest expense) (a) 1. 2. 3. 4.

A current ratio of 1.14 indicates lower liquidity. The debt to assets ratio indicates that $.54 of each dollar of assets have been financed by creditors. The times interest earned of over 14 times indicates that McDonald’s income is large enough to make required interest payments as they come due.

EXERCISE 10-16 (Continued) (b) Debt to assets ratio, adjusted for off-balance-sheet lease obligations. $16,191.0 + $8,800 = 64% $30,224.9 + $8,800 By including these off-balance-sheet obligations the debt to assets ratio increases from 54% to 64%, suggesting that McDonald’s is not as solvent as it first appears. LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 10-17 (a) Current ratio 2017 2016

$10,795 ÷ $4,897 = 2.20:1 $9,598 ÷ $5,839 = 1.64:1

(b) Current ratio $10,495 ÷ $4,597 = 2.28:1 It would make its current ratio increase from 2.20 to 2.28. LO 4 BT: AN Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 10-18 (a) Current ratio 2017 2016

$6,244 ÷ $4,503 = 1.39:1 $3,798 ÷ $2,619 = 1.45:1

(b) Current ratio ($6,244 – $1,500) ÷ ($4,503 – $1,500) = 1.58:1 It would make its current ratio increase (from 1.39:1 to 1.58:1). (c) The liquidity ratios would not change but having access to a line of credit means that cash is available on a short-term basis and therefore the assessment of the company’s short-term liquidity would improve. LO 4 BT: AN Difficulty: EASY TOT: 7 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 10-19 (a)

The company does not have to record these contingent liabilities because they have determined that they are not likely to occur and the impact would be immaterial in any event.

(b) For financial statement users it is important to understand the possible implications that the contingent liabilities could have on the financial results of the company. If the contingent liabilities result in material losses for the company it will negatively impact the company’s financial results and affect the decisions made by the users of the financial statements. LO 4 BT: C Difficulty: Medium TOT: 6 min. AACSB: None AICPA FC: Reporting

*EXERCISE 10-20 2017 (a) Jan. 1

Cash ($500,000 X 103%) ...................... Bonds Payable ............................. Premium on Bonds Payable ........ (Cash received = Face value of bond X 1.03)

515,000 500,000 15,000

(b) Dec. 31

Interest Expense .................................. 29,500 Premium on Bonds Payable ($15,000 X 1/30) ................................. 500 Interest Payable ($500,000 X 6%) ......................... 30,000 (Amortization of premium = Premium on bonds payable ÷ Number of interest periods) 2018 (c) Jan. 1 2047 (d) Jan. 1

Interest Payable ................................... Cash ..............................................

30,000

Bonds Payable ..................................... Cash ..............................................

500,000

30,000

LO 3, 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

500,000

*EXERCISE 10-21 2016 (a) Dec. 31

Cash ...................................................... Discount on Bonds Payable ................ Bonds Payable ..............................

288,000 12,000 300,000

2017 (b) Dec. 31

Interest Expense................................... 24,800 Cash ($300,000 X 8%) ................... 24,000 Discount on Bonds Payable ($12,000 X 1/15) .......................... 800 (Amortization of discount = Discount on Bonds Payable ÷ Number of interest periods) 2031 (c) Dec. 31

Bonds Payable...................................... Cash...............................................

300,000 300,000

LO 3, 5 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 10-22 2017 (a) Jan. 1

Cash........................................................ Discount on Bonds Payable.................. Bonds Payable ...............................

360,727 39,273 400,000

(b) Dec. 31

Interest Expense (360,727 X 8%) .......... 28,858 Interest Payable ($400,000 X 7%) ........................... 28,000 Discount on Bonds Payable.......... 858 (Interest expense = Carrying value of bond X effective interest rate)

2018 (c) Jan. 1

Interest Payable ..................................... Cash ................................................

28,000

For explanation of calculations, see the following table.

28,000

*EXERCISE 10-23 2017 (a) Jan. 1

Cash ....................................................... Bonds Payable ............................... Premium on Bonds Payable..........

407,968 380,000 27,968

(b) Dec. 31

Interest Expense ($407,968 X 6%) ........ 24,478 Premium on Bonds Payable ................. 2,122 Interest Payable ($380,000 X 7%) ........................... 26,600 (Interest expense = Carrying value of bond X effective interest rate)

2018 (c) Jan. 1

Interest Payable ..................................... Cash................................................

26,600

For explanation of calculations, see the following table.

26,600

*EXERCISE 10-24 2017

2018

2019

Dec. 31

Dec 31

Dec. 31

Issuance of Note Cash ................................................. Mortgage Payable .................... First Installment Payment Interest Expense ($300,000 X 10%) ......................... Mortgage Payable ........................... Cash.......................................... Second Installment Payment Interest Expense [($300,000 – $20,000) X 10%] ...... Mortgage Payable ........................... Cash.......................................... (A)

Annual Interest Period Issue date 12/31/18 12/31/19

300,000

Cash Payment

(B) Interest Expense (D X 10%)

$50,000 50,000

$30,000 28,000

$20,000 22,000

300,000

30,000 20,000 50,000

28,000 22,000

LO 7 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

50,000 (D) Principal Balance (D) – (C) $300,000 280,000 258,000

*EXERCISE 10-25 (A) Annual Interest Period 1/1/2017 1/1/2018

Cash Payment

(B) Interest Expense (D) X 10%

$8,137

$5,000

$3,137

(D) Principal Balance (D) – (C) $50,000 46,863

WAITE CORPORATION Balance Sheet (Partial) December 31, 2017 Current liabilities Notes payable .............................................................................. Interest payable ...........................................................................

$3,137 5,000

Long-term liabilities Notes payable ..............................................................................

46,863

LO 7 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO PROBLEMS PROBLEM 10-1A

(a) Jan. 1 5

12 14

Cash........................................................... Notes Payable....................................

18,000

Cash........................................................... Sales Revenue ($6,254 ÷ 1.06).......... Sales Taxes Payable ($6,254 – $5,900) ............................

6,254

Unearned Service Revenue...................... Service Revenue ...............................

10,000

Sales Taxes Payable................................. Cash ...................................................

6,600

18,000 5,900 354 10,000 6,600

Accounts Receivable................................ 25,440 Sales Revenue................................... Sales Taxes Payable (500 X $48 X 6%) ............................ (Sales revenue = Total cash receipts ÷ (1 + sales tax rate)) (b) Jan. 31

Interest Expense ....................................... Interest Payable ($18,000 X 5% X 1/12) ....................

Salaries and Wages Expense................... FICA Taxes Payable .......................... Federal Income Taxes Payable ........ State Income Taxes Payable ............ Salaries and Wages Payable ............

70,000

Payroll Tax Expense ................................. FICA Taxes Payable ..........................

5,355

24,000 1,440

75 5,355 5,000 1,500 58,145 5,355

PROBLEM 10-1A (Continued) (c) Current liabilities Notes payable................................................................. $ 18,000 Accounts payable........................................................... 42,500 Salaries and wages payable .......................................... 58,145 FICA taxes payable ($5,355 X 2) .................................... 10,710 Unearned service revenue ($19,000 – $10,000) ............ 9,000 Federal income taxes payable....................................... 5,000 Sales taxes payable ....................................................... 1,794* State income taxes payable........................................... 1,500 Interest payable .................................................................. 75 Total current liabilities ................................................ $146,724 *($6,600 + $354 – $6,600 + $1,440) LO 1, 4 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 10-2A

(a) Sept. 1 30

Oct.

1 31

Nov.

Dec.

Inventory.................................................... Notes Payable .................................... Interest Expense ($12,000 X .06 X 1/12) ............................ Interest Payable ................................. Equipment.................................................. Notes Payable .................................... Interest Expense [($16,500 X .08 X 1/12) + $60] ................ Interest Payable ................................. Equipment.................................................. Notes Payable .................................... Cash.................................................... Interest Expense [($26,000 X .06 X 1/12) + $110 + $60] .... Interest Payable ................................. Notes Payable............................................ Interest Payable......................................... Cash....................................................

12,000 12,000 60 60 16,500 16,500 170 170 34,000 26,000 8,000 300 300 12,000 180 12,180

Interest Expense ($110 + $130) ................ 240 Interest Payable ................................. 240 (Nov. 30 Interest expense = ($12,000 X .06 X 1/12) + ($16,500 X .08 X 1/12) + ($26,000 X .06 X 1/12)) (b) 12/1

Notes Payable 12,000 9/1 10/1 11/1

12,000 16,500 26,000

12/31 Bal. 42,500

12/1

Interest Payable 180 9/30 10/31 11/30 12/31 12/31 Bal.

60 170 300 240 590

PROBLEM 10-2A (Continued) Interest Expense 9/30 60 10/31 170 11/30 300 12/31 240 12/31 Bal. 770 (c) Current liabilities Notes payable..................................................................... Interest payable .................................................................. (d) Total interest expense is $770. See (b) above. LO 1, 4 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

42,500 590

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

PROBLEM 10-3A

(a) Jan. 1

Interest Payable ................................ Cash...........................................

40,000

Bonds Payable.................................. Loss on Bond Redemption .............. Cash ($200,000 X 103%) ........... (Cash received = Face value of bond X 1.03)

200,000 6,000

(b) Jan. 1

Interest Expense............................... Interest Payable ($300,000 X 8%) ......................

40,000

206,000

24,000

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

24,000

PROBLEM 10-4A

2016 (a) Oct. 1

Cash................................................... Bonds Payable ..........................

700,000 700,000

(b) Dec. 31

Interest Expense ............................... 8,750 Interest Payable ($700,000 X 5% X 3/12) ........... (Interest expense = Face value of bond X Interest rate X 3/12)

(c) Current Liabilities Interest Payable ............................................ Long-term Liabilities Bonds Payable ..............................................

8,750

8,750 700,000

2017 (d) Oct. 1

Interest Expense ($700,000 X 5% X 9/12)................... 26,250 Interest Payable ................................ 8,750 Cash ($700,000 X 5%) ............... (Interest expense = Face value of bond X Interest rate X 9/12)

(e) Dec. 31

(f)

2018 Jan. 1

Interest Expense ............................... Interest Payable.........................

8,750

Interest Payable ................................ Cash ...........................................

8,750

35,000

8,750

Bonds Payable .................................. 700,000 Loss on Bond Redemption .............. 28,000 Cash ($700,000 X 104%)............ 728,000 Loss on redemption = Carrying value of bond – (Face value of bond X 1.04)) LO 3, 4 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 10-5A

2017 (a) Jan. 1

Cash ($6,000,000 X 98%) ............... Discount on Bonds Payable ......... Bonds Payable ....................... (Cash received = Face value of bond X .98)

5,880,000 120,000 6,000,000

(b) Long-term Liabilities Bonds Payable, due 2032............................ $6,000,000 Less: Discount on bonds payable ........ 112,000 $5,888,000 2019 (c) Jan. 1

Bonds Payable............................... Loss on Bond Redemption ($6,120,000 – $5,896,000) .......... Cash ($6,000,000 X 102%) ..... Discount on Bonds Payable ...............................

6,000,000 224,000 6,120,000 104,000*

*$6,000,000 – $5,896,000 (Loss on redemption = Carrying value of bond – (Face value of bond X 1.02)) LO 3, 4 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 10-6A

(a) 1. Current ratio 2. Free cash flow 3. Debt to assets ratio 4. Times interest earned

2017 $2,893 ÷ $2,806 = 1.03:1 ($1,521) – $923 – $13 = ($2,457) $9,355 ÷ $14,308 = 65% $4081 ÷ $130 = 3.14 times

2016 $4,443 ÷ $4,836 = .92:1 $2,845 – $1,331 – $14 = $1,500 $9,831 ÷ $16,772 = 59% $1,1772 ÷ $119 = 9.89 times

1$178 + $100 + $130 = $408 2$645 + $413 + $119 = $1,177

(b)

The company’s position as measured through all ratios except the current ratio has deteriorated. Southwest appears to be much less liquid and solvent when comparing 2017 to 2016.

(c)

Southwest’s use of operating leases (vs. capital leases) would reduce its solvency. If the leases were capital rather than operating, the balance sheet would include higher total assets and higher liabilities. Using the $1,600 as an estimate of the increase in liabilities and assets that would result if the operating leases were capital leases, the revised debt to assets ratio would be [($9,355 + $1,600) ÷ ($14,308 + $1,600)] = 69%.

LO 4 BT: AN Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*PROBLEM 10-7A

2017 (a) Jan. 1

Interest Payable ................................ Cash...........................................

96,000 96,000

(b) Dec. 31

Interest Expense............................... 98,400 Interest Payable ($2,400,000 X 4%) .................. 96,000 Discount on Bonds Payable ($24,000 ÷ 10)......................... 2,400 (Amortization of discount = Discount on bonds payable ÷ Number of interest periods) 2018 (c) Jan. 1

Bonds Payable.................................. Loss on Bond Redemption .............. Cash ($400,000 X 102%) ........... Discount on Bonds Payable.....

400,000 11,600 408,000 3,600*

*($24,000 – $2,400) X $400,000/ $2,400,000 = $3,600 (Loss on redemption = Carrying value of bond – (Face value of bond X 1.02)) (d) Dec. 31

Interest Expense............................... 82,000 Interest Payable ........................ 80,000** Discount on Bonds Payable..... 2,000* (Amortization of discount = Remaining discount balance ÷ Remaining number of interest periods) *$24,000 – $2,400 – $3,600 = $18,000; $18,000 ÷ 9 = $2,000 or $2,400 X $2,000,000/$2,400,000 = $2,000 **($2,400,000 – $400,000 = $2,000,000; $2,000,000 X 4% = $80,000) LO 3, 5 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 10-8A

(a) Jan. 1

Cash ($2,000,000 X 102%) .............. Bonds Payable ........................ Premium on Bonds Payable ...

2,040,000 2,000,000 40,000

Dec. 31

Interest Expense ............................. 132,000 Premium on Bonds Payable ($40,000 ÷ 5) ............................... 8,000 Interest Payable ($2,000,000 X 7%) ................ 140,000 (Amortization of Premium = (Cash received – Face value of bond) ÷ Number of interest periods) (b) Jan. 1

Cash ($2,000,000 X 97%) ................ Discount on Bonds Payable .......... Bonds Payable ........................

1,940,000 60,000 2,000,000

Dec. 31

Interest Expense ............................. 152,000 140,000 Interest Payable....................... Discount on Bonds 12,000 Payable ($60,000 ÷ 5) .......... (Amortization of discount = (Cash received – Face value of bond) ÷ Number of interest periods) (c) Premium Current Liabilities Interest payable ........................................

$ 140,000

Long-term Liabilities Bonds payable, due 2022 ............................. $2,000,000 Add: Premium on bonds payable........... 32,000

2,032,000

Discount Current Liabilities Interest payable ........................................

$ 140,000

Long-term Liabilities Bonds payable, due 2022 ............................. $2,000,000 Less: Discount on bonds payable ......... 48,000

1,952,000

LO 3 - 5 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 10-9A

(a) 1.

1/1/17

Cash ($3,000,000 X 103%) ....... Bonds Payable ................. Premium on Bonds Payable .........................

3,090,000 3,000,000 90,000

1/1/17

Cash ($3,000,000 X 98%) ......... 2,940,000 Discount on Bonds 60,000 Payable................................. Bonds Payable ................. 3,000,000 (Premium/discount = (Face value of bond X issue price) – Face value of bond) (b) See amortization tables on following page. (c) 1.

12/31/17

Interest Expense...................... Premium on Bonds Payable................................. Interest Payable ...............

231,000 9,000 240,000

Interest Expense...................... 246,000 Interest Payable ............... 240,000 Discount on Bonds 6,000 Payable ......................... (Amortization of premium/discount = (Cash received – Face value of bond) ÷ Number of interest periods) (d) 1.

12/31/17

Long-term Liabilities: Bonds Payable.................................... Plus: Unamortized Bond Premium................................... Long-term Liabilities: Bonds Payable.................................... Less: Unamortized Bond Discount ..................................

$3,000,000 81,000 $3,081,000 $3,000,000 54,000 $2,946,000

(b), (1) Annual Interest Periods

(For Instructor Use Only)

Issue date 1 2 3

(A) Interest to Be Paid (8% X $3,000,000)

(B) Interest Expense to Be Recorded (A) – (C)

(D) Unamortized Premium (D) – (C)

$240,000 240,000 240,000

$231,000 231,000 231,000

$9,000 9,000 9,000

$90,000 81,000 72,000 63,000

(A) Interest to Be Paid (8% X $3,000,000)

(B) Interest Expense to Be Recorded (A) + (C)

(D) Unamortized Discount (D) – (C)

$6,000 6,000 6,000

$60,000 54,000 48,000 42,000

(2) Annual Interest Periods Issue date 1 2 3

$240,000 240,000 240,000

$246,000 246,000 246,000

LO 3 - 5 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Reporting 10-4 4

Kimmel, Financial Accounting, 8/e, Solutions Manual

(For Instructor Use Only)

*PROBLEM 10-10A

2017 (a) Jan. 1

(b)

Cash ................................................. Discount on Bonds Payable ........... Bonds Payable .........................

1,667,518 132,482 1,800,000

LACHTE CORP. Bond Discount Amortization Effective-Interest Method—Annual Interest Payments 5% Bonds Issued at 6% (B) (C) (D) (E) Interest Discount UnamorBond Interest Expense Amortized Carrying to Be to Be tization Discount Value Paid Recorded (B) – (A) (D) – (C) ($1,800,000 – D) (A)

Annual Interest Periods

Issue date 1 $90,000 2 90,000 3 90,000

$100,051 100,654 101,293

$10,051 10,654 11,293

$132,482 122,431 111,777 100,484

$1,667,518 1,677,569 1,688,223 1,699,516

Interest Expense ($1,667,518 X 6%) ......................................100,051 Interest Payable ($1,800,000 X 5%) .......................... 90,000 Discount on Bonds Payable............. 10,051 (Interest expense = Carrying value of bond X effective interest rate)

2018 (d) Jan. 1

(e) Dec. 31

Interest Payable ........................................ Cash...................................................

90,000

Interest Expense [($1,667,518 + $10,051) X 6%] ...................100,654 Interest Payable ................................ Discount on Bonds Payable.............

LO 3, 6 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

90,000

90,000 10,654

*PROBLEM 10-11A

(a) 1.

3. 4.

Jan. 1

Dec. 31

Jan. 1

2017 Cash ............................................... 2,147,202 Bonds Payable ................... Premium on Bonds Payable............................ Interest Expense ($2,147,202 X 6%) ................... Premium on Bonds Payable ................................... Interest Payable ($2,000,000 X 7%) ........... 2018 Interest Payable ......................... Cash ....................................

2,000,000 147,202

128,832 11,168 140,000

140,000 140,000

Dec. 31

Interest Expense ........................ 128,162 [($2,147,202 – $11,168) X 6%] Premium on Bonds Payable ................................... 11,838 Interest Payable.................. 140,000 (Interest expense = Carrying value of bond X effective interest rate) (b) Bonds payable........................................................ 2,000,000 Add: Premium on bonds payable ..................... 124,196*

2,124,196

*($147,202 – $11,168 – $11,838) (c) 1.

Total bond interest expense—2018, $128,162.

2. The effective-interest method will result in more interest expense reported than the straight-line method in 2018 when the bonds are sold at a premium. Straight-line interest expense for 2018 is $125,280 [$140,000 – ($147,202 ÷ 10)]. LO 3, 4, 6 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 10-12A

(A)

(a)

Annual Interest Period

Cash Payment

(B) Interest Expense (D) X 8%

Issue Date 1 $80,146 $25,600 $54,546 2 80,146 21,236 58,910 3 80,146 16,524 63,622 4 80,146 11,434 68,712 5 80,146 5,936* 74,210 (See Illustration 10C-1) * Rounded to make principal element equal to balance. (b)

(c)

Dec. 31

Mortgage Payable ................................. Interest Expense ................................... Cash ...............................................

(D) Principal Balance (D) – (C) $320,000 265,454 206,544 142,922 74,210 0

54,546 25,600 80,146

Current liabilities Mortgage payable............................................

$ 58,910*

Long-term liabilities Mortgage payable............................................ Total liabilities ..................................

206,544 $265,454

LO 4, 7 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 10-13A

(a) Cash Payment (A)

Period July 1, 2016 June 30, 2017 June 30, 2018 June 30, 2019 June 30, 2020 June 30, 2021 Total

$ 36,584 36,584 36,584 36,584 36,584 $182,920

Interest Principal Expense Reduction (B) = (D) X 7% (C) = (A) – (B) $10,500 8,674 6,720 4,630 2,396* $32,920

$ 26,084 27,910 29,864 31,954 34,188 $150,000

Balance (D) = (D) – (C) $150,000 123,916 96,006 66,142 34,188 0

*Rounded to make principal element equal to balance. (See Illustration 10C-1) (b) July

2016 Cash .................................................. Notes Payable .............................

June 2017

June 2018

150,000 150,000

Notes Payable .................................. Interest Expense .............................. Cash .............................................

26,084 10,500

Notes Payable .................................. Interest Expense .............................. Cash .............................................

27,910 8,674

36,584

$29,864 $66,142

LO 4, 7 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

ACR 10

(a)

ACCOUNTING CYCLE REVIEW

1. Interest Payable .............................................. Cash .........................................................

2,500

2. Inventory ......................................................... Accounts Payable ...................................

241,100

3. Cash................................................................. Sales Revenue......................................... Sales Taxes Payable ...............................

508,800

Cost of Goods Sold ........................................ Inventory..................................................

265,000

4. Account Payable............................................. Cash .........................................................

230,000

5. Interest Expense ............................................. Cash .........................................................

2,500

6. Insurance Expense ......................................... Prepaid Insurance ...................................

5,600

7. Prepaid Insurance .......................................... Cash .........................................................

10,200

8. Sales Taxes Payable....................................... Cash .........................................................

17,000

9. Other Operating Expenses............................. Cash .........................................................

91,000

10. Interest Expense ............................................. Cash .........................................................

2,500

Bonds Payable................................................ Cash ......................................................... Gain on Bond Redemption .....................

50,000

2,500 241,100 480,000 28,800 265,000 230,000 2,500 5,600 10,200 17,000 91,000 2,500 48,000 2,000

ACR 10 (Continued) 11.

Cash (90,000 X 103%) ..................................... Bonds Payable ........................................ Premium on Bonds Payable ...................

92,700 90,000 2,700

Adjusting Entries

(b)

1. Insurance Expense ($10,200 X 5/12).............. Prepaid Insurance ...................................

4,250

2. Depreciation Expense ($38,000 – $3,000) ÷ 5 .... Accumulated Depreciation— Equipment.............................................

7,000

3. Income Tax Expense ...................................... Income Taxes Payable ............................

31,245

4,250

7,000 31,245

AIMES CORPORATION Trial Balance 12/31/2017 Account Cash ............................................................ Inventory..................................................... Prepaid Insurance ...................................... Equipment .................................................. Accumulated Depreciation—Equipment .. Accounts Payable ...................................... Sales Taxes Payable .................................. Income Taxes Payable ............................... Bonds Payable ........................................... Premium on Bonds Payable...................... Common Stock........................................... Retained Earnings...................................... Sales Revenue............................................ Cost of Goods Sold.................................... Depreciation Expense................................ Insurance Expense .................................... Other Operating Expenses ........................ Interest Expense ........................................ Gain on Bond Redemption ........................ Income Tax Expense..................................

Debit $227,800 6,850 5,950 38,000

Credit

7,000 24,850 11,800 31,245 90,000 2,700 25,000 13,100 480,000

265,000 7,000 9,850 91,000 5,000 2,000 31,245

$687,695

ACR 10 (Continued) (a) and (b)

Bal.

Optional T accounts

Cash 30,000 508,800 92,700

2,500 230,000 2,500 10,200 17,000 91,000 2,500 48,000

Bal. Interest Payable 2,500 Bal. Bal.

24,850 2,500 0

Sales Taxes Payable 17,000 28,800 Bal. 11,800

227,800 Income Taxes Payable 31,245

Bal. Bal.

Inventory 30,750 241,100 6,850

Bal.

Prepaid Insurance 5,600 10,200 5,950

Bal.

Equipment 38,000

Bal.

265,000 Bonds Payable 50,000 Bal. Bal.

50,000 90,000 90,000

5,600 4,250

Accumulated Depreciation—Equipment 7,000

Accounts Payable 13,750 230,000 Bal. 241,100

Premium on Bonds Payable 2,700

Common Stock Bal.

25,000

Retained Earnings Bal. 13,100

Sales Revenue 480,000

ACR 10 (Continued) (a) and (b) (Continued) Cost of Goods Sold 265,000

Interest Expense 2,500 2,500 5,000

Bal. Depreciation Expense 7,000

Bal.

Insurance Expense 5,600 4,250 9,850

Income Tax Expense 31,245

Gain on Bond Redemption 2,000

Other Operating Expenses 91,000

(c)

AIMES CORPORATION Income Statement For the Year Ending 12/31/17 Sales revenue............................................. Cost of goods sold..................................... Gross profit ................................................ Operating expenses Insurance expense ............................. Depreciation expense ........................ Other operating expenses ................. Total operating expenses .......................... Income from operations ............................ Other revenues and expenses Gain on bond redemption .................. Interest expense ................................. Income before taxes .................................. Income tax expense ...........................

$480,000 265,000 215,000 $ 9,850 7,000 91,000 107,850 107,150 2,000 5,000 104,150 31,245

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

$ 72,905

ACR 10 (Continued) AIMES CORPORATION Retained Earnings Statement For the Year Ending 12/31/17 Retained earnings, 1/1/17 ............................................................ $13,100 Add: Net income .......................................................................... 72,905 Retained earnings, 12/31/17 ........................................................ $86,005 AIMES CORPORATION Balance Sheet 12/31/2017 Current Assets Cash..................................................... Inventory ............................................. Prepaid insurance............................... Total current assets ...................... Property, Plant, and Equipment Equipment ........................................... Accumulated depreciation— equipment ........................................ Total plant assets.......................... Total assets Current Liabilities Accounts payable ............................... Income taxes payable......................... Sales taxes payable............................ Total current liabilities.................. Long-term liabilities Bonds payable .................................... Premium on bonds payable ............... Total long-term liabilities.............. Total liabilities ............................... Stockholders’ Equity Common stock.................................... Retained earnings............................... Total stockholders’ equity............ Total liabilities and stockholders’ equity .......................................................

$227,800 6,850 5,950 $240,600 38,000 7,000 31,000 $271,600 $24,850 31,245 11,800 $ 67,895 90,000 2,700 92,700 160,595 25,000 86,005 111,005 $271,600

LO 1, 3, 4 BT: AP Difficulty: Hard TOT: 120 min. AACSB: Analytic AICPA FC: Reporting

CT 10-1

FINANCIAL REPORTING PROBLEM

(a) Total current liabilities at September 27, 2014, $63,448 millions. Apple's total current liabilities increased by $19,790 millions ($63,448 – $43,658) relative to the prior year. (b) Apple's accounts payable at September 27, 2014, $30,196 millions. (c) The other components of current liabilities are: Accrued expenses .......................................................... $18,453 millions Deferred revenue ......................................................... 8,491 Commercial paper........................................................ 6,308 LO 4 BT: AN Difficulty: Medium TOT: 10 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CT 10-2

(a)

COMPARATIVE ANALYSIS PROBLEM

VF Corporation

Columbia Sportswear $1,266,041 (1) Current ratio

$373,120

$4,185,854 $1,620,241

= 3.39:1

= 2.58

Based on the current ratio, Columbia is more liquid than VFC. Columbia’s current ratio is 31% larger than VFC. Columbia appears much more able to meet its current obligations. (b)

VF Corporation

Columbia Sportswear (1) Debt to assets

$436,975

$4,349,258 *

= 24.4%

$1,792,209 (2) Times interest earned

$141,859 + $56,662 + $1,053 $1,053 189.5 times

= 43.6%

$9,980,190 =

$1,047,505 + $304,861 + $86,725 $86,725 = 16.6 times

*$1,620,241 + $1,423,581 + $1,305,436

The higher the percentage of debt to assets, the greater the risk that a company may be unable to meet its maturing obligations. Columbia 2014 debt to assets ratio was considerably less than VFC’s; thus, Columbia would be considered significantly better able to meet its obligations. The times interest earned provides an indication of a company’s ability to meet interest payments. Since Columbia’s times interest earned is approximately 11.4 times as large as VFC’s, Columbia had a much greater ability to meet its interest payments in 2014 than VFC. Columbia appears to be significantly more solvent. LO 4 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

CT 10-3

COMPARATIVE ANALYSIS PROBLEM

(a)

Amazon .com $31,327 (1) Current ratio

$28,089

= 1.12:1

Wal-Mart

$63,278 = 0.97:1 $65,272

Based on the current ratio, Amazon is more liquid than Wal-Mart. Amazon’s current ratio is 15% larger than Wal-Mart. Amazon appears more able to meet its current obligations. (b)

Amazon .com (1) Debt to assets

$43,764 * $54,505

(2) Times interest earned

= 80.3%

($241) + $167 + $210 $210

= 0.65 times

Wal-Mart $203,706 - $85,937

= 57.8%

$203,706

$16,363 + $7,985 + $2,461 $2,461 = 10.9 times

*$28,089 + $8,265 + $7,410

The higher the percentage of debt to assets, the greater the risk that a company may be unable to meet its maturing obligations. Wal-Mart’s 2014 debt to assets ratio was considerably less than Amazon’s; thus, Wal-Mart would be considered significantly better able to meet its obligations. The times interest earned provides an indication of a company’s ability to meet interest payments. Since Wal-Mart’s times interest earned is approximately 16.8 times as large as Amazon’s, WalMart had a much greater ability to meet its interest payments in 2014 than Amazon. Wal-Mart appears to be significantly more solvent.

LO 4 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

CT 10-4

(a)

INTERPRETING FINANCIAL STATEMENTS

Hechinger

Home Depot

Working capital

$1,153 – $938 = $215

$4,933 – $2,857 = $2,076

Current ratio

$1,153 ÷ $938 = 1.23:1

$4,933 ÷ $2,857 = 1.73:1

On both measurements Hechinger’s liquidity is low and Home Depot’s is strong. (b) Debt to assets ratio Times interest earned

$1, 339

$4, 716

= 85%

$1, 577 –$93 + $67 + $3

$13, 465

= –.34 times

$67

= 35%

$1,614 + $37 + $1,040 $37

= 72.7 times

Hechinger relied heavily on debt financing—85% of every dollar of assets was financed with debt versus only 35% by Home Depot. Hechinger’s times interest earned ratio was negative, suggesting it did not have the ability to service its debt. In contrast, Home Depot’s times interest earned ratio is exceptionally high, suggesting it could handle even more debt. (c) Return on

–$93

assets

($1, 577 + $1, 668)  2

Profit margin

–$93 $3, 444

= –5.7%

= –2.7%

$1, 614 ($13, 465 + $11, 229)  2 $1, 614 $30, 219

= 13.1%

= 5.3%

Hechinger reported negative profitability ratios because it reported a loss for the year. If you combine its low liquidity and low solvency with its inability to generate a profit, it was clearly headed for trouble.

CT 10-4 (Continued) (d)

Original $4,716 Debt to assets

$13,465

= 35%

Restated $4,716 + $2,347 = 45% $13,465 + $2,347

After treating Home Depot’s operating leases as purchases, its debt to assets ratio increases from 35% to 45%. While this suggests that its reliance on debt is actually higher than the balance sheet indicates, its reliance on debt is still quite reasonable and not cause for concern. LO 4 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

CT 10-5

INTERPRETING FINANCIAL STATEMENTS

Borders

Barnes and Noble

(a)

Current ratio

$978.7 ÷ $918.1 = 1.07 : 1

$1, 719.5 ÷ $1, 724.4 = 1.00 : 1

(b)

Debt to assets ratio

$1,257.3 ÷ $1,415.6 = 89%

$2,802.3 ÷ $3,705.7 = 76%

Times interest earned

$(109.4) + $24.1 + $(31.3) $24.1

= (4.84)times

$36.7 + $28.2 + $8.4

= 2.60times

$28.2

(c) Neither Borders nor Barnes and Noble were very liquid since their respective current ratio were only 1.07:1 and 1.0:1. Both companies had very high debt to assets ratios and their times interest earned were negative or relatively low. The bankruptcy of Borders did seem likely considering they had a very high debt to assets ratio and a negative times interest earned. In addition, its current ratio was fairly low. LO 4 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 10-6

REAL-WORLD FOCUS

(a) An ‘A’ rating means that the company has a strong capacity to meet financial commitments, but is somewhat susceptible to adverse economic conditions and changes in circumstances. A ‘C’ rating means that a company is currently highly vulnerable due to obligations and other defined circumstances. (b) Some factors that can change a company’s credit rating are new competition, changes in technology, increases or decreases in debt burdens, changes in the economy or business environment, or in the case of states or municipalities, shifts in populations or changes in taxpayer incomes. (c) To determine whether an investment has merit really depends on particular issues of importance to an individual. For example, a risky investment might have merit to a wealthy investor that can afford to take a chance in order to have the chance of a large gain. That same investment might not have merit to somebody with limited wealth who cannot afford to take large risks. Therefore, credit ratings provide important inputs in determining whether an investment would be of interest to an investor. But a high (or low) credit rating does not necessary mean that a particular investment would be a good or bad investment. LO 2, 3 BT: S Difficulty: Medium TOT: 30 min. AACSB: Analytic, Technology, and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 10-7

REAL-WORLD FOCUS

(a) If a company can determine a reasonable estimate of the expected loss and if it is probable it will lose the suit, then the company should accrue for the loss. It should debit a loss account and credit a liability account. If it cannot arrive at a reasonable estimate, or if the loss is only possible (not probable) then it should disclose the item in the notes to the financial statements. (b) The article suggests that many of these companies are paying out amounts each year, but that their liability account remains roughly the same. This would suggest that rather than accruing for the full amount of their expected costs in the year that these costs become evident, they are simply expensing costs as they pay for them. This is not consistent with the approach described in part (a) because they are not accruing for the estimated costs up front. (c) The article suggests that if a company cannot come up with a reasonable estimate of costs, but instead can only estimate a range of possible costs, then financial reporting rules say that they should accrue for the low end of the range. For example, if you thought you would lose between $1,000 and $10,000, you would accrue for $1,000. However, for insurance purposes they often report the higher number. The problem for the perspective of investors is that if they rely on the numbers reported in the financial statements they may not be well informed about the potential loss that the company may well incur. (d) International accounting rules differ from U.S. rules with regard to dealing with estimated ranges. They require in a situation where a company estimates a range of possible losses, the company should accrue for the midpoint. LO 4 BT: S Difficulty: Medium TOT: 40 min. AACSB: Analytic, Technology, and Communication AICPA FC: Reporting AICPA PC: Communication

CT 10-8

(a) 1.

DECISION MAKING ACROSS THE ORGANIZATION

Bonds Payable .......................................... Cash ................................................... Discount on Bonds Payable ............. Gain on Bond Redemption ($2,946,000 – $2,500,000) .............. (To record redemption of 8% bonds)

3,000,000 2,500,000 54,000* 446,000

*($3,000,000 – $2,946,000) 2.

Cash ........................................................... Bonds Payable................................... (To record sale of 10-year, 12% bonds at par)

2,500,000 2,500,000

(b) Dear President Marquis: The early redemption of the 8%, 5-year bonds results in recognizing a gain of $446,000 that increases current year net income by the after-tax effect of the gain. The amount of the liabilities on the balance sheet will be lowered by the issuance of the new bonds and redemption of the 5-year bonds. 1.

The cash flow of the company as it relates to bonds payable will be adversely affected as follows: Annual interest payments on the new issue ($2,500,000 X .12) ....................................................... $300,000 Annual interest payments on the 5-year bonds ($3,000,000 X .08).............................................................( 240,000) Additional cash outflows per year ................................ $ 60,000

CT 10-8 (Continued) 2.

The amount of interest expense shown on the income statement will be higher as a result of the decision to issue new bonds: Annual interest expense on new bonds.......... Annual interest expense on 8% bonds: Interest payment ........................................ Discount amortization ($54,000 ÷ 3 yrs.) ... Additional interest expense per year...............

$300,000 $240,000 18,000 (258,000) $ 42,000

These comparisons hold for only the 3-year remaining life of the 8%, 5-year bonds. The company must acknowledge either redemption of the 8% bonds at maturity, January 1, 2020, or refinancing of that issue at that time and consider what interest rates will be in 2020 in evaluating a redemption and issuance in 2017. Sincerely, LO 3 BT: AN Difficulty: Medium TOT: 45 min. AACSB: Analytic and Communication Reporting AICPA PC: Interaction, Leadership, and Communication

AICPA FC:

CT 10-9

COMMUNICATION ACTIVITY

To:

Jerry Hogan

From:

I. M. Student

Subject:

Bond Financing

The advantages of bond financing over common stock financing include: 1.

Stockholder control is not affected.

Tax savings result.

Income to common stockholders may increase.

Earnings per share of common stock may be higher.

The types of bonds that may be issued are: 1.

Secured or unsecured bonds. Secured bonds have specific assets of the issuer pledged as collateral while unsecured bonds do not.

Convertible bonds, which can be converted by the bondholder into common stock.

Callable bonds, which are subject to early redemption by the issuer at a stated amount.

State laws grant corporations the power to issue bonds after formal approval by the board of directors and stockholders. The terms of the bond issue are set forth in a legal document called a bond indenture. After the bond indenture is prepared, bond certificates are printed. LO 2 BT: C Difficulty: Easy TOT: 20 min. AACSB: None AICPA FC: Reporting AICPA PC: Communication

CT 10-10

ETHICS CASE

(a) The stakeholders in this situation include: Stockholders Creditors Employees Government inspectors Customers flying in airplanes (b) The possible courses of action and their consequences include: 1.

The CEO could inform the auditors. The auditors would then require that this information be disclosed in the annual report. When the lenders learn about this potential problem, they may decide to call their loans, and the company’s suppliers may decide to quit sending it goods. This could result in the bankruptcy of the company, even if the company was not at fault for the engine failures. However, this would be in compliance with the accounting requirement to disclose all material facts. By not disclosing, the CEO is misinforming a large number of important stakeholders.

The CEO could conceal the information from the auditors. If the company is not ultimately found at fault, then the company will not have sustained any financial hardship. However, if the company is found to be at fault for the engine failures, then not only is it likely the company will go bankrupt, but the CEO could face prosecution for failing to disclose the existence of this problem to auditors.

(c) Answer will vary according to student. (d) If the CEO conceals the information, and the company is subsequently found to be at fault, a number of stakeholders will suffer. First, the company’s creditors will lose money because it is likely the company won’t be able to repay its loans in full. The stockholders will lose because the value of their shares will plummet. The employees may well lose their jobs because the company is likely to go bankrupt. Also, it is possible that other engines might fail in the interim, possibly resulting in a crash. Answers as to whether the CEO should be punished for concealing this information will vary by student. LO 4 BT: E Difficulty: Hard TOT: 30 min. AACSB: Analytic, Ethics, and Communication AICPA FC: Reporting AICPA PC: Communication and Personal Demeanor

CT 10-11

ETHICS CASE

(a) The stakeholders include: 1. Enron management 2. Citigroup management 3. Enron investors 4. Enron creditors (b) Yes. Although the primary responsibility for proper accounting rests with company management, other knowledgable parties have secondary responsibilities. Auditors are expected to attest to full disclosure. Lenders, with access to information that is generally unavailable to others, are expected to provide full and accurate disclosure of transactions with borrowers. (c) The auditor may have been unable to detect the inappropriate accounting treatment because “secret” agreements between Enron and Citigroup were not made available for review. (d) A company may wish to conceal financing arrangements in order to appear more solvent to investors and creditors. GAAP requires full disclosure of all information that would make a difference to financial statement users. Intentionally understating liabilities is a violation of GAAP and thus inappropriate. It is unethical for lenders to market deals that circumvent GAAP. (e) The Citigroup deal was more harmful than other off-balance-sheet transactions because it was not fully explained in the financial statement notes. (The auditors didn’t even know the details.) This lack of explanation made it impossible for users of Enron's financial statements to incorporate such off-balance-sheet information into their evaluation of Enron’s performance. LO 4 BT: S Difficulty: Hard TOT: 30 min. AACSB: Analytic, Ethics, and Communication AICPA FC: Reporting AICPA PC: Communication and Personal Demeanor

CT 10-12

ALL ABOUT YOU

The answer to these questions depends on the state in which the student resides. It also will be depend on the year chosen, although we expect that the results will be much the same whether they pick any rates between 2015 and 2017. We provide a solution for this problem using the state of Wisconsin as an example. It should be pointed out that certain taxes can be deducted for computing federal income tax but are ignored in our computation. (a) Wisconsin state income tax for a single person with a taxable income of $60,000 is $3,710.80. The tax rate between $17,680 and $132,580 is $950.30 plus 6.5 percent over $17,680. Therefore the computation is as follows: ($60,000 – $17,680) X 6.5% = $2,751 Base rate 950 Total state income tax $3,701 (b) The property tax on a $200,000 home at 2.1% is $4,200. (c) The state gasoline tax in Wisconsin is 32.9 cents per gallon and the federal gasoline tax is 18.4 cents per gallon. Your total taxes on gasoline are computed as follows: 300 gallons X ($0.329 + $0.184) = $154 (d) In Wisconsin the state sales tax rate is 5% and excludes food and prescription drug purchases. Therefore the sales tax is $200 ($4,000 X 5%). (e) The social security rate is 7.65% on income of $60,000 or $4,590. (f) Federal income tax for a single person with a taxable income of $60,000 is $11,538. The tax rate between $30,650 and $74,200 is $4,220 plus 25% over $30,650. Therefore the computation is as follows: ($60,000 – $30,650) X 25% = $ 7,338 Base amount 4,220 Total tax $11,558

CT 10-12 (Continued) The total taxes paid therefore are computed as follows, based on a $60,000 income amount: State income tax .................................................................. Property tax on home.......................................................... Gasoline tax ......................................................................... Sales tax............................................................................... Social security tax ............................................................... Federal income tax .............................................................. Total tax ...............................................................................

$ 3,701 4,200 154 200 4,590 11,558 $24,403

The percentage of total taxes to income is therefore 41% ($24,403/$60,000), given the information above. LO 1 BT: AP Difficulty: Medium TOT: 60 min. AACSB: Analytic AICPA FC: Reporting

CT 10-13

FASB CODIFICATION ACTIVITY

(a) Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities. See paragraphs 210-10-45-5 through 45-12. (b) Long-term obligations are those scheduled to mature beyond one year (or the operating cycle, if applicable) from the date of an entity’s balance sheet. (c) The Codification provides the following guidance for disclosure of longterm obligations: Bonds, mortgages and other long-term debt, including capitalized leases. (1)

State separately, in the balance sheet or in a note thereto, each issue or type of obligation and such information as will indicate (see §210.4–06): (i)

The general character of each type of debt including the rate of interest; (ii) the date of maturity, or, if maturing serially, a brief indication of the serial maturities, such as “maturing serially from 1980 to 1990”; (iii) if the payment of principal or interest is contingent, an appropriate indication of such contingency; (iv) a brief indication of priority; and (v) if convertible, the basis. (2)

The amount and terms (including commitment fees and the conditions under which commitments may be withdrawn) of unused commitments for long-term financing arrangements that would be disclosed under this rule if used shall be disclosed in the notes to the financial statements if significant.

LO 1, 4 BT: S Difficulty: Medium TOT: 60 min. AACSB: Analytic, Technology, and Communication AICPA FC: Measurement AICPA PC: Communication

CT 10-14

CONSIDERING PEOPLE, PLANET AND PROFIT

(a) The monthly rates paid by borrowers on loans from these microfinance organizations is 5% to 10%. This would convert to roughly 60% (5% × 12) to 120% (10% × 12) per year. (b) These rates are incredibly high. Under most circumstances they would be considered usurious. However, the borrowers benefit because they also receive very high interest on their savings at the institution. The structure helps to smooth the ups and downs of a families cash inflows and outflows during the course of a year so that they can weather financial distruptions. (c) The organizations are structured as savings and loans. (Savings and loans used to be quite common in the U.S. until a financial crisis in the 1980s caused many of them to go bankrupt.) The organizations in the article typically only involve a small group of people (15 to 30) who pool their savings. Each buys a share in a fund from which they can borrow. All must also contribute a small sum to a social fund, which acts as micro-insurance for misfortunes suffered by members. The organizations have a limited life cycle – typically one year. At the end of the cycle all of the money accumulated by the fund is shared out to members based on their contributions. Then a new cycle begins. LO - BT: S Difficulty: Medium TOT: 60 min. AACSB: Analytic, Technology, and Communication AICPA FC: Measurement AICPA PC: Communication

IFRS EXERCISES IFRS 10-1 The similarities between GAAP and IFRS include: (1) the basic definition of a liability and (2) liabilities are normally reported in the order of their liquidity. Differences between GAAP and IFRS include: (1) GAAP allows straight line amortization of bond discounts and premiums, but IFRS requires the effective-interest method in all cases, (2) IFRS does not isolate unamortized bond discount or premium in a separate account, and (3) IFRS splits the proceeds from convertible bonds into debt and equity components. LO 8 BT: C Difficulty: Easy TOT: 10 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS 10-2 (a) Jan.

Cash (€2,000,000 X .97) .......................... 1,940,000 Bonds Payable............................... 1,940,000

(b) Jan.

Cash (€2,000,000 X 1.04) ........................ 2,080,000 Bonds Payable............................... 2,080,000

LO 3, 8 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

IFRS 10-3 Cash (£4,000,000 X .99) ................................................... 3,960,000 Bonds Payable ........................................................ 3,800,000 Share Premium—Conversion Equity .................... 160,000 LO 3, 8 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

IFRS10-4

INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) Total current liabilities for the Louis Vuitton at December 31, 2014 were €12,175 million, including provisions of €332 million. (b) Gross long-term borrowings total €5,054 million, consisting of bonds and medium term notes of €4,794, finance leases of €116 and bank borrowings of €144. (c) The borrowings are measured at amortized cost. (d) The gross amount of fixed-rate borrowings is €7,689. The gross amount of adjustable-rate (floating) borrowings is €1,554. LO 4, 8 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

CHAPTER 11 Reporting and Analyzing Stockholders’ Equity Learning Objectives 1. Discuss the major characteristics of a corporation. 2. Explain how to account for the issuance of common and preferred stock, and the purchase of treasury stock. 3. Explain how to account for cash dividends and describe the effect of stock dividends and stock splits. 4. Discuss how stockholders’ equity is reported and analyzed. *5. Prepare entries for stock dividends.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5. 6. 1. 2. 3. 1. 2a. 1. 2. 3. 4.

1 1 1 1 1 2 1 2 2 1 2 2 2 2, 4 2, 4

BT C C C K K K K AP AP C AP AP AP AP C

1. 2, 4, AP 2. 2, 3, 4 AP

Item 7. 8. 9. 10. 11.

4. 5. 6. 2b.

5. 6. 7. 8. 3. 4.

Item

AP C C C C

Questions 12. 4 C 13. 4 C 14. 3 K 15. 3 C 16. 3 C

17. 18. 19. 20. 21.

3 3 3 4 4

C C C K C

22. 23. 24. 25. 26.

4 4 4 4 4

C C C C C

Brief Exercises 7. 3 K 8. 4 AP

9. 10.

4 4

C AP

11. 12.

4 5*

AP AP

Do It! Exercises 3a. 3 AP

3b.

4a. 4b.

4 4

AP AP

AN AP AP AP

Exercises 9. 4 AP 10. 4 AP 11. 4 AP 12. 4 AP

13. 14. 15. 16.

4 4 4 5*

AN AN AN AP

2, 3, 4 AP 3, 4 AP

Problems: Set A 5. 2, 4, AP 6. 2, 3, 4 AP

7. 8.

4 3, 4, 5*

AP AP

2 2 2 2 3

2 3 3 2

2 3 3 4

AP AP AP

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Journalize stock transactions, post, and prepare paid-in capital section.

Simple

30–40

Journalize transactions, post, and prepare a stockholders’ equity section; calculate ratios.

Moderate

40–50

Prepare a stockholders’ equity section.

Moderate

20–30

Reproduce Retained Earnings account, and prepare a stockholders’ equity section.

Moderate

30–40

Prepare entries for stock transactions, and prepare a stockholders’ equity section.

Moderate

20–30

Prepare a stockholders’ equity section.

Simple

20–30

Evaluate a company’s profitability and solvency.

Moderate

20–30

*8A

Prepare dividend entries, prepare a stockholders’ equity section, and calculate ratios.

Moderate

40–50

ANSWERS TO QUESTIONS 1.

(a)

Separate legal existence. A corporation is separate and distinct from its owners and it acts in its own name rather than in the name of its stockholders. In contrast to a partnership, the acts of the owners (stockholders) do not bind the corporation unless the owners are agents of the corporation.

(b)

Limited liability of stockholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of stockholders is normally limited to their investment in the corporation.

(c)

Transferable ownership rights. Ownership of a corporation is shown in shares of capital stock. The shares are transferable units. Stockholders may dispose of part or all of their interest by simply selling their stock. The transfer of ownership to another party is entirely at the discretion of the stockholder.

LO 1 BT: K Difficulty: Easy TOT: 3 min. Legal/Regulatory Perspective 2.

AACSB: None AICPA FC: Reporting

AICPA BB:

(a) Corporate management is an advantage to a corporation because it can hire professional managers to run the company. Corporate management is a disadvantage to a corporation because it prevents owners from having an active role in directly managing the company. (b)

Two other disadvantages of a corporation are government regulations and additional taxes. A corporation is subject to numerous state and federal regulations. For example, state laws prescribe the requirements for issuing stock, and federal securities laws govern the sale of stock to the general public. Corporations must pay both federal and state income taxes. These taxes are substantial. In addition, stockholders must pay income taxes on cash dividends received.

LO 1 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 3.

Nona is incorrect. A corporation must be incorporated in only one state. It is to the company’s advantage to incorporate in a state whose laws are favorable to the corporate form of business organization. A corporation may incorporate in a state in which it does not have a headquarters’ office or major operating facilities.

LO 1 BT: K Difficulty: Easy TOT: 2 min. Legal/Regulatory Perspective 4.

AACSB: None AICPA FC: Reporting

AICPA BB:

In the absence of restrictive provisions, the basic ownership rights of common stockholders are the rights to: (1) (2) (3) (4)

vote in the election of the board of directors and in corporate actions that require stockholders’ approval. share in corporate earnings. maintain the same percentage ownership when additional shares of common stock are issued (the preemptive right). share in assets upon liquidation.

LO 1 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: reporting AICPA BB: Legal/Regulatory Perspective

Legally, a corporation is an entity, separate and distinct from its owners. As a legal entity, a corporation possesses most of the privileges and is subject to the same duties and responsibilities as a natural person. The corporation acts under its own name rather than under the names of its stockholders. A corporation may buy, own, and sell property, borrow money, enter into legally binding contracts, and sue or be sued.

LO 1

BT: K Difficulty: Easy TOT: 3 min. Legal/Regulatory Perspective

The principal components of stockholders’ equity for a corporation are paid-in capital and retained earnings.

AACSB: None

AICPA

FC: reporting

AICPA

BB:

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 7.

The maximum number of shares that a corporation is legally allowed to issue is the number authorized. Gage Corporation is authorized to sell 100,000 shares. Of these shares, 70,000 shares have been issued. Outstanding shares are those issued shares which have not been reacquired by the corporation; in other words, issued shares less treasury shares. Gage has 66,000 shares outstanding (70,000 issued less 4,000 treasury).

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 8.

The relative par values should have no effect on the investment decision. The par value of common stock has no effect on its market value. Par value used to be a legal amount per share which usually indicated the minimum amount at which a share of stock can be issued. Therefore, either stock mentioned in the question could be the better investment.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 9.

A corporation may acquire treasury stock (1) to reissue the shares to officers and employees under bonus and stock compensation plans, (2) to increase trading of the company’s stock in the securities market in the hopes of enhancing its market value, (3) to have additional shares available for use in the acquisition of other companies, (4) to reduce the number of shares outstanding and, thereby, increase earnings per share, or (5) to avoid a takeover of the company by investors that are hostile to management.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 10.

When treasury stock is purchased, Treasury Stock is debited and Cash is credited at cost ($11,000 in this example). Treasury stock is a contra stockholders’ equity account and cash is an asset. Thus, this transaction has (a) no effect on net income, (b) decreases total assets, (c) has no effect on total paid-in capital, and (d) decreases total stockholders’ equity.

LO 2 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 11.

(a) Common stock and preferred stock both represent ownership of the corporation. Common stock signifies the basic residual ownership; preferred stock is ownership with certain privileges or preferences. Preferred stockholders typically have a preference as to dividends and as to assets in the event of liquidation. However, preferred stockholders generally do not have voting rights.

(b)

Some preferred stocks possess the additional feature of being cumulative. Cumulative preferred stock means that preferred stockholders must be paid both current year dividends and unpaid prior year dividends before common stockholders receive any dividends.

(c)

Dividends in arrears are disclosed in the notes to the financial statements.

LO 3 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 12.

The debits and credits to retained earnings are:

1. 2.

Debits Net loss Cash and stock dividends

Credits Net income

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

13.

The answers are summarized in the table below:

(a) (b) (c) (d)

Account Common Stock Paid-in Capital in Excess of Par Value Retained Earnings Treasury Stock

(e) (f)

Paid-in Capital in Excess of Stated Value Preferred Stock

Classification Paid-in capital—capital stock Paid-in capital—additional paid-in capital Retained earnings Deducted from total paid-in capital and retained earnings Paid-in capital—additional paid-in capital Paid-in capital—capital stock

LO 4 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 14.

For a cash dividend to be paid, a corporation must have retained earnings, adequate cash, and a dividend declared by the board of directors.

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 15.

May 1 is the date on which the board of directors formally declares (authorizes) and announces the cash dividend. May 15 is the record date which marks the time when ownership of outstanding shares is determined for dividend purposes from the stockholders’ records. May 31 is the date when the dividend checks are mailed to stockholders. Accounting entries are made on May 1 (debit Cash Dividends and credit Dividends Payable), and on May 31 (debit Dividends Payable and credit Cash).

LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 16.

A cash dividend decreases assets, retained earnings, and total stockholders’ equity. A stock dividend decreases retained earnings, increases paid-in capital, and has no effect on total assets and total stockholders’ equity.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

17.

Doris is incorrect. A corporation generally issues stock dividends for one of the following reasons: (1) (2)

(3)

To satisfy stockholders’ dividend expectations without spending cash. To increase the marketability of its stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes it easier for small investors to purchase shares. To emphasize that a portion of stockholders’ equity that had been reported as retained earnings has been permanently reinvested in the business and therefore is unavailable for cash dividends.

LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 18.

In a stock split, the number of shares is increased in the same proportion that par value is decreased. Thus, in Jayne Corporation the number of shares will increase to 30,000 (10,000 X 3) and the par value will decrease to $5 ($15 ÷ 3). The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $40 per share ($120 ÷ 3).

LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 19.

The different effects of a stock split versus a stock dividend are: Item Total paid-in capital Total retained earnings Total par value (common stock) Par value per share

Stock Split No change No change No change Decrease

Stock Dividend Increase Decrease Increase No change

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

20.

The cost of Apple’s treasury stock at September 27,2014 was $45,000 million. It declared cash dividends of $11,215 million. The stock split declared in 2014 was 7 to 1.

LO 3 BT: AN Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 21.

(a)

The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends.

(b)

Restrictions may result from the following causes: legal, contractual, or voluntary.

LO 4 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 22.

Par value is a legal amount per share, often set at an arbitrarily selected amount, which usually indicates the minimum amount at which a share of stock can be issued. Market value is generally unrelated to par value. A stock’s market value will reflect many factors, including the company’s anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the securities markets.

LO 1 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

23.

The payout ratio is computed by dividing cash dividends declared on common stock by net income. The payout ratio indicates the percentage of earnings distributed as cash dividends to common stockholders.

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 24.

Debt financing will increase the return on common stockholders’ equity when the return on assets exceeds the interest rate paid on debt.

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 25.

The return on assets will equal the return on common stockholders’ equity when a company has no preferred dividends or debt.

LO 4 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 26.

The issuance of bonds combined with a reduction in outstanding shares increases the company’s reliance on debt financing which will be reflected in an increase of the debt to assets ratio. The return on common stockholders’ equity should increase because the company’s return on assets exceeds the interest rate on the new debt and because the amount of stockholders’ equity in the denominator of the ratio has been reduced.

LO 4 BT: AN Difficulty: Hard TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 The advantages and disadvantages of a corporation are as follows: Advantages Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporate management— professional managers

Disadvantages Corporate management— separation of ownership and management Government regulations Additional taxes

LO 1 BT: K Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement

BRIEF EXERCISE 11-2 May 10 Cash (2,500 X $13) ....................................... Common Stock (2,500 X $5) ................. Paid-in Capital in Excess of Par Value—Common Stock (2,500 X $8) .........................................

32,500 12,500 20,000

(Common stock = Number of shares issued × per value per share) LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 11-3 June 1 Cash (3,000 X $7) ......................................... Common Stock .....................................

21,000

LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

21,000

BRIEF EXERCISE 11-4 Cash (8,000 X $106).................................................... Preferred Stock (8,000 X $100) ........................... Paid-in Capital in Excess of Par Value— Preferred Stock (8,000 X $6) ............................

848,000 800,000 48,000

(Preferred stock = Number of shares used × per value per share) LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 11-5 Nov.

Dec. 31

Cash Dividends (7,000 X $1) .................... Dividends Payable ............................

7,000

Dividends Payable.................................... Cash ...................................................

7,000

7,000 7,000

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 11-6

(a) Stockholders’ equity Paid-in capital Common stock, $8 par Paid in capital in excess of par value—common stock Total paid-in capital Retained earnings Total stockholders’ equity

Before Dividend

After Dividend

$1,000,000

$1,100,000

– 1,000,000 300,000 $1,300,000

137,500 1,237,500 62,500 $1,300,000

(A stock dividend reduces retained earnings by the number of shares issued × Market price per share.

(b) Outstanding shares

125,000

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

137,500

BRIEF EXERCISE 11-7 Total Total Total Stockholders’ Assets Liabilities Transaction Equity (a) Declared cash dividend N/A + – (b) Paid cash dividend declared in (a) – – N/A (c) Declared stock dividend N/A N/A N/A (d) Distributed stock dividend declared in (c) N/A N/A N/A (e) Split stock three-for-one N/A N/A N/A LO 3 BT: K Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 11-8 Stockholders’ equity Paid-in capital Capital stock Common stock, $10 par value, 5,000 shares issued and 4,500 shares outstanding ................... $ 50,000 Additional paid-in capital Paid-in capital in excess of par value— common stock ................................ ....................... 22,000 Total paid-in capital ............................................. 72,000 Retained earnings ..................................................................... 42,000 Total paid-in capital and retained earnings ....... 114,000 Less: Treasury stock (500 shares).......................................... (11,000) Total stockholders’ equity .................................. $103,000 LO 4 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 11-9 Payout ratio—last year =

$120,000

= 20%

$600,000 Dividends paid this year = $1,600,000 X .20 = $320,000 (assuming the same payout ratio) Maintaining a constant payout ratio may be considered a sign of stability from the stockholders’ perspective. However, maintaining a constant payout ratio may have a negative impact on the company’s cash flow and its ability to grow. LO 4 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

BRIEF EXERCISE 11-10 Return on stockholders’ equity =

Net income–Preferred dividends Average common stockholders’ equity $393 – $0 = 14.37% ($2,581+ $2,887) ÷ 2

Supervalu’s 14.37% return on stockholders’ equity indicates that about 14 cents of net income was earned for each dollar invested by common stockholders. LO 4 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 11-11 Income before interest and taxes Interest ($2,000,000 X 6%) Income before income taxes Income tax expense (30%) Net Income (a) Outstanding shares (b) Earnings per share (a) ÷ (b)

Issue Stock $1,500,000 0 1,500,000 450,000 $1,050,000

Issue Bond $1,500,000 120,000 1,380,000 414,000 $ 966,000

900,000 $1.17

700,000 $1.38

Net income is higher if stock is used. However, earnings per share is lower than earnings per share if bonds are used because of the additional shares of stock that are outstanding. Issuance of bonds is preferable since earnings per share is higher under this alternative. LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 11-12 Dec. 1

Stock Dividends (24,000 X $17) ..................... Common Stock Dividends Distributable (24,000 X $10) ......................................... Paid-in Capital in Excess of Par Value— Common Stock (24,000 X $7)...........................................

408,000

Common Stock Dividends Distributable ...... Common Stock .........................................

240,000

240,000 168,000

(Stock Dividends = Number of shares issued × Market price per share) LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

240,000

SOLUTIONS TO DO IT! EXERCISES DO IT! 11-1 1. 2. 3. 4. 5.

True. True. False. Additional government regulation is a disadvantage of the corporate form of business. True. False. No-par value stock is quite common today.

LO 1 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement

DO IT! 11-2a Apr. 1

Cash (55,000 × $13) ........................................ Common Stock (55,000 × $5) ................... Paid-in Capital in Excess of Par Value—Common Stock...................

715,000

Cash (1,000 × $6) ............................................ Preferred Stock (1,000 × $1)..................... Paid-in Capital in Excess of Par Value—Preferred Stock ..................

6,000

275,000 440,000 1,000 5,000

LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 11-2b Aug. 1

Treasury Stock .............................................. Cash...........................................................

76,000

(Treasury stock is recorded at cost) LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

76,000

DO IT! 11-3a (1) The company has not missed past dividends and the preferred stock is noncumulative; thus, the preferred stockholders are paid only this year’s dividend. The dividend paid to preferred stockholders would be $24,000 (3,000 X .08 X $100). The dividend paid to common stockholders would be $81,000 ($105,000 – $24,000). (2) The preferred stock is noncumulative; thus, past unpaid dividends do not have to be paid. The dividend paid to preferred stockholders would be $24,000 (3,000 X .08 X $100). The dividend paid to common stockholders would be $81,000 ($105,000 – $24,000). (3) The preferred stock is cumulative; thus, dividends that have been missed in the past (dividends in arrears) must be paid. The dividend paid to preferred stockholders would be $72,000 (3 X 3,000 X .08 X $100). The dividend paid to common stockholders would be $33,000 ($105,000 – $72,000). LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 11-3b (a) 1.

The stock dividend amount is $3,000,000 [(400,000 X 15%) X $50]. The new balance in retained earnings is $9,000,000 ($12,000,000 – $3,000,000).

The retained earnings after the stock split would be the same as it was before the split: $12,000,000.

(A stock dividend reduces retained earnings by the number of shares used × market price per share)

DO IT! 11-3b (Continued) (b) (1) and (2) The effects on the stockholders’ equity accounts are as follows:

Paid-in capital Retained earnings Total stockholder’s equity Shares outstanding

Original Balance $ 2,400,000 12,000,000 $14,400,000 400,000

After Dividend $ 5,400,000 9,000,000 $14,400,000 460,000

After Split $ 2,400,000 12,000,000 $14,400,000 800,000

Total stockholders’ equity remains the same under both options. (Paid in capital is increased by the total amount of the stock dividend)

(c) 1. The stock dividend will not affect the par value per share. It remains at $2. 2. The 2-for-1 stock split will cut the par value per share in half. It will be $1($2 × 1/2). LO 3 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 11-4a HOYLE CORPORATION Balance Sheet (Partial) Stockholders’ equity Paid-in capital Capital Stock 9% preferred stock, $100 par value, 10,000 shares authorized, 2,000 shares issued and outstanding....... Common stock, $5 par value, 500,000 shares authorized, 100,000 shares issued, and 93,000 shares outstanding .............. Total capital stock ....................... Additional paid-in capital Paid-in capital in excess of par value— preferred stock ................................. Paid-in capital in excess of par value— common stock .................................. Total additional paid-in capital ... Total paid-in capital ..................... Retained earnings ............................................. Total paid-in capital and retained earnings...................... Accumulated other comprehensive income.... Less: Treasury stock (7,000 shares) (at cost) .................................................. Total stockholders’ equity ..........

$200,000

500,000 $ 700,000 23,000 263,000

LO 4 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

286,000 986,000 372,000 1,358,000 67,000 46,000 $1,379,000

DO IT! 11-4b (a)

2016 ($100,000– $30,000) Return on common = 10.4% stockholders’ equity ($600,000 + $750,000) /2

2017 ($110,000– $30,000)

= 10.1%

($750,000 + $830,000)/2

(b) Between 2016 and 2017, return on common stockholders’ equity decreased from 10.4% to 10.1%. It is important to note that even though net income increased during this period average common stockholders’ equity increased more causing the return percentage to slightly decrease. LO 4 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement

SOLUTIONS TO EXERCISES EXERCISE 11-1 (a) Jan. 10 July

Cash (30,000 X $5)................................ Common Stock..............................

150,000

Cash (60,000 X $7)................................ Common Stock (60,000 X $5) ....... Paid-in Capital in Excess of Par Value—Common Stock (60,000 X $2) ...............................

420,000

150,000 300,000 120,000

(Common stock = Number of shares issued × Par value per share)

(b) Jan. 10

July

Cash (30,000 X $5)................................ Common Stock (30,000 X $1) ....... Paid-in Capital in Excess of Stated Value—Common Stock (30,000 X $4) ...............................

150,000

Cash (60,000 X $7)................................ Common Stock (60,000 X $1) ....... Paid-in Capital in Excess of Stated Value—Common Stock (60,000 X $6) ...............................

420,000

30,000 120,000

(Common stock = Number of shares issued × Par value per share) LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

60,000 360,000

EXERCISE 11-2 June

July

Nov.

Cash.......................................................... Common Stock (80,000 X $1)........... Paid-in Capital in Excess of Par Value—Common Stock .................

300,000

Cash (3,000 X $106) ................................. Preferred Stock (3,000 X $100) ........ Paid-in Capital in Excess of Par Value—Preferred Stock (3,000 X $6).....................................

318,000

Treasury Stock ........................................ Cash...................................................

9,000

80,000 220,000 300,000

18,000 9,000

(Preferred stock = Number of shares issued × Par value per share) LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-3 (a) Feb. 1 Cash (40,000 X $51) .............................. Preferred Stock (40,000 X $50) ..... Paid-in Capital in Excess of Par Value—Preferred Stock (40,000 X $1)................................

2,040,000

July 1 Cash (60,000 X $56) .............................. Preferred Stock (60,000 X $50) ..... Paid-in Capital in Excess of Par Value—Preferred Stock (60,000 X $6)................................

3,360,000

2,000,000 40,000 3,000,000 360,000

(Preferred stock = Number of shares issued × Par value per share)

(b) Preferred Stock 2/1 2,000,000 7/1 3,000,000 5,000,000

Paid-in Capital in Excess of Par Value—Preferred Stock 2/1 40,000 7/1 360,000 400,000

EXERCISE 11-3 (Continued) (c) Preferred Stock—listed first in paid-in capital under capital stock. Paid in Capital in Excess of Par Value—Preferred Stock—listed first under additional paid-in capital. LO 2, 4 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-4 (a) Common stock outstanding is 574,000 shares. (Issued shares 580,000 less treasury shares 6,000.) (b) The stated value of the common stock is $5 per share. (Common stock issued $2,900,000 ÷ 580,000 shares.) (c) The par value of the preferred stock is $100 per share. (Preferred stock $600,000 ÷ 6,000 shares.) (d) The dividend rate is 6% ($36,000 ÷ $600,000). (e) The Retained Earnings balance is still $1,158,000. Cumulative dividends in arrears are only disclosed in the notes to the financial statements. LO 2, 4 BT: C Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-5 May

Cash (8,000 X $13) .................................... Common Stock (8,000 X $10) ........... Paid-in Capital in Excess of Par Value—Common Stock (8,000 X $3) .....................................

104,000

Cash (10,000 X $53) .................................. Preferred Stock (10,000 X $20) ......... Paid-in Capital in Excess of Par Value—Preferred Stock (10,000 X $33) .................................

530,000

Treasury Stock (600 X $12) ...................... Cash ...................................................

7,200

80,000

24,000 200,000 330,000 7,200

LO 2 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-6 (a) June 15 Cash Dividends (69,000* X $1.50)..... Dividends Payable .....................

103,500 103,500

*60,000 shares + 9,000 shares July 10 Dividends Payable ............................ Cash ............................................

103,500

Dec. 15 Cash Dividends (73,000** X $1.60) ... Dividends Payable .....................

116,800

103,500 116,800

**69,000 shares + 4,000 shares (Cash dividends = Number of shares outstanding × dividend per share)

(b) In the retained earnings statement, dividends of $220,300 will be deducted. In the balance sheet, Dividends Payable of $116,800 will be reported as a current liability. LO 3 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-7

Stockholders’ equity Paid-in capital Retained earnings Total stockholders’ equity Outstanding shares

Before Action

After Stock Dividend

After Stock Split

$ 648,000 400,000

$ 716,850 331,150

$ 648,000 400,000

$1,048,000 81,000

$1,048,000 85,050

$1,048,000 162,000

(A stock dividend reduces retained earnings by the number of shares issued × market price per share) LO 3 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-8 WELLS FARGO & COMPANY Partial Balance Sheet December 31, 2017 (in millions) Stockholders’ equity Paid-in capital Capital stock Preferred stock................................................. Common stock, $123 par value, 6 billion shares authorized, 5,245,971,422 shares issued, and 5,178,624,593 shares outstanding .............. Total capital stock ...................................... Additional paid-in capital Paid-in capital in excess of par value— common stock.............................................. Total paid-in capital .................................... Retained earnings ................................................. Total paid-in capital and retained earnings ................................................. Accumulated other comprehensive income ......... Less: Treasury stock (67,346,829 shares) ............ Total stockholders’ equity .........................

$8,485

8,743

LO 4 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

$ 17,228 52,878 70,106 41,563 111,669 8,327 2,450 $117,546

EXERCISE 11-9 RYDER CORPORATION Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, noncumulative, 6,000 shares issued ........................... $ 600,000 Common stock, no par, $2 stated value, 800,000 shares issued, and 788,000 shares outstanding ........................................... 1,600,000 Total capital stock ......................... $2,200,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ..................... 45,000 Paid-in capital in excess of stated value—common stock ........................ 1,050,000 Total additional paid-in capital ..... 1,095,000 Total paid-in capital ....................... 3,295,000 Retained earnings ............................................... 1,334,000 Total paid-in capital and retained earnings........................ 4,629,000 Less: Treasury stock (12,000 common shares) ......................... 72,000 Total stockholders’ equity ............ $4,557,000 LO 4 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-10 PAISAN INC. Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $50 par value, 40,000 shares authorized, 14,000 shares issued ....................... $ 700,000 Common stock, no-par, $1 stated value, 400,000 shares authorized, 250,000 shares issued and 241,000 outstanding .......................................... 250,000 Total capital stock ....................... $ 950,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock .................... 24,000 Paid-in capital in excess of stated value—common stock ..................... 1,200,000 Total additional paid-in capital ... 1,224,000 Total paid-in capital ..................... 2,174,000 Retained earnings (See Note R) ....................... 920,000 Total paid-in capital and retained earnings...................... 3,094,000 Accumulated other comprehensive loss......... 31,000 Less: Treasury stock (9,000 common shares) ........................ 64,000 Total stockholders’ equity .......... $2,999,000 Note R: Retained earnings restricted for plant expansion, $100,000. LO 4 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-11 Payout ratio

Return on common stockholders’ equity

2017 $298 = 59.1% $504

2016 $611 = 110.1% $555

$504 – $40 =18.3% $2,532

$555 – $40 =19.9% $2,591

Flintlock Corporation’s dividends decreased over 51% even though its net income decreased only 9% and return on stockholders’ equity decreased 8%. The company’s dividend policies should be reviewed for an explanation of these inconsistencies. (Return on common stockholders’ equity = (Net income – preferred dividends ÷ Average common stockholders’ equity) LO 4 BT: AP Difficulty: Easy TOT: 8 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 11-12 Payout ratio

Return on common stockholders’ equity

2017 $471 = 23.5% $2,006 $2,006 – $0 = 14.7% $13,622.5

2016 394

= 18.3%

$2,157 $2,157 – $0 = 18% $11,986.5

Walgreen’s payout ratio increased 28% even though its return on common stockholders’ equity and net income decreased by 18% and 7% respectively. The company’s dividend policies should be reviewed for an explanation. (Payout ratio = Common dividends ÷ Net income) LO 4 BT: AP Difficulty: Easy TOT: 8 min. AACSB: Analytic AICPA FC: Measurement

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

EXERCISE 11-13 (a) 2017:

$182,000– $8,000 = 17.4% $1,000,000

2016:

$150,000 – $8,000 = 20.3% $700,000

(Return on common stockholders’ equity = (Net income – preferred dividends) ÷ Average common stockholders’ equity)

(b) Kojak Corporation’s net income increased in part because it retired bonds and eliminated the interest expense associated with the bonds. Such an increase in income would produce an increase in return on common equity if stockholders’ equity had remained constant. In this example, common stockholders’ equity increased by 43% [($1,000,000 – $700,000) ÷ $700,000] while income increased by only 21%. (c) 2017:

$200,000 = 16.7% $1,200,000

2016:

$500,000 = 41.7% $1,200,000

Kojak Corporation retired all of its long term debt on January 1, 2017. This decreased its debt to assets ratio from 41.7% to 16.7%. Kojak Corporation would be considered to be very solvent. (Debt to assets ratio = Total liabilities ÷ Total assets) LO 4 BT: AN Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement

EXERCISE 11-14

Income before interest and taxes ......... Interest ($2,000,000 X 12%) ................... Income before taxes .............................. Income tax expense (30%) .................... Net income ............................................. Outstanding shares ............................... Earnings per share ................................

(a) Plan One Issue Stock $800,000

(b) Plan Two Issue Bonds $800,000 240,000 560,000 168,000 $392,000 90,000 $4.36

800,000 240,000 $560,000 140,000 $4.00

(Earnings per share = Net income ÷ Number of shares outstanding) LO 4 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 11-15 (a) Pre-debt net income .............................. Adjustment for interest expense ($400,000 X .04) ................................... Net income ............................................. Outstanding shares ............................... Earnings per share ................................

2016 $100,000

2017 $100,000

0 $100,000 40,000 $ 2.50

16,000 $ 84,000 20,000 $ 4.20

(Interest expense = Face value of debt × interest rate)

(b) Net income Average common stockholders’ equity

2016 $ 100,000 = 10% $1,000,000

2017 $ 84,000 = 14% $600,000

0 =0 $1,000,000

$ 400,000 = 40% $1,000,000

EXERCISE 11-15 (Continued) (d) The issuance of debt reduced the company’s net income because of the interest cost that was incurred. However, the debt significantly increased the company’s earnings per share because it was used to acquire treasury stock. This reduced the number of outstanding shares, thus increasing earnings per share. The issuance of debt also increased the company’s leverage. Because the interest rate paid on the debt was only 4% but the company’s return on assets was 10%, the company was able to earn much more on each dollar invested in assets than it was paying on the debt. Thus, it was able to significantly increase its return on common stockholders’ equity. This was especially true because it used the debt to repurchase shares of stock. The issuance of the debt did, however, reduce the company’s solvency. Prior to the debt, the company had no liabilities. After issuing the debt, it had a debt to total assets ratio of 40%. Investors might be concerned that the increased reliance on debt has made the company too risky. The determination as to whether this was a good decision depends on one’s opinion regarding the tradeoff between the increased risk versus the increased return. LO 4 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 11-16 (a) Stock Dividends (22,500* X $15) ........................ Common Stock Dividends Distributable (22,500 X $10)...................... Paid-in Capital in Excess of Par Value— Common Stock (22,500 X $5) ...................

337,500 225,000 112,500

*[($1,200,000 ÷ $10) + 30,000] X 15% (Stock dividends = Number of shares to be issued × Market price per share)

(b) Stock Dividends (40,500* X $8) .......................... Common Stock Dividends Distributable (40,500 X $5)........................ Paid-in Capital in Excess of Par Value— Common Stock (40,500 X $3) ...................

324,000

*[($1,200,000 ÷ $5) + 30,000] X 15% (Stock dividends = Number of shares to be issued × Market price per shares) LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

202,500 121,500

SOLUTIONS TO PROBLEMS PROBLEM 11-1A (a) Jan. 10

Mar. 1

May

Sept. 1

Nov. 1

Cash (70,000 X $4)............................. Common Stock (70,000 X $1) .... Paid-in Capital in Excess of Stated Value—Common Stock (70,000 X $3)..................

280,000

Cash (12,000 X $53)........................... Preferred Stock (12,000 X $50) .... Paid-in Capital in Excess of Par Value—Preferred Stock (12,000 X $3) ............................

636,000

Cash (120,000 X $6)........................... Common Stock (120,000 X $1) .. Paid-in Capital in Excess of Stated Value—Common Stock (120,000 X $5)................

720,000

Cash (5,000 X $5)............................... Common Stock (5,000 X $1) ...... Paid-in Capital in Excess of Stated Value—Common Stock (5,000 X $4)....................

25,000

Cash (3,000 X $56)............................. Preferred Stock (3,000 X $50) .... Paid-in Capital in Excess of Par Value—Preferred Stock (3,000 X $6) ..............................

168,000

70,000

210,000 600,000 36,000 120,000

600,000 5,000

20,000 150,000 18,000

(Paid-in capital in excess of par or stated value = Number of shares issued × (Market price per share – Par or stated value per share))

(b) Preferred Stock 3/1 600,000 11/1 150,000

Paid-in Capital in Excess of Par Value—Preferred Stock 3/1 36,000 11/1 18,000

12/31 Bal. 750,000

12/31 Bal.

54,000

PROBLEM 11-1A (Continued) Common Stock 1/10 70,000 5/1 120,000 9/1 5,000 12/31 Bal. 195,000

(c)

Paid-in Capital in Excess of Stated Value—Common Stock 1/10 210,000 5/1 600,000 9/1 20,000 12/31 Bal. 830,000

TIDAL CORPORATION Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 6% Preferred stock, $50 par value, 20,000 shares authorized and 15,000 shares issued.............................. $750,000 Common stock, no-par, $1 stated value, 500,000 shares authorized, 195,000 shares issued .......................................... 195,000 Total capital stock .................. Additional paid-in capital Paid-in capital in excess of par value— preferred stock ............... 54,000 Paid-in capital in excess of stated value— common stock................ 830,000 Total additional paid-in capital ................................... Total paid-in capital................

LO 2, 4 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

$ 945,000

884,000 $1,829,000

PROBLEM 11-2A (a) Feb.

1 Cash .......................................................... Common Stock (5,000 X $4) ............. Paid-in Capital in Excess of Stated Value—Common Stock......

30,000

Mar. 20 Treasury Stock (1,000 X $7) ..................... Cash ...................................................

7,000

Oct.

1 Cash Dividends ($300,000 X .07) ............. Dividends Payable ............................

21,000

1 Dividends Payable ................................... Cash ...................................................

21,000

124,500

Nov. Dec.

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

20,000 10,000 7,000 21,000 21,000

[250,000* + 5,000 – (5,000 + 1,000)] X $.50

Dividends Payable ............................ Dec. 31 31

124,500

Income Summary ..................................... Retained Earnings.............................

280,000

Retained Earnings.................................... Cash Dividends ($21,000 + $124,500) ........................

145,500

Dividends Payable ................................... Cash ...................................................

124,500

280,000

145,500 124,500

*$1,000,000 ÷ $4 (Cash dividends = Number of shares outstanding × dividend per share)

(b)

300,000 300,000

Paid-in Capital in Excess of Par Value—Preferred Stock 1/1 Bal. 15,000 12/31 Bal. 15,000

Common Stock 1/1 Bal. 1,000,000 2/1 20,000 12/31 Bal. 1,020,000

Paid-in Capital in Excess of Stated Value—Common Stock 1/1 Bal. 480,000 2/1 10,000 12/31 Bal. 490,000

Preferred Stock 1/1 Bal. 12/31 Bal.

PROBLEM 11-2A (Continued) 12/31

Retained Earnings 145,500 1/1 Bal. 688,000 12/31 280,000 12/31 Bal. 822,500

Cash Dividends 10/1 21,000 12/1 124,500 12/31 12/31 Bal. –0– (c)

Treasury Stock 1/1 Bal. 40,000 3/20 7,000 12/31 Bal. 47,000

145,500

CYRUS CORPORATION Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, noncumulative, 5,000 shares authorized, 3,000 shares issued and outstanding ................................. $ 300,000 Common stock, no-par, $4 stated value, 300,000 shares authorized, 255,000 shares issued and 249,000 shares outstanding ..................................... 1,020,000 Total capital stock .................. $1,320,000 Additional paid-in capital Paid-in capital in excess of par value— preferred stock .............. 15,000 Paid-in capital in excess of stated value— common stock............... 490,000 Total additional paid-in capital ................................... 505,000 Total paid-in capital................ 1,825,000 Retained earnings ........................................ 822,500 Total paid-in capital and retained earnings................. 2,647,500 Less: Treasury stock (6,000 common shares)............................................... 47,000

Total stockholders’ equity .....

$2,600,500

PROBLEM 11-2A (Continued) (d) Payout ratio =

$124,500

= 44.5%

$280,000

Earnings per share = *250,000 – 5,000

$280,000 – $21,000 = $259,000 = $1.05 (245,000 * + 249,000 * *) ÷ 2 247,000

**255,000 – 6,000

Return on common stockholders’ equity = $280,000 – $21,000 = $259,000 = 11.7% a b ($2,128,000 + $2,285,500 ) ÷ 2 $2,206,750 a

Beginning common stockholders’ equity: $1,000,000 + $480,000 + $688,000 – $40,000

Ending common stockholders’ equity: $1,020,000 + $490,000 + $822,500 – $47,000

(Earnings per share = (Net income – preferred dividends) ÷ Average number of common shares outstanding) LO 2 - 4 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 11-3A JONS COMPANY Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 9% Preferred stock, $100 par value, cumulative, 120,000 shares issued and outstanding ................................. $12,000,000 Common stock, $5 par value, 1,300,000 shares issued and 1,285,000 shares outstanding ........... 6,500,000 Total capital stock ....................... $18,500,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock .................... 840,000 Paid-in capital in excess of par value—common stock ........................ 1,800,000 Total additional paid-in capital ... 2,640,000 Total paid-in capital ..................... 21,140,000 Retained earnings ............................................. 2,178,000* Total paid-in capital and retained earnings...................... 23,318,000 Less: Treasury stock (15,000 shares)............ 165,000 Total stockholders’ equity .......... $23,153,000 *$1,200,000 + $3,600,000 – $1,542,000a – $1,080,000 a

1,300,000 shares issued less 15,000 shares in treasury = 1,285,000 shares; outstanding; 1,285,000 X $1.20 = $1,542,000.

(Ending retained earnings = Beginning retained earnings + Net income – dividends declared) LO 2 - 4 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 11-4A (a)

Retained Earnings Dec. 31

(b)

400,000 Jan. 1 Dec. 31 Dec. 31

Balance Balance

2,380,000 880,000 2,860,000

WAITE CORPORATION Partial Balance Sheet December 31, 2017

Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, noncumulative, 20,000 shares authorized, 10,000 shares issued and outstanding .......................................... $1,000,000 Common stock, no-par, $5 stated value, 600,000 shares authorized, 300,000 shares issued and outstanding ....................... 1,500,000 Total capital stock .................. $2,500,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ..................... 200,000 Paid-in capital in excess of stated value—common stock...................... 1,600,000 Total additional paid-in capital ..... 1,800,000 Total paid-in capital ....................... 4,300,000 Retained earnings (See Note A) ......................... 2,860,000 Total stockholders’ equity ............ $7,160,000 Note A: Retained earnings restricted for plant expansion, $160,000. LO 3, 4 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 11-5A

(a) 1.

Cash .............................................................. Preferred Stock (1,500 X $100)............. Paid-in Capital in Excess of Par Value—Preferred Stock .....................

170,000

Cash .............................................................. Common Stock (400,000 X $5) ............. Paid-in Capital in Excess of Stated Value—Common Stock .....................

3,520,000

Treasury Stock (4,000 X $9) ........................ Cash.......................................................

36,000

150,000 20,000

2,000,000 1,520,000 36,000

(Paid in capital in excess of par or stated value = Number of shares issued × (Market price per share – par or stated value per share

PROBLEM 11-5A (Continued) (b)

LAYES CORPORATION Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, noncumulative, 20,000 shares authorized, 1,500 shares issued and outstanding ................................. $ 150,000 Common stock, no-par, $5 stated value, 1,000,000 shares authorized, 400,000 shares issued, and 396,000 shares outstanding ....................... 2,000,000 Total capital stock .................. $2,150,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... 20,000 Paid-in capital in excess of stated value—common stock................ 1,520,000 Total additional paid-in 1,540,000 capital ................................... Total paid-in capital................ 3,690,000 Retained earnings................................. 82,000 Total paid-in capital and retained earnings................. 3,772,000 Accumulated other comprehensive income 51,000 Less: Treasury stock (4,000 shares) ............................ 36,000 Total stockholders’ equity ..... $3,787,000

LO 2, 4 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 11-6A

KIMBEL INC. Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Common stock, $1 par value, 2,000,000 shares authorized, 710,000* shares issued, and 690,000 shares outstanding .................................... Additional paid-in capital Paid-in capital in excess of par value— common stock ................................................ Total paid-in capital ..................................... Retained earnings ............................................................. Total paid-in capital and retained earnings .................................................... Accumulated other comprehensive income ($60,000 + $17,000)......................................................... Less: Treasury stock—common (20,000 shares) .......... Total stockholders’ equity ..........................

$ 710,000 1,780,000** 2,490,000 903,000*** 3,393,000 77,000 76,000 $3,394,000

*600,000 + 50,000 + 60,000 = 710,000 shares **$1,500,000 + (50,000 X $2) + (60,000 X $3) = $1,780,000 ***$700,000 – $207,000 + $410,000 = $903,000 (Ending retained earnings = Beginning retained earnings + Net income – Dividends declared) LO 2 - 4 BT: AP Difficulty: Easy TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 11-7A (a) (1)

2017 Return on assets

2016

$2,240,000

= 14.3%

$15,687,500 (2)

(3)

Return on common stockholders’ equity

Payout ratio

= 20.6%

$9,400,000

= 39.7%

Times interest earned

$1,026,000

$3,000,000 = 41.4%

$14,500,000

(5)

= 15.6%

= 41.0%

$2,500,000

$6,000,000 Debt to assets ratio

$2,500,000 – $300,000 $14,100,000

$2,240,000

(4)

= 14.1%

$17,763,000

$2,240,000 – $300,000

$890,000

$2,500,000

= 17.8%

$16,875,000

($2,240,000 + $500,000 + $670,000)

($2,500,000 + $140,000 + $750,000)

$500,000 = 6.8 times

$140,000 = 24.2 times

(b) Spahn’s net income declined from $2,500,000 to $2,240,000. Its return on assets increased slightly, but its return on common stockholders’ equity increased 32%. Based on these two measures, profitability improved. The payout ratio declined about 3%. (c) Spahn’s debt to assets ratio increased from 17.8% to 41.4% and its times interest earned decreased from 24.2 to 6.8 times. These changes indicate that Spahn is less solvent in 2017 than 2016. (d) It appears that the decision to issue debt to purchase common stock was wise. Spahn’s 10% interest rate was less than its return on assets of 14.3%. This resulted in the 32% increase in return on common stockholders’ equity. Although the solvency ratios declined, Spahn does not appear to be in trouble covering the extra debt. Its times interest earned ratio of 6.8 times is probably good coverage. If Spahn’s earnings start to drop, it could consider reissuing the treasury stock and paying off debt. LO 4 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*PROBLEM 11-8A

(a) Jan. 15 Cash Dividends (70,000 X $0.50) ...... Dividends Payable .....................

35,000

Feb. 15 Dividends Payable ............................ Cash ............................................

35,000

Apr. 15 Stock Dividends (7,000 X $14).......... Common Stock Dividends Distributable (7,000 X $10)...... Paid-in Capital in Excess of Par Value—Common Stock (7,000 X $4) ..............................

98,000

May

Dec.

15 Common Stock Dividends Distributable ................................... Common Stock (7,000 X $10) ....

35,000 35,000

70,000

28,000 70,000 70,000

1 Cash Dividends (77,000 X $0.60) ...... Dividends Payable .....................

46,200

31 Income Summary .............................. Retained Earnings......................

400,000

31 Retained Earnings............................. Stock Dividends .........................

98,000

31 Retained Earnings............................. Cash Dividends ..........................

81,200

46,200 400,000 98,000 81,200

(Common stock dividends distributable = (Number of shares outstanding × 10%) × par value per share))

(b) Common Stock 1/1 Bal. 700,000 5/15 70,000 12/31 Bal. 770,000

12/31 12/31

Retained Earnings 98,000 1/1 Bal. 620,000 81,200 12/31 400,000 12/31 Bal. 840,800

*PROBLEM 11-8A (Continued) Paid-in Capital in Excess of Par Value 1/1 Bal. 500,000 4/15 28,000 12/31 Bal. 528,000 Cash Dividends 1/15 35,000 12/1 46,200 12/31 12/31 Bal. –0–

81,200

Common Stock Dividends Distributable 5/15 70,000 4/15 70,000 12/31 Bal. –0–

Stock Dividends 4/15 98,000 12/31 12/31 Bal. –0–

98,000

(Ending returned earnings = Beginning retained earnings + Net income – (stock dividends + Cash dividends))

(c)

TACOMA CORPORATION Partial Balance Sheet December 31, 2017 Stockholders’ equity Paid-in capital Capital stock Common stock, $10 par value, 77,000 shares issued and outstanding ........................................ Additional paid-in capital Paid-in capital in excess of par value . Total paid-in capital....................... Retained earnings ............................................... Total stockholders’ equity ............

$ 770,000 528,000 1,298,000 840,800 $2,138,800

*PROBLEM 11-8A (Continued) (d) Payout ratio =

$81,200

= 20.3%

$400,000

Return on common stockholders’ equity = $400,000 – 0 ($1,820,000*+$2,138,800**) ÷ 2 *$700,000 + $500,000 + $620,000

= $400,000 = 20.2% $1,979,400

**from req. (c)

(Return common stockholders’ equity = (Net income – preferred dividends) ÷ Average common stockholders’ equity)) LO 3 - 5 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Measurement and Reporting

ACR 11-1

(a)

ACCOUNTING CYCLE REVIEW

1. Cash ................................................................ Preferred Stock ....................................... Paid-in Capital in Excess of Par Value—Preferred Stock ...........

49,200

Cash ................................................................ Common Stock ....................................... Paid-in Capital in Excess of Par Value—Common Stock............

21,000

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

320,000

Cash ................................................................ Unearned Service Revenue....................

36,000

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

276,000

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

35,100

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

32,200

Treasury Stock .............................................. Cash.........................................................

11,200

9. Other Operating Expenses ............................ Cash.........................................................

188,200

10. Cash Dividends ($3,360 + $10,200*) .............. Dividends Payable ..................................

13,560

11. Allowance for Doubtful Accounts ................. Accounts Receivable..............................

1,700

3. 4. 5. 6. 7. 8.

*[($80,000 ÷ $10) + 900 – 400] X $1.20

48,000 1,200 9,000 12,000 320,000 36,000 276,000 35,100 32,200 11,200 188,200 13,560 1,700

ACR 11-1 (Continued) Adjusting Entries 1. Supplies Expense ($4,400 + $35,100 – $5,900).. Supplies ...................................................... 2. Unearned Service Revenue............................... Service Revenue ($36,000 X 9/12) ............ 3. Bad Debts Expense [$3,500 – ($1,500 – $1,700)].... Allowance for Doubtful Accounts ............ 4. Depreciation Expense........................................ Accumulated Depreciation—Buildings ($142,000 – $10,000) ÷ 30 ....................... 5. Income Tax Expense.......................................... Income Taxes Payable...............................

(b)

33,600 33,600 27,000 27,000 3,700 3,700 4,400 4,400 35,130* 35,130

*[($347,000 – $188,200 – $33,600 – $4,400 – $3,700) × .30] HAWKEYE CORPORATION Adjusted Trial Balance 12/31/17 Account Cash..................................................................... Accounts Receivable .......................................... Allowance for Doubtful Accounts...................... Supplies............................................................... Land ..................................................................... Buildings ............................................................. Accumulated Depreciation—Buildings ............. Accounts Payable ............................................... Income Taxes Payable........................................ Unearned Service Revenue ................................ Dividends Payable .............................................. Preferred Stock ................................................... Paid-in Capital in Excess of Par Value—P.S..... Common Stock ................................................... Paid-in Capital in Excess of Par Value—C.S..... Retained Earnings .............................................. Cash Dividends ................................................... Treasury Stock ................................................... Service Revenue ................................................. Bad Debt Expense .............................................. Depreciation Expense ........................................ Supplies Expense ............................................... Other Operating Expenses................................. Income Tax Expense .......................................... Total .................................................................

Debit $175,200 87,800

Credit $

3,500

5,900 40,000 142,000 26,400 28,500 35,130 9,000 13,560 48,000 1,200 89,000 12,000 127,400 13,560 11,200 3,700 4,400 33,600 188,200 35,130 $740,690

347,000

$740,690

ACR 11-1 (Continued) (c) Bal.

Bal.

Bal. Bal.

Optional T Accounts Cash 24,600 49,200 21,000 36,000 276,000 175,200

32,200 11,200 188,200

Accounts Receivable 45,500 276,000 320,000 1,700 87,800

Allowance for Doubtful Accounts 1,700 Bal. 1,500 3,700 Bal. 3,500

Bal. Bal.

Supplies 4,400 35,100 5,900

Accum. Depreciation—Buildings Bal. 22,000 4,400 Bal. 26,400 Accounts Payable 32,200 Bal. 25,600 35,100 Bal. 28,500 Income Taxes Payable 35,130 Unearned Service Revenue 27,000 36,000 Bal. 9,000

Dividends Payable 13,560

33,600 Preferred Stock

48,000 Bal.

Land 40,000

Bal.

Buildings 142,000

Paid-in Capital in Excess of Par Value—P.S. 1,200

ACR 11-1 (Continued) (c)

(Continued) Common Stock Bal. Bal.

80,000 9,000 89,000

Paid-in Capital in Excess of Par Value—C.S. 12,000

Retained Earnings Bal. 127,400

Depreciation Expense 4,400 Supplies Expense 33,600 Other Operating Expenses 188,200 Income Tax Expense 35,130

Cash Dividends 13,560 Treasury Stock 11,200 Service Revenue

Bal.

Bad Debt Expense 3,700

320,000 27,000 347,000

ACR 11-1 (Continued) (c)

HAWKEYE CORPORATION Income Statement For the Year ending December 31, 2017 Service revenue .......................................... Operating expenses Other operating expenses .................. Supplies expense ................................ Depreciation expense ......................... Bad debt expense................................ Total operating expenses........................... Income before taxes ................................... Income tax expense ............................ Net income ..................................................

$347,000 $188,200 33,600 4,400 3,700 229,900 117,100 35,130 $ 81,970

HAWKEYE CORPORATION Statement of Retained Earnings For the Year ending December 31, 2017 Retained earnings, 1/1/17 ............................................ Add: Net income ........................................................ Less: Dividends .......................................................... Retained earnings, 12/31/17 ........................................

$127,400 81,970 209,370 13,560 $195,810

ACR 11-1 (Continued) HAWKEYE CORPORATION Balance Sheet At December 31, 2017 Assets Current assets Cash ......................................................... Accounts receivable ............................... Less: Allowance for doubtful accounts ........ Supplies ................................................... Total current assets.......................... Property, plant, and equipment Land.......................................................... Buildings.................................................. $142,000 Less: Accumulated depreciation Bldg.......... 26,400 Total assets .....................................................

$175,200 $ 87,800 3,500

84,300 5,900 265,400

40,000 115,600

155,600 $421,000

Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................... Income taxes payable .............................. Dividends payable.................................... Unearned service revenue ...................... Total current liabilities ..................................... Stockholders’ equity Paid-in capital Capital stock Preferred stock ................................. $48,000 Common stock ................................. 89,000 Total capital stock ..................... Additional paid-in capital Paid-in capital in excess of par value—preferred stock ....... 1,200 Paid-in capital in excess of par value—common stock............ 12,000 Total additional paid-in capital ....... Total paid-in capital ...................... Retained earnings .................................... Total paid-in capital and retained earnings ....................... Less: Treasury stock (400 shares) .................................. Total stockholders’ equity ........... Total liabilities and stockholders’ equity ...........

$ 28,500 35,130 13,560 9,000 $ 86,190

137,000

13,200 150,200 195,810 346,010 11,200

LO 2, 4 BT: AP Difficulty: Medium TOT: 75 min. AACSB: Analytic AICPA FC: Reporting

334,810 $421,000

ACR 11-2

ACCOUNTING CYCLE REVIEW

(a) 2017 Feb. 1

Cash .................................................................... Common Stock .............................................. Paid in Capital in Excess of Par ..................

13,000

Cash..................................................................... Note Payable..................................................

8,000

Equipment ........................................................... Cash................................................................

9,020

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

220

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

980

7,500 5,500

8000

9,020

220

980

No entry ...............................................................

Prepaid Insurance .............................................. Cash................................................................

2,460

Cash..................................................................... Loss on Disposal of Plant Assets .................... Equipment......................................................

3,950 250

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

3,900

Cash..................................................................... Unearned Service Revenue..........................

540

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

300

Treasury Stock ................................................... Cash................................................................

900

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

4,300

Salaries and Wages Expense............................ Cash................................................................

3,840

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

2,500

Prepaid Expenses .............................................. Cash................................................................

220

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

940

2,460

4,200

3,900

540

300

900

4,300

3,840

2,500

220 940

ACR 11-2 (Continued) (d) Debit Credit Feb. 28 1.

10.

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

3,800

Allowance for Doubtful Accounts ........................ Accounts Receivable.........................................

200

Bad Debt Expense ................................................. Allowance for Doubtful Accounts ....................

479

Depreciation Expense ........................................... Accumulated Depreciation-Equipment............

Insurance Expense ................................................ Prepaid Insurance..............................................

820

Supplies Expense .................................................. Supplies ..............................................................

580

Unearned Service Revenue................................... Service Revenue ................................................

135

Salaries and Wages Expense ............................... Salaries and Wages Payable ............................

1,920

Interest Expense .................................................... Interest Payable .................................................

Income Tax Expense ............................................. Income Taxes Payable.......................................

779

3,800

200

479

820

580

135

1,920

40 779

ACR 11-2 (Continued) (c) and (f)

Accounts Cash Accounts Receivable Allowance for Doubtful Accounts Prepaid Expenses Prepaid Insurance Supplies Equipment Accumulated DepreciationEquipment Accounts Payable Unearned Service Revenue Salaries and Wages Payable Interest Payable Note Payable Common Stock Paid-in Capital in Excess of Par Retained Earnings Dividends Treasury Stock Service Revenue Utilities Expense Salaries and Wages Expense Loss on Disposal of Plant Assets Bad Debt Expense Depreciation Expense Insurance Expense Supplies Expense Interest Expense Income Tax Expense Income Taxes Payable Total

Trial Balance Debit Credit $10,090 5,700

Adjusted Trial Balance Debit Credit $10,090 9,300 $279

220 2,460 980 4,820

220 1,640 400 4,820 90 680 405 1,920 40 8,000 7,500 5,500

$680 540

8,000 7,500 5,500 940 900

940 900 8,200

12,135

220 3,840

220 5,760

250

250 479 90 820 580 40 779

$30,420 $30,420

779 $37,328 $37,328

ACR 11-2 (Continued) (h) Debit Feb. 28

Service Revenue ..................................... Income Summary ................................

12,135

Income Summary .................................... Bad Debt Expense .............................. Depreciation Expense ........................ Insurance Expense ............................. Supplies Expense ............................... Salaries and Wages Expense ............ Interest Expense ................................. Utilities Expense ................................. Loss on Disposal of Plant Assets ..... Income Tax Expense ..........................

9,018

Income Summary .................................... Retained Earnings ..............................

3,117

Retained Earnings .................................. Dividends.............................................

940

Credit

12,135 479 90 820 580 5,760 40 220 250 779

3,117 940

ACR 11-2 (Continued)

(b), (e), and (h) Cash 2/1 13,000 2/1 2/1 8,000 2/1 2/5 3,950 2/5 2/17 540 2/18 2/25 2,500 2/20 2/24 2/27 2/28 2/28 Bal. 10,090

9,020 220 2,460 300 900 3,840 220 940

Accounts Receivable 2/16 3,900 2/25 2,500 2/23 4,300 2/28 200 2/28 3,800 2/28 Bal. 9,300 2/3 2/28 Bal.

Supplies 980 2/28 400

Prepaid Insurance 2/5 2,460 2/28 2/28 Bal. 1,640

580

820

Allowance for Doubtful Accounts 2/28 200 2/28 479 2/28 Bal. 279

2/1 2/28 Bal.

980 680

Notes Payable 2/1 2/28 Bal.

8,000 8,000

Salaries and Wages Payable 2/28 1,920 2/28 Bal. 1,920 Interest Payable 2/28

2/28 Bal.

Income Taxes Payable 2/28 2/28 Bal.

779 779

Unearned Service Revenue 2/28 135 2/17 540 2/28 Bal. 405

Prepaid Expenses 2/27 220 2/28 Bal. 220

Equipment 9,020 2/5 4,820

2/18

Accounts Payable 300 2/3 2/28 Bal.

4,200

Accumulated Depr.—Equipment 2/28 90 2/28 Bal. 90

ACR 11-2 (Continued)

Common Stock 2/1 2/28 Bal.

7,500 7,500

Paid in Cap. In Excess of Par 2/1 5,500 2/28 Bal. 5,500

2/28 2/28 Bal.

Dividends 940 2/28 0

940

Treasury Stock 2/20 900 2/28 Bal. 900

2/28

Retained Earnings 940 2/28 3,117 2/28 Bal. 2,177

2/28 2/28

Income Summary 9,018 2/28 12,135 3,117 2/28 Bal. 0

Service Revenue 2/28 12,135 2/16 2/23 2/28 2/28 2/28 Bal.

3,900 4,300 3,800 135 0

ACR 11-2 (Continued)

Utilities Expense 2/1 220 2/28 2/28 Bal. 0

220

Salaries and Wages Expense 2/24 3,840 2/28 5,760 2/28 1,920 2/28 Bal. 0 Insurance Expense 2/28 820 2/28 2/28 Bal. 0

820

Depreciation Expense 2/28 90 2/28 2/28 Bal. 0

Bad Debt Expense 2/28 479 2/28 479 2/28 Bal. 0 Supplies Expense 2/28 580 2/28 2/28 Bal. 0

580

Interest Expense 2/28 40 2/28 2/28 Bal. 0

Loss on Disposal of Plant Assets 2/5 2/28 Bal.

250 2/28 0

250

Income Tax Expense 2/28 779 2/28 779 2/28 Bal. 0

ACR 11-2 (Continued) (g) Clean Sweep Income Statement For the Month Ending February 28, 2017 Service revenue..................................... Operating expenses: Salaries and wages expense............ Utilities expense ................................ Bad debt expense.............................. Depreciation expense ....................... Insurance expense ............................ Supplies expense .............................. Income from operations ....................... Loss on disposal of plants assets ...... Interest expense.................................... Income before income taxes................ Income tax expense (20%) ................... Net income.............................................

$12,135 $5,760 220 479 90 820 580 250 40

7,949 4,186 290 3,896 779 $3,117

Clean Sweep Retained Earnings Statement For the Month Ending February 28, 2017 Retained earnings, 2/1/17 ..................... Add: Net income.................................... Less: Dividends.................................... Retained earnings, 2/28/17 ...................

– 3,117 940 $2,177

ACR 11-2 (Continued) Clean Sweep Balance Sheet February 28, 2017 Assets Current assets Cash ...........................................................

$10,090

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

$9,300

Less: Allowance for doubt. accounts .........

279

9,021

Prepaid expenses ......................................

220

Prepaid insurance ......................................

1,640

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

400 21,371

Property, plant and equipment Equipment ..................................................

4,820 90

Less: Accum depreciation-equipment........ Total Assets ..................................................

4,730 $26,101

Liabilities and Stockholders Equity Current liabilities .............................................. Accounts payable ........................................

$680

Unearned service revenue ..........................

405

Salaries and wages payable .......................

1,920

Income tax payable .....................................

779

Interest payable...........................................

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

$3,824

Note payable, 6% due 2/1/2019 ......................

8,000

Total Liabilities .................................................

11,824

Stockholders' Equity Common stock, $1.50 par ..........................

$7,500

Paid-in capital in excess of par ..................

5,500

Retained earnings ...................................... Less: Treasury stock at cost ...................... Total stockholders' equity........................... Total Liabilities and Stockholders' equity ..

13,000 2,177

15,177 900 14,277 $26,101

CT 11-1

FINANCIAL REPORTING PROBLEM

(a) The common stock has a par value of $0.00001 per share. (b) There are 12,600,000 thousand shares authorized of which 5,866,161 thousand are issued. The percentage is 47% (5,866,161 ÷ 12,600,000). (c) The shares outstanding were (Thousands)

(d) Payout ratio =

$11,126

2014 5,866,161

2013 6,294,494

= 28.2%

$39,510

Basic earnings per share = $6.49

Return on common stockholders’ equity =

$39,510 – 0 = 33.6% $117,548*

*($111,547 + $123,549) ÷ 2 LO 4 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 11-2

COMPARATIVE ANALYSIS PROBLEM

(a)

Columbia Sportswear Company Return on common stockholders’ equity

$141,859 ÷ $1,304,049* = 10.9%

*($1,355,234 + $1,252,864) ÷ 2

Debt to assets

VF Corporation

$1,047,505 ÷ $5,853,960** = 17.9%

**($5,630,882 + $6,077,038) ÷ 2

$436,975 ÷ $1,792,209 = 24.4%

$4,349,258** ÷ $9,980,140 = 43.6% **($1,620,241 + $1,423,581 + $1,305,436)

Return on assets

$141,859 ÷ $1,698,898.5* = 8.4%

*($1,792,209 + $1,605,588) ÷ 2

$1,047,505 ÷ $10,147,791.5** = 10.3%

**($9,980,140 + $10,315,443) ÷ 2

(b) VFC’s return on assets, 10.3%, is larger than Columbia Sportswear’s 8.4% indicating that it is more profitable. Comparing the return on common stockholders’ equity indicates that VFC is 64% more profitable because its shareholders earned 17.9% on each dollar invested while Columbia’s investors earned only 10.9%. These differences in profitability can be better understood by looking at the debt to assets ratios. VFC relies much more on debt to provide a return to its investors. VFC’s return to stockholders is higher than Columbia Sportswear’s because it uses leverage to boost its return to shareholders. VFC’s interest rate on borrowing is less than the rate it earns on its assets, therefore by borrowing it can increase its return. However, its reliance on debt increases its risk of default and decreases its solvency.

CT 11-2 (Continued)

Columbia Sportswear Company

VF Corporation

$39,836 = 28.1% $141,859

$478,933 = 45.7% $1,047,505

VFC pays out a higher portion of its earnings as dividends. LO 4 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 11-3

COMPARATIVE ANALYSIS PROBLEM

(a) Return on common stockholders’ equity

Amazon.com

Wal-Mart Stores

$(241) ÷ $10,243.5* = (2.4%)

$16,363 ÷ $78,824.5 * = 20.8%

*($10,741 + $9,746) ÷ 2

Debt to assets

Return on assets

*($81,394 + $76,255) ÷ 2

$43,764 ÷ $54,505 = 80.3%

$117,769* ÷ $203,706 = 57.8%

*($28,089 + $8,265 + $7,410)

($65,272 + $41,086 +$2,606+ $8,805)

$(241) ÷ $47,332* = (0.5%)

*($54,505 + $40,159) ÷ 2

$16,363 ÷ $204,228.5* = 8.0% *($203,706 + $204,751) ÷ 2

(b) Wal-Mart is profitable with net income and positive returns on common stockholder’s equity and assets while Amazon had a net loss for 2014. Both companies have significant amounts of debt as indicated by the debt to assets ratios of 80.3% for Amazon and 57.8% for Wal-Mart. WalMart is able to use this debt to generate returns for its shareholders but Amazon is not. (c) Payout ratio

Amazon.com $0 = 0% $(241)

Wal-Mart Stores $6,185 = 37.8% $16,363

Wal-Mart pays a higher portion of its earnings as dividends since Amazon neither paid any dividends nor generated any earnings in 2014. LO 4 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 11-4

INTERPRETING FINANCIAL STATEMENTS

(a) This is a dividend transaction—a property dividend. (b) Debt to assets ratio (c) Return on assets

Host Marriott $3,112 = 81.4% $3,822 $(25)

= (.7%)

$3,822 Return on common stockholders’ equity

$(25) $710

Marriott International $2, 440 = 76.1% $3,207 $200

= 6.2%

$3,207 = (3.5%)

$200

= 26.1%

$767

(d) The debtholders were concerned that by splitting the company and leaving most of the debt with only one half of the original company the likelihood that the debtholders would be repaid was reduced—that is, the probability that Marriott would default on the debt increased. This reduces the value of the debt investment. LO 4 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 11-5

REAL-WORLD FOCUS

Answers will vary depending on the company chosen by the student. LO 4 BT: AN Difficulty: Medium TOT: 20 min. AACSB: Analytic and Technology AICPA FC: Reporting

CT 11-6

DECISION MAKING ACROSS THE ORGANIZATION

Year ended After Purchase of Before Purchase of Treasury Stock Treasury Stock $193.6 - 0 $123.4 - 0 = $1.76 = $1.03 109.7 119.9

(a) Earnings per share

Return on common stockholders’ equity

$193.6 = 18% $1,078

$123.4 = 11% $1,126.2

Return on assets

$193.6 = 9.6% $2,016.9

$123.4 = 6.5% $1,889.8

All three measures indicate a significant increase in profitability. $26.8 = 13.8% $193.6

(b) Payout ratio

Average cash dividend paid per share

$26.8 = $.24 109.7

$31.0

= 25.1%

$123.4 $31.0 = $.26 119.9

Wendy’s paid less of its earnings as dividends after the purchase of treasury shares than the year before. Wendy’s appeared to be retaining more of its earnings to invest in its operations. (c) Debt to assets ratio

$1,046.3 = 50.4% $2,076.0

$769.9 = 41.9% $1,837.9

Times interest earned ratio

($193.6 + $30.2 + $113.7) $30.2 = 11.2 times

($123.4 + $19.8 + $84.3) $19.8 = 11.5 times

CT 11-6 (Continued) Wendy’s debt to assets ratio increased from 41.9% to 50.4% indicating a decrease in its solvency. This increase may not be cause for concern since Wendy’s times interest earned decreased only slightly. (d) Since Wendy’s return on assets and its return on common stockholders’ equity both increased it can be concluded that the improvement was due partially to increased reliance on debt financing and partially to improved profitability in use of assets. (e) It appears that Wendy’s International acted wisely in purchasing treasury stock and taking on more debt. Its profitability improved significantly and it appears to be handling its debt payments comfortably. Wendy’s has been able to increase its earnings per share and return to its stockholders. LO 4 BT: E Difficulty: Medium TOT: 40 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 11-7

COMMUNICATION ACTIVITY

Dear Uncle Earl: Thanks for your recent letter and for asking me to explain four terms. Here are my explanations: (1) Authorized stock is the total amount of stock that a corporation is given permission to sell as indicated in its charter. If all authorized stock is sold, a corporation must obtain the consent of the state to amend its charter before it can issue additional shares. (2) Issued stock is the amount of stock that has been sold either directly to investors or indirectly through an investment banking firm. (3) Outstanding stock is capital stock that has been issued and is being held by stockholders. It represents the difference between the stock issued by the company and the stock repurchased by the company. (4) Preferred stock is capital stock that has contractual preferences over common stock in certain areas. I really enjoy my accounting classes and especially like the accounting instructors. I hope your corporation does well, and I wish you continued success with your inventions. Regards, LO 1 BT: C Difficulty: Easy TOT: 6 min. AACSB: Analytic and Communication AICPA FC: Measurement AICPA PC: Communication

CT 11-8

ETHICS CASE

(a) The stakeholders in this situation are: The director of Pele’s R&D division. The president of Pele. The shareholders of Pele. Those who live in the environment to be sprayed by the new (untested) chemical. (b) The president is risking the environment and everything and everybody in it that is exposed to this new chemical in order to enhance his company’s sales and to preserve his job. Presidents and entrepreneurs frequently take risks in performing their leadership functions, but this action appears to be irresponsible and unethical. (c) A parent company may protect itself against loss and most reasonable business risks by establishing separate subsidiary corporations, but whether it can insulate itself against this type of action is a matter of state corporate law and criminal law. LO - BT: E Difficulty: Medium TOT: 10 min. AACSB: Analytic, Ethics and Communication AICPA FC: Reporting AICPA PC: Personal Demeanor

CT 11-9

ETHICS CASE

(a) The stakeholders in this situation are: Mr. Boyd, president of Cooper Corporation. Dana Marks, financial vice-president. The stockholders of Cooper Corporation. (b) There is nothing unethical in issuing a stock dividend. But the president’s order to write a press release convincing the stockholders that the stock dividend is just as good as a cash dividend is unethical. A stock dividend is not a cash dividend and does not necessarily place the stockholder in the same position. A stock dividend is a “paper” dividend—the issuance of a certificate, not a check (cash). (c) The stock dividend results in a decrease in retained earnings and an increase of the same amount in paid-in capital with no change in total stockholders’ equity. There is no change in total assets and no change in total liabilities and stockholders’ equity. As a stockholder, preference for a cash dividend versus stock dividend is dependent upon one’s investment objective—income (cash flow) or growth (reinvestment). LO 3 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic, Ethics and Communication AICPA FC: Reporting AICPA PC: Personal Demeanor

CT 11-10

ALL ABOUT YOU

Student responses will vary depending on the organization chosen by the student. LO - BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic, Ethics and Communication AICPA FC: Reporting AICPA PC: Personal Demeanor

CT 11-11

FASB CODIFICATION ACTIVITY

(a)

Stock Dividend: An issuance by a corporation of its own common shares to its common shareholders without consideration and under conditions indicating that such action is prompted mainly by a desire to give the recipient shareholders some ostensibly separate evidence of a part of their respective interests in accumulated corporate earnings without distribution of cash or other property that the board of directors deems necessary or desirable to retain in the business.

(b)

Stock Split: An issuance by a corporation of its own common shares to its common shareholders without consideration and under conditions indicating that such action is prompted mainly by a desire to increase the number of outstanding shares for the purpose of effecting a reduction in their unit market price and, thereby, of obtaining wider distribution and improved marketability of the shares. It is sometimes called a stock split-up.

(c)

Except for a few instances, the issuance of additional shares of less than 20 or 25 percent of the number of previously outstanding shares would call for treatment as a stock dividend as described in paragraph 505-20-30-3.

LO 3 BT: C Difficulty: Easy TOT: 20 min. AACSB: None AICPA FC: Measurement AICPA PC: Communication

CT 11-12

CONSIDERING PEOPLE, PLANET AND PROFIT

(a)

The new law allows a company to incorporate under a new charter which classifies a company as a “benefit company.” A benefit company’s governing board is allowed to consider social or environmental objectives ahead of profits. The purpose of the law is to shield the board from lawsuits from investors who feel that the purpose of the company should be to maximize profits and shareholder value.

(b)

The article says that some people say the biggest benefit of the law would occur when the company is being considered for either a sale or break-up. Currently, if shareholder value would be maximized by selling the company or breaking it into pieces, board members can be sued if they do not agree to sell or breakup the company. Under this law, the board would be allowed to consider other factors, such as the impact of a sale on the employees or the community. The article suggests that if Ben and Jerry’s had been structured as a benefit corporation the board would not have allowed the company to be sold to Unilever.

(c)

Critics of the new law say that it reduces the accountability of the company to its shareholders. They say that if management makes a bad decision which hurts the value of the company, management can say that it made the decision for reasons other than to maximize profits.

(d)

Previously companies could apply for “B Corp” certification. Under this program, companies are evaluated by a private entity that created and administers the certification. Companies choose to obtain this certification in order to demonstrate their commitment to social and environmental causes. The difference is that this certification does not shield a company from investor lawsuits which claim that the company’s social or environment programs are causing it to not maximize profits.

CT 11-12 (Continued) (e)

The companies that the article cites as either having adopted benefit corporation standing, or are considering it are: Patagonia Ben and Jerry’s Homemade Emerge Workplace Solutions Greyston Bakery Comet Skateboards

LO 1 BT: C Difficulty: Medium TOT: 40 min. AACSB: None AICPA FC: Measurement AICPA PC: Communication

IFRS CONCEPTS AND APPLICATION IFRS 11-1 May 10

Cash (1,000 X $18) ...................................... Share Capital—Ordinary (1,000 X $10) ..................................... Share Premium—Ordinary (1,000 X $8) .......................................

18,000 10,000 8,000

LO 6 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

IFRS 11-2 MEENEN CORPORATION Partial Statement of Financial Position December 31, 2017 Equity Share capital—ordinary, €10 par value, 5,000 shares issued and 4,500 shares outstanding....................................................... Share premium—ordinary................................... Retained earnings ............................................... Less: Treasury shares (500 shares)................... Total equity...............................................

€50,000 10,000 45,000 11,000 €94,000

LO 6 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

IFRS 11-3 Mar. 2

June 12

July 11

Nov. 28

Organization Expense ............................. Share Capital—Ordinary (5,000 X $1)..................................... Share Premium—Ordinary................

30,000

Cash .......................................................... Share Capital—Ordinary (60,000 X $1)................................... Share Premium—Ordinary................

375,000

Cash (1,000 X $110).................................. Share Capital—Preference (1,000 X $100).................................. Share Premium—Preference (1,000 X $10)....................................

110,000

Treasury Shares ....................................... Cash ...................................................

80,000

5,000 25,000

60,000 315,000

100,000 10,000

LO 6 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

80,000

IFRS 11-4 INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) The company’s total equity is €23,003 million at year-end 2014, including revaluation reserves of €1,019 million. The number of treasury shares held is 5,851,370. (see Note 15.2) (b)

(1) Share capital (2) Share premium (3) Net profit group share

Common stock Paid-in capital in excess of par Controlling interest in net income

(c) The company declared and paid a dividend for 2014 of €8,434 million. This information is determined from Note 15.3 to the financial statements. (d) The company has a 22.2% return on ordinary shareholders’ equity. The computation is as follows: €5,648 (€23,003 + €27,907) ÷ 2 (e) Earnings per share is €11.27 per share for basic and a €11.21 for fully diluted. LO 6 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CHAPTER 12 Statement of Cash Flows Learning Objectives 1. 2. 3. *4.

Discuss the usefulness and format of the statement of cash flows. Prepare a statement of cash flows using the indirect method. Use the statement of cash flows to evaluate a company. Prepare a statement of cash flows using the direct method.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

Questions 1.

11.

16.

21.

12.

17.

22.

13.

18.

14.

19.

10.

15.

20.

Brief Exercises 1.

10.

13.

11.

14.

12.

15.

Do It! Exercises 1.

2a.

2b.

Exercises 1.

10.

13.

1, 2

11.

14.

12.

15.

Problems: Set A 1.

1, 2

2, 3

11.

10.

12.

Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Distinguish among operating, investing, and financing activities.

Simple

10–15

Determine cash flow effects of changes in equity accounts.

Simple

10–15

Prepare the operating activities section—indirect method.

Simple

20–30

*4A

Prepare the operating activities section—direct method.

Simple

20–30

Prepare the operating activities section—indirect method.

Simple

20–30

*6A

Prepare the operating activities section—direct method.

Simple

20–30

Prepare a statement of cash flows—indirect method, and compute free cash flow.

Moderate

40–50

*8A

Prepare a statement of cash flows—direct method, and compute free cash flow.

Moderate

40–50

Prepare a statement of cash flows—indirect method.

Moderate

40–50

*10A

Prepare a statement of cash flows—direct method.

Moderate

40–50

11A

Prepare a statement of cash flows—indirect method.

Moderate

40–50

12A

Identify the impact of transactions on free cash flow.

Simple

10–15

ANSWERS TO QUESTIONS 1.

(a) The statement of cash flows reports the cash receipts and cash payments from operating, investing, and financing activities during a period in a format that reconciles the beginning and ending cash balances. (b) Disagree. The statement of cash flows is required. It is the fourth basic financial statement.

LO 1 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 2.

The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period? LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

The three activities are: Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Investing activities include: (a) purchasing and disposing of investments and productive longlived assets and (b) lending money and collecting loans. Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying them dividends. LO 1 BT: K Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

(a) The sources of cash (inflows) in the statement of cash flows come from: (1)

Operating activities i. Sale of goods or services ii. Interest and dividends received

(2)

Investing activities i. Sale of property, plant, and equipment ii. Sale of investments in other entities’ securities iii. Collection of principal on loans to other entities

(3)

Financing activities i. Sale of common stock ii. Issuance of debt (bonds and notes)

(b) The uses of cash (outflows) in the statement of cash flows come from: (1)

Operating activities i. Payments to suppliers for inventory ii. Payments to employees for services iii. Payments to government for taxes iv. Payments to lenders for interest v. Payments to others for expenses

(2)

Investing activities

i. Purchase of property, plant, and equipment ii. Purchase of investments in other entities’ securities iii. Making loans to other entities

Questions Chapter 12 (Continued) (3)

Financing activities i. Payment of cash dividends to stockholders ii. Redeeming principal of long-term debt iii. Payment to reacquire capital stock (treasury stock)

LO 1 BT: K Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 5.

The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.

LO 1 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 6.

Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment.

LO 1 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 7.

Comparative balance sheets, a current income statement, and certain transaction data all provide information necessary for preparation of the statement of cash flows. Comparative balance sheets indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided or used by operations. Certain transactions provide additional detailed information needed to determine how cash was provided or used during the period.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 8.

The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate. The advantage of the indirect method is it is often considered easier to prepare, and it provides a reconciliation of net income to net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation. Both methods are acceptable but the FASB expressed a preference for the direct method. However, the indirect method is the overwhelming favorite of companies.

LO 2 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 9.

When total cash inflows exceed total cash outflows, the excess is identified as a “net increase in cash” near the bottom of the statement of cash flows.

LO 2 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 10. The indirect method involves converting accrual net income to net cash provided (used) by operating activities. This is done by starting with accrual net income and adjusting for items that do not affect cash. Examples of adjustments include depreciation and other noncash expenses,

gains and losses on the sale of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next. LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 11.

It is necessary to convert accrual basis net income to cash basis income because the unadjusted net income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual basis net income must be adjusted to reflect the net cash provided by operating activities.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting

Questions Chapter 12 (Continued) 12.

A number of factors could have caused an increase in cash despite the net loss. These are (1) high cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 13.

Student answers will vary, however the five items selected should come from the following list: Depreciation/amortization/depletion expense. Gain or loss on disposal of a noncurrent asset. Increase/decrease in specific current assets. Increase/decrease in specific current liabilities.

LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 14.

Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided (used) by operating activities because depreciation is an expense but not a cash payment.

LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 15. The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company’s ability to generate future cash flows, (2) the company’s ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash and noncash financing and investing transactions during the period. LO 1 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 16. This transaction is reported in the note or schedule entitled “Noncash investing and financing activities” as follows: “Acquired land through issuance of common stock, $1,700,000.” LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 17.

(a) The phases of the corporate life cycle are the introductory phase, growth phase, maturity phase, and decline phase. (b) During the introductory phase, net cash provided by operating and investing activities would be expected to be negative, and cash from financing would be positive. During the growth phase, a company would be expected to show some small amounts of cash from operations while continuing to show negative cash from investing and positive cash from financing. During the maturity phase, net cash provided by operating, investing, and financing activities would all be expected to be positive while in the decline phase, net cash provided by operating and investing activities would continue to be positive while cash from financing would be negative.

LO 3 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting

18.

Apple has positive net cash provided by operating activities that exceeds its net income. Net cash provided by operating exceeded its investing needs and it bought back shares of stock and paid dividends. Apple Roll appears to be in the middle to late maturity phase.

LO 3 BT: AN Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting *19. Net cash provided (used) by operating activities under the direct approach is the difference between cash revenues and cash expenses. The direct approach adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to “net cash provided by operating activities.” LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

*20. (a) Cash receipts from customers = Revenues from sales

(b) Purchases = Cost of goods sold

+ Decrease in accounts receivable – Increase in accounts receivable

+ Increase in inventory – Decrease in inventory

Cash payments to suppliers = Purchases

+ Decrease in accounts payable – Increase in accounts payable

LO 4 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting *21.

Sales revenue........................................................................................................ Add: Decrease in accounts receivable .................................................................. Cash receipts from customers ...............................................................................

$2,000,000 150,000 $2,150,000

LO 4 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting *22.

Depreciation expense is not listed in the direct method operating activities section not a cash flow item—it does not affect cash.

LO 4 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

because it is

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) (b) (c) (d)

Cash inflow from financing activity, $200,000. Cash outflow from investing activity, $180,000. Cash inflow from investing activity, $20,000. Cash outflow from financing activity, $50,000.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 12-2 (a) Investing activity. (b) Investing activity. (c) Financing activity.

(d) Operating activity. (e) Financing activity. (f) Financing activity.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE 12-3 Cash flows from financing activities Proceeds from issuance of bonds payable ....................... Payment of dividends.......................................................... Net cash provided by financing activities ..................

$300,000 (40,000) $260,000

(Financing activity cash flows = Issuance/repayment of L-T debt, Issuance/repurchase of stock, and payment of cash dividends) LO 1 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 12-4 Net cash provided by operating activities is $2,730,000. Using the indirect approach, the solution is: Net income ................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................... Decrease in accounts receivable ........ Decrease in accounts payable ............ Net cash provided by operating activities............................................

$2,500,000

$160,000 350,000 (280,000)

230,000 $2,730,000

(Adjustments to net income include depreciation (+); decrease in non-cash current assets (+); and decrease in current liabilities (−)) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 12-5 Cash flows from operating activities Net income ................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................... Loss on disposal of plant assets ........ Net cash provided by operating activities............................................

$280,000

$70,000 28,000

(Adjustments to net income include depreciation (+); loss (−)) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

98,000 $378,000

BRIEF EXERCISE 12-6 Net income........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable................ Increase in prepaid expenses ..................... Increase in inventories ................................ Net cash provided by operating activities ...................................................

$186,000 $80,000 (28,000) (40,000)

12,000 $198,000

(Adjustments to net income include decrease in non-cash current assets (+); and increase in non-cash current assets (−)) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 12-7 Original cost of equipment sold................................................. Less: Accumulated depreciation .............................................. Book value of equipment sold ................................................... Less: Loss on disposal of equipment....................................... Cash flow from sale of equipment .............................................

$22,000 5,100 16,900 3,500 $13,400

(Loss on disposal = book value of disposal equipment – cash proceeds) LO 2 BT: AN Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE 12-8 (a) Net cash provided by operating activities would be lower than net income during the growth phase because inventory must be purchased for future projected sales. Since sales during the growth phase are projected to be increasing, inventory purchases must increase and inventory expensed on an accrual basis would be less than inventory purchased on a cash basis. Also, collections on accounts receivable would lag behind sales; thus, accrual sales would exceed cash collections during the period. (b) Cash from investing is often positive during the late maturity phase and the decline phase because the firm may sell off excess long-term assets that are no longer needed for productive purposes. LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Measurement and Reporting

BRIEF EXERCISE 12-9 Free cash flow = $89,303,000 – $25,823,000 – $0 = $63,480,000 LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Measurement

BRIEF EXERCISE 12-10 Free cash flow = $412,000 – $200,000 – $0 = $212,000 LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Measurement

BRIEF EXERCISE 12-11 Free cash flow = ($104,539,000) – $79,330,000 – $0 = ($183,869,000) LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Measurement

BRIEF EXERCISE 12-12 Free cash flow is net cash provided by operating activities less capital expenditures and cash dividends paid. For Uhuru Inc. this would be $332,000 ($734,000 – $310,000 – $92,000). Since it has positive free cash flow that far exceeds its dividend, an increase in the dividend might be possible. However, other factors should be considered. For example, it must have adequate retained earnings, and it should be convinced that a larger dividend can be sustained over future years. It should also use the free cash flow to expand its operations or pay down its debt. LO 3 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*BRIEF EXERCISE 12-13 Receipts from Sales = customers revenue

+ Decrease in accounts receivable – Increase in accounts receivable

$1,317,060,000 = $1,244,023,000 + $73,037,000 (Decrease in accounts receivable) LO 4 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 12-14 + Decrease in income taxes payable

Cash payment Income Tax = for income taxes Expense

– Increase in income taxes payable

$119,000,000 = $370,000,000 – $251,000,000* *$528,000,000 – $277,000,000 = $251,000,000 (Increase in income taxes payable) LO 4 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

*BRIEF EXERCISE 12-15 Cash payments for operating = expenses

Operating expenses, excluding depreciation

+ Increase in prepaid expenses – Decrease in prepaid expenses and + Decrease in accrued expenses payable – Increase in accrued expenses payable

$78,400 = $90,000 – $7,200 – $4,400 LO 4 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 12-1 (1) (2) (3) (4) (5)

Financing activity Operating activity Financing activity Investing activity Investing activity

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Measurement and Reporting

DO IT! 12-2a Cash flows from operating activities Net income ................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................................... Patent amortization expense ............................... Gain on disposal of plant assets......................... Decrease in accounts receivable ........................ Increase in accounts payable.............................. Net cash provided by operating activities ....

$100,000 $6,300 4,000 (3,600) 6,000 3,200

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

15,900 $115,900

DO IT! 12-2b ALEX COMPANY Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2017 Cash flows from operating activities Net income.................................................................. $156,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................................... 40,000 Loss on disposal of equipment............................ 2,000 Increase in accounts receivable .............................. (40,000) Increase in inventory................................................ (44,000) Increase in prepaid expenses .............................. (2,000) Increase in accounts payable............................... 3,000 Decrease in accrued expenses payable .............. (10,000) (51,000) Net cash provided by operating activities..... 105,000 Cash flows from investing activities Sale of land ................................................................. 15,000 Sale of equipment ...................................................... 34,000 Purchase of equipment.............................................. (166,000) Net cash used by investing activities ............ (117,000) Cash flows from financing activities Redemption of bonds................................................. (50,000) Sale of common stock ............................................... 170,000 Payment of dividends ................................................ (85,000) Net cash provided by financing activities ..... 35,000 Net increase in cash.......................................................... 23,000 Cash at beginning of period ............................................. 36,000 Cash at end of period........................................................ $59,000 (See Illustration 12-13) LO 2 BT: AP Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

DO IT! 12-3 (a) Free cash flow = $73,700 – $24,200 – $13,000 = $36,500 (b) Net cash provided by operating activities fails to take into account that a company must invest in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability. LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO EXERCISES EXERCISE 12-1 (a) (b) (c) (d) (e) (f) (g)

Noncash investing and financing activities. Financing activities. Noncash investing and financing activities. Financing activities. Investing activities. Operating activities. Operating activities.

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting

EXERCISE 12-2 (a) Operating activity. (b) Noncash investing and financing activity. (c) Investing activity. (d) Financing activity. (e) Operating activity. (f) Noncash investing and financing activity. (g) Operating activity.

(h) Financing activity. (i) Operating activity. (j) Noncash investing and financing activity. (k) Investing activity. (l) Operating activity. (m) Operating activity (loss); investing activity (cash proceeds from sale). (n) Financing activity.

LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Measurement and Reporting

EXERCISE 12-3 SOSA COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Increase in accounts receivable.............. Increase in prepaid expenses ................. Increase in accounts payable.................. Net cash provided by operating activities................................................

$190,000 $35,000 5,000 (15,000) (4,000) 17,000

38,000 $228,000

(See Illustration 12-13) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 12-4 SUNN INC. Partial Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Decrease in accounts receivable ............ Decrease in inventory .............................. Increase in prepaid expenses ................. Increase in accrued expenses payable... Decrease in accounts payable ................ Net cash provided by operating activities................................................

$153,000 $27,000 9,000 4,000 (5,000) 10,000 (7,000)

(See Illustration 12-13) LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

38,000 $191,000

EXERCISE 12-5 STAMOS CORPORATION Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2017 Cash flows from operating activities Net income.................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ......................................... Increase in accounts receivable ........................ Increase in inventory .......................................... Increase in income taxes payable ..................... Decrease in accounts payable ........................... Net cash provided by operating activities...

$284,100 $162,000 (8,200) (11,000) 4,700 (3,700)

Cash flows from investing activities Sale of land.......................................................... Purchase of building........................................... Net cash used by investing activities ..........

35,000 (289,000)

Cash flows from financing activities Issuance of bonds .............................................. Payment of dividend ........................................... Purchase of treasury stock ................................ Net cash provided by financing activities ...

200,000 (12,000) (26,000)

143,800 427,900

(254,000)

Net increase in cash................................................... Cash at beginning of period ...................................... Cash at end of period................................................. (See Illustration 12-13) LO 2 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

162,000 335,900 45,000 $380,900

EXERCISE 12-6 BEIBER CORP Partial Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Net cash provided by operating activities................................................ Cash flows from investing activities Sale of equipment ............................................ Purchase of equipment ................................... Construction of equipment ............................. Net cash used by investing activities .....

$ 72,000

$28,000 8,000

108,000

25,000* (70,000) (53,000) (98,000)

Cash flows from financing activities Payment of cash dividends............................. *Cost of equipment sold.................................. Accumulated depreciation............................. Book value ...................................................... Loss on sale of equipment ............................ Cash proceeds................................................

36,000

(14,000) $49,000 (16,000) 33,000 (8,000) $25,000

(See Illustration 12-13 and cash proceeds = book value – loss on sale of equipment) LO 2 BT: AN Difficulty: High TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

EXERCISE 12-7 MITCH COMPANY Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense........................ Increase in accounts receivable ....... Decrease in inventory ....................... Decrease in accounts payable.......... Net cash provided by operating activities ......................................... Cash flows from investing activities Sale of land................................................ Purchase of equipment............................. Net cash used by investing activities ......................................... Cash flows from financing activities Issuance of common stock ...................... Payment of cash dividends ...................... Redemption of bonds ............................... Net cash used by financing activities .........................................

$ 93,000

$34,000 (12,000) 22,000 (4,000)

40,000 133,000

20,000 (60,000) (40,000) 42,000 (39,000) (50,000)

Net increase in cash ......................................... Cash at beginning of period ............................ Cash at end of period ....................................... (See Illustration 12-13) LO 2 BT: AP Difficulty: High TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

(47,000) 46,000 22,000 $ 68,000

EXERCISE 12-8 Point in Time

Phase

M N O P

Introductory phase Decline phase Maturity phase Growth phase

During the introductory phase (point M), net cash provided by operating and investing activities are expected to be negative while cash from financing would be positive. In the growth phase (point P), a company would continue to show negative net cash provided by operating and investing and positive cash from financing. During the maturity phase (point O), net cash provided by operating activities and net income would be approximately the same. Net cash provided by operating activities would exceed investing needs. In the decline phase (point N), net cash provided by operating activities would diminish while cash from financing would be negative. LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 12-9

Free cash flow

PepsiCo

Coca-Cola

$6,796 – $2,128 – $2,732 = $1,936

$8,186 – $1,993 – $3,800 = $2,393

Coca-Cola’s free cash flow is greater than Pepsi's. LO 3 BT: AN Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 12-10

Free cash flow

Merrill Corporation

Wingate Corporation

$80,000 – $40,000 – $5,000 = $35,000

$100,000 – $70,000 – $10,000 = $20,000

Merrill's free cash flow is better than Wingate's LO 3 BT: AN Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*EXERCISE 12-11 Revenues ................................................................ Deduct: Increase in accounts receivable ............ Cash receipts from customers* ..................... Operating expenses ............................................... Deduct: Increase in accounts payable................. Cash payments for operating expenses** .... Net cash provided by operating activities ............ *

$198,000 60,000 $138,000 83,000 23,000

Accounts Receivable Balance, Beginning of year 0 Revenues for the year 198,000 Cash receipts for year Balance, End of year 60,000

** Payments for the year

Accounts Payable Balance, Beginning of year 60,000 Operating expenses for year Balance, End of year

60,000 $ 78,000

138,000

0 83,000 23,000

(Cash receipts from customers = Revenues – increase in accounts receivable; cash payments for operating expense = Operating expenses – increase in accounts payable) LO 4 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 12-12 (a) Cash payments to suppliers Cost of goods sold........................ Deduct: Decrease in inventory .... Cost of purchases ......................... Deduct: Increase in accounts payable ........................... Cash payments to suppliers.........

$5,178.0 million 5.3 $5,172.7 million 15.6 $5,157.1 million

(See Illustration 12A-9)

(b) Cash payments for operating expenses Operating expenses exclusive of depreciation ($10,725.7 – $1,216.2) ................ Add: Increase in prepaid expenses ........................ Deduct: Increase in accrued expenses payable ..................... Cash payments for operating expenses....................................

$9,509.5 million $42.2 199.8

(157.6) $9,351.9 million

(See Illustration 12A-11) LO 4 BT: AP Difficulty: Hard TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

*EXERCISE 12-13 Cash flows from operating activities Cash receipts from Customers ................................................. Dividend revenue ...................................... Less cash payments: To suppliers for merchandise .................. For salaries and wages............................. For operating expenses............................ For income taxes....................................... For interest ................................................ Net cash provided by operating activities.................................................

$243,000* 18,000 261,000 $97,000 53,000 28,000 12,000 10,000

*$48,000 + $195,000 (See Illustration 12A-14) LO 4 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

200,000 $ 61,000

*EXERCISE 12-14 BALBOA CORP. Statement of Cash Flows—Direct Method For the Year Ended December 31, 2017 Cash flows from operating activities Cash receipts from customers ........................... Less: Cash payments: For goods and services................................ For income taxes .......................................... For operating expenses ............................... For interest .................................................... Net cash provided by operating activities...............................................

$566,100 $279,100 99,000 77,000 22,400

477,500 88,600

Cash flows from investing activities Sale of building ............................................. 197,600 Purchase of equipment ...................................... (113,200) Net cash provided by investing activities...............................................

84,400

Cash flows from financing activities Issuance of common stock .......................... Payment of cash dividend............................ Purchase treasury stock .............................. Cash paid to redeem bonds at maturity ...... Net cash provided by financing activities...............................................

85,100

355,000 (21,800) (48,100) (200,000)

Net increase in cash.................................................. Cash at beginning of period ..................................... Cash at end of period................................................ (See Illustration 12A-16) LO 4 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting

258,100 11,000 $269,100

*EXERCISE 12-15 Cash payments for rent Rent expense .............................................................. Add: Increase in prepaid rent ................................... Cash payments for rent..............................................

$ 30,000 1,500 $ 31,500

Cash payments for salaries Salaries and wages expense ..................................... Deduct: Increase in salaries and wages payable .... Cash payments for salaries .......................................

$ 54,000 6,000 $ 48,000

Cash receipts from customers Revenue from sales.................................................... Add: Decrease in accounts receivable..................... Cash receipts from customers ..................................

$160,000 9,000 $169,000

(See Illustrations 12A-5 and 12A-11) LO 4 BT: AN Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO PROBLEMS PROBLEM 12-1A

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Depreciation expense was $80,000 Interest Payable account increased $5,000 Received $26,000 from sale of Plant assets Acquired land by issuing common stock to seller Paid $17,000 cash dividend to preferred stockholders Paid $4,000 cash dividend to common stockholders Accounts Receivable account decreased $10,000 Inventory increased $2,000 Received $100,000 from issuing bonds payable Acquired equipment for $16,000 cash

SCF Section Affected O

If Operating, did it increase/decrease Reported cash from Operating activities A

–

O F

S –

–

LO 1, 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 12-2A

(a) Net income can be determined by analyzing the retained earnings account. Retained earnings beginning of year .............................. $270,000 Add: Net income (plug).................................................... 58,800* 328,800 Less: Cash dividends.................................................. 20,000 Stock dividends .................................................... 8,800 Retained earnings, end of year ....................................... $300,000 *($300,000 + $8,800 + $20,000 – $270,000) (Analyze the change in the Retained earnings account balance)

(b) Cash inflow from the issue of stock was $12,000 ($160,800 – $140,000 – $8,800). Common Stock 140,000 8,800 12,000 160,800

Stock Dividend Shares Issued for Cash

Cash outflow for dividends was $20,000. The stock dividend does not use cash. (c) Both of the above activities (issue of common stock and payment of dividends) would be classified as financing activities on the statement of cash flows. LO 2 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 12-3A

MUNSUN COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2017 Cash flows from operating activities Net income ........................................................... $1,750,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................. $ 110,000 Decrease in accounts receivable............... 380,000 Decrease in inventory ............................. 300,000 Increase in prepaid expenses ................ (150,000) Decrease in accounts payable ............... (350,000) Decrease in accrued expenses payable... (100,000) 190,000 Net cash provided by operating activities .......................................... $1,940,000 (See Illustration 12-13) LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

*PROBLEM 12-4A MUNSUN COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2017 Cash flows from operating activities Cash receipts from customers ........ Less cash payments: To suppliers............................... For operating expenses............ Net cash provided by operating activities ........................................

$7,980,000 (1) $4,750,000 (2) 1,290,000 (3)

6,040,000 $1,940,000

(See Illustrations 12A-5; 12A-9; and 12A-11)

Computations: (1) Cash receipts from customers Sales ................................................................. Add: Decrease in accounts receivable .......... Cash receipts from customers........................

$7,600,000 380,000 $7,980,000

(2) Cash payments to suppliers Cost of goods sold........................................... Deduct: Decrease in inventories .................... Cost of purchases............................................ Add: Decrease in accounts payable .............. Cash payments to suppliers ...........................

$4,700,000 300,000 4,400,000 350,000 $4,750,000

(3) Cash payments for operating expenses Operating expenses, exclusive of depreciation .............................. Add: Increase in prepaid expenses ................................. Decrease in accrued expenses payable.................. Cash payments for operating expenses........................................

$1,040,000* $150,000 100,000

*$450,000 + ($700,000 – $110,000) LO 4 BT: AP Difficulty: Hard TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

250,000 $1,290,000

PROBLEM 12-5A

REWE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Increase in accounts receivable.............. Increase in accounts payable.................. Increase in income taxes payable........... Net cash provided by operating activities................................................

$229,000

$55,000 16,000 (10,000) 9,000 6,000

(See Illustration 12-13) LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting

76,000 $305,000

*PROBLEM 12-6A

REWE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Cash receipts from customers ........ Less cash payments: For operating expenses............ For income taxes....................... Net cash provided by operating activities ........................................

$960,000 (1) $605,000 (2) 50,000 (3)

655,000 $305,000

(See Illustrations 12A-5; 12A-11; and 12A-13)

(1) Cash receipts from customers Revenues........................................................................ Deduct: Increase in accounts receivable ($70,000 – $60,000) ......................................... Cash receipts from customers ..................................... (2) Cash payments for operating expenses Operating expenses per income statement ................. Deduct: Increase in accounts payable ($41,000 – $32,000) ......................................... Cash payments for operating expenses ...................... (3) Cash payments for income taxes Income tax expense per income statement ................. Deduct: Increase in income taxes payable ($13,000 – $7,000) ........................................... Cash payments for income taxes ................................. LO 4 BT: AP Difficulty: Hard TOT: 25 min. AACSB: Analytic AICPA FC: Reporting

$970,000 10,000 $960,000

$614,000 9,000 $605,000 $ 56,000 6,000 $ 50,000

PROBLEM 12-7A

(a)

WARNER COMPANY Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................... Increase in accounts receivable ......... Increase in inventory ........................... Increase in accounts payable.............. Decrease in income taxes payable ..... Net cash provided by operating activities............................................

$32,000

$17,500 (6,000) (8,000) 4,000 (1,000)

38,500

Cash flows from investing activities Sale of equipment ...................................... Cash flows from financing activities Issuance of common stock ....................... Redemption of bonds ................................ Payment of dividends ................................ Net cash used by financing activities............................................. Net increase in cash ......................................... Cash at beginning of period............................. Cash at end of period .......................................

6,500

8,500 4,000 (16,000) (20,000) (32,000) 15,000 20,000 $35,000

(See Illustration 12-13)

(b) $38,500 – $0 – $20,000 = $18,500 LO 2, 3 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement and Reporting

*PROBLEM 12-8A

(a)

WARNER COMPANY Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Cash receipts from customers...... Less cash payments: To suppliers ............................ For operating expenses ......... For interest.............................. For income taxes .................... Net cash provided by operating activities .............

$236,000 (1) $179,000 (2) 6,500 (3) 3,000 9,000 (4)

38,500

Cash flows from investing activities Sale of equipment .......................... Cash flows from financing activities Issuance of common stock ........... Redemption of bonds .................... Payment of dividends .................... Net cash used by financing activities ..............................

197,500

8,500 4,000 (16,000) (20,000)

Net increase in cash .............................. Cash at beginning of period ................. Cash at end of period ............................

(32,000) 15,000 20,000 $ 35,000

(See Illustrations 12A-5; 12A-9; 12A-11; 12A-13; and 12A-16)

Computations: (1) Cash receipts from customers Sales ....................................................................... Deduct: Increase in accounts receivable ............ Cash receipts from customers .....................................

$242,000 6,000 $236,000

*PROBLEM 12-8A (Continued) (2) Cash payments to suppliers Cost of goods sold....................................................... Add: Increase in inventory ......................................... Cost of purchases ........................................................ Deduct: Increase in accounts payable....................... Cash payments to suppliers........................................

$175,000 8,000 183,000 4,000 $179,000

(3) Cash payments for operating expenses Operating expenses ..................................................... Deduct: Depreciation .................................................. Cash payments for operating expenses.....................

$ 24,000 17,500 $ 6,500

(4) Cash payments for income taxes Income tax expense ..................................................... Add: Decrease in income taxes payable ................... Cash payments for income taxes................................

$ $

8,000 1,000 9,000

(b) $38,500 – $0 – $20,000 = $18,500 LO 3, 4 BT: AP Difficulty: Hard TOT: 50 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 12-9A GRANGER INC. Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ........................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Loss on disposal of plant assets ............. Increase in accounts receivable .............. Increase in inventory ................................ Increase in prepaid expenses .................. Increase in accounts payable................... Decrease in accrued expenses payable.... Net cash provided by operating activities................................................. Cash flows from investing activities Sale of plant assets .......................................... Purchase of investments ................................. Purchase of plant assets.................................. Net cash used by investing activities................................................. Cash flows from financing activities Sale of common stock...................................... Payment of cash dividends.............................. Redemption of bonds ....................................... Net cash used by financing activities.................................................

$154,580

$46,500 7,500 (49,800) (9,650) (2,400) 34,700 (4,500)

22,350 176,930

1,500 (29,000) (100,000) (127,500) 45,000 (26,030) (36,000)

Net increase in cash................................................. Cash at beginning of period .................................... Cash at end of period............................................... (See Illustration 12-13) LO 2 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

(17,030) 32,400 48,400 $ 80,800

*PROBLEM 12-10A

GRANGER INC. Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Cash receipts from customers.............. Less cash payments: To suppliers.................................... For income taxes............................ For operating expenses ................. For interest ..................................... Net cash provided by operating activities...................................... Cash flows from investing activities Sale of plant assets ............................... Purchase of investments....................... Purchase of plant assets....................... Net cash used by investing activities...................................... Cash flows from financing activities Sale of common stock ........................... Payment of cash dividends................... Redemption of bonds ............................ Net cash used by financing activities...................................... Net increase in cash...................................... Cash at beginning of period ......................... Cash at end of period .................................... (See Illustration 12A-5; 12A-9; 12A-11; and 12A-16)

$338,660 (1) $110,410 (2) 27,280 19,310 (3) 4,730

161,730 176,930

1,500 (29,000) (100,000) (127,500) 45,000 (26,030) (36,000) (17,030) 32,400 48,400 $ 80,800

*PROBLEM 12-10A (Continued) Computations: (1) Cash receipts from customers Sales ............................................................................... $388,460 Deduct: Increase in accounts receivable .......................... 49,800 Cash receipts from customers...................................... $338,660 (2) Cash payments to suppliers Cost of goods sold......................................................... Add: Increase in inventory ........................................... Cost of purchases.......................................................... Deduct: Increase in accounts payable ........................ Cash payments to suppliers ......................................... (3) Cash payments for operating expenses Operating expenses exclusive of depreciation .............................................. Add: Increase in prepaid expenses ................... $2,400 Decrease in accrued expenses payable ................................................. 4,500 Cash payment for operating expenses ................................................... LO 4 BT: AP Difficulty: Hard TOT: 50 min. AACSB: Analytic AICPA FC: Reporting

$135,460 9,650 145,110 34,700 $110,410

$12,410 6,900 $19,310

PROBLEM 12-11A

SPICER COMPANY Statement of Cash Flows For the Year Ended December 31, 2017 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Loss on disposal of plant assets ................ Decrease in accounts receivable ................ Increase in inventory ................................... Decrease in prepaid expenses .................... Increase in accounts payable...................... Net cash provided by operating activities.................................................... Cash flows from investing activities Sale of land ($130,000 + $40,000 – $145,000) ..... Sale of equipment ................................................ Purchase of equipment ....................................... Net cash used by investing activities .........

$ 37,000

$42,000 2,000 8,000 (9,450) 5,720 8,730

57,000 94,000

25,000 8,000 (92,000) (59,000)

Cash flows from financing activities Payment of cash dividends.................................

(12,000)

Net increase in cash.................................................... Cash at beginning of period ....................................... Cash at end of period ..................................................

23,000 45,000 $68,000

Noncash investing and financing activities Acquired land by issuance of common stock..........................................

$40,000

(See Illustration 12-13) LO 2 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Reporting

PROBLEM 12-12A

(a) (b) (c) (d) (e) (f)

Transaction Recorded credit sales $2,500. Collected $1,900 owed by customers. Paid amount owed to suppliers, $2,750. Recorded sales returns of $500 and credited the customer’s account. Purchased new equipment $5,000; signed a long-term note payable for the cost of the equipment. Purchased a patent and paid $65,000 cash for the asset.

Free Cash Flow ($125,000) NE I D NE D* D

*Note to Instructor: If only cash capital expenditures are deducted, this answer would be NE. LO 3 BT: C Difficulty: Medium TOT: 15 min. AACSB: None AICPA FC: Measurement and Reporting

CT 12-1

FINANCIAL REPORTING PROBLEM

(a) Net cash provided by operating activities (in millions): 2014 2013

$59,713 $53,666

(b) The decrease in cash and cash equivalents for the year ended September 27, 2014 was $415 million. (c) Apple uses the indirect method of computing and presenting the net cash provided by operating activities. (d) According to the statement of cash flows, accounts receivable increased $4,232 million in the year ended September 27, 2014. Inventories increased $76 million. Accounts payable increased $5,938 million in fiscal year ending September 27, 2014. (e) The net cash used by investing activities in fiscal year ending September 27, 2014 was $22,579 million. (f)

The supplemental disclosure of cash flow information disclosed interest paid of $339 million and income taxes paid of $10,026 million in fiscal year ending September 27, 2014.

LO 1, 2 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 12-2

(a)

COMPARATIVE ANALYSIS PROBLEM

(in thousands) $185,783 − $60,283 − $39,836 = $1,697,629−$234,077−$478,933 =

Columbia Sportswear

VF Corporation

$85,664 $984,619

(b) VF Corporation generated over 11 times as much free cash flow as Sportswear. However, both had a significant amount of "free cash" available after covering capital expenditures and cash dividends. LO 3 BT: AN Difficulty: Medium TOT: 15 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CT 12-3

(a)

COMPARATIVE ANALYSIS PROBLEM

(All amounts in millions) $6,842 − $4,893 − $0 =

Amazon

Wal-Mart

$1,949

$10,205* *$28,564 –$12,174 – $6,185

(b) Both companies had a significant amount of “free cash” available after covering capital expenditures and cash dividends. However, Wal-Mart did generate approximately five times as much free cash flow compared to Amazon. LO 3 BT: E Difficulty: Medium TOT: 15 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

CT 12-4

REAL-WORLD FOCUS

Answers will vary depending on the company chosen by the student. LO - BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 12-5

REAL-WORLD FOCUS

(a) At the end of 2009 the nonfinancial companies in the Standard and Poor’s 500 had accumulated $932 billion. This represented a 31% increase over the prior year. (b) First, cash (and short term investments) do not generate a very good return. Thus, having too much cash on your balance sheet can drag down the return on assets. Second, managers worry that if they accumulate too much cash it will appear that they have run out of good ideas to invest in to grow the company. Another concern is that, if you have a lot of cash on your balance sheet, another company might decide to acquire your company. If you use debt to acquire a company that has a lot of cash, you can use the acquired company’s cash to pay down the debt. (c) In order to motivate its managers to accumulate cash, Alcoa pegged the compensation of its top executives to cash goals. In response, top management cut 28,000 jobs (32% of its workforce), and reduced capital expenditures by 53%. As a consequence, even though its revenue dropped by 31%, it nearly doubled its cash to $1.5 billion. (d) At the time the article was written the stock prices of the Standard and Poor’s 500 was 29% below its October 2007 peak. As a consequence, companies felt that their shares were still undervalued, so they didn’t want to use them to acquire other companies. They felt that they should instead use cash. (e) In addition to acquisitions, companies can increase their dividends or do stock buybacks (buy treasury shares). LO - BT: S Difficulty: Hard TOT: 40 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 12-6

REAL-WORLD FOCUS

(a) The stock was issued at a price of $70 per share. A few months previously it sold for more than $300 per share. (b) The company issued shares of stock, even though its stock price was depressed, because its cash flows were not meeting its immediate needs. The company’s cash flows declined because the company lost subscribers when it raised its prices. (c) Netflix had used up more than $1 billion of cash to buy back stock during the previous four years. (d) The article says that growth companies should be very cautious about using cash to buy back stock. Growth companies have many ups and downs. They need to make sure they have enough cash on hand to get them through downtrends. LO - BT: S Difficulty: Hard TOT: 30 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 12-7

(a)

DECISION MAKING ACROSS THE ORGANIZATION

COMPUTER SERVICES COMPANY Statement of Cash Flows For the Year Ended January 31, 2017 Cash flows from operating activities Net loss .................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.................... Gain from disposal of investment Net cash provided by operating activities ..................................... Cash flows from investing activities Sale of investment................................. Purchase of investment ........................ Purchase of fixtures and equipment.... Net cash used by investing activities ..................................... Cash flows from financing activities Sale of capital stock .............................. Purchase of treasury stock .................. Net cash provided by financing activities ..................................... Net increase in cash ..................................... Cash at beginning of period......................... Cash at end of period ................................... Noncash investing and financing activities Issuance of note for truck.....................

$ (35,000)*

$ 55,000 (5,000)

50,000 15,000

80,000 (75,000) (320,000) (315,000) 405,000 (10,000) 395,000 95,000 140,000 $235,000 $ 20,000

CT 12-7 (Continued) *Computation of net income (loss) Sales of merchandise ............................... Interest revenue ........................................ Gain on sale of investment ($80,000 – $75,000) ................................ Total revenues and gains.................. Merchandise purchased ........................... Operating expenses ($170,000 – $55,000) .............................. Depreciation .............................................. Interest expense........................................ Total expenses................................... Net loss ......................................................

$385,000 6,000 5,000 396,000 $258,000 115,000 55,000 3,000 431,000 $ (35,000)

(b) From the information given, it appears that from an operating standpoint, Computer Services Company did not have a superb first year, having suffered a $35,000 net loss. Maria is correct; the statement of cash flows is not prepared in correct form. The correct format classifies cash flows from three activities—operating, investing, and financing; and it also presents significant noncash investing and financing activities in a separate schedule. Maria is wrong, however, about the actual increase in cash not being $95,000; $95,000 is the correct increase in cash. LO 2 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Interaction, Leadership and Communication

CT 12-8

COMMUNICATION ACTIVITY

MEMO To:

Walt Jax

From:

Student

Re:

Statement of cash flows

The statement of cash flows provides information about the cash receipts and cash payments of a firm, classified as operating, investing, and financing activities. The operating activities section of the company’s statement of cash flows shows that cash increased by $172,000 as a result of transactions which affected net income. This amount is computed by adjusting net income for those items which affect net income, but do not affect cash, such as sales on account which remain uncollected at year-end. The investing activities section of the statement reports cash flows resulting from changes in investments and other long-term assets. The company had a cash outflow from investing activities due to purchases of buildings and equipment. The financing activities section of the statement reports cash flows resulting from changes in long-term liabilities and stockholders’ equity. The company had a cash inflow from financing activities due to the issuance of common stock and an outflow due to the payment of cash dividends. If you have any further questions, please do not hesitate to contact me. LO 1, 2 BT: C Difficulty: Medium TOT: 30 min. AACSB: None AICPA FC: Reporting AICPA PC: Communication

CT 12-9

ETHICS CASE

(a) The stakeholders in this situation are: Hans Pfizer, president of Pendleton Automotive Corporation. Kurt Nolte, controller. The Board of Directors. The stockholders of Pendleton Automotive Corporation. (b) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller. This statement along with his statement, “I know you won’t let me down Kurt,” encourages Kurt to do something unethical. Controller Kurt Nolte's reclassification (intentional misclassification) of a cash inflow from a long-term note (financing activity) issuance to an “increase in payables” (operating activity) is inappropriate and unethical. (c) It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company’s transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Pendleton Automotive Corporation’s statement of cash flows. It is also possible that close scrutiny of the balance sheet showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the statement of cash flows. LO 2 BT: E Difficulty: Hard TOT: 40 min. AACSB: Communication and Ethics AICPA FC: Reporting AICPA PC: Professional Demeanor

CT 12-10

ALL ABOUT YOU

(a) The article describes three factors that determine how much money you should set aside. (1) Your willingness to take risk. You need to evaluate how willing you are to experience wide swings in your financial position. (2) Your needs. You need to carefully evaluate your situation and evaluate the possibility of various events and what the financial implications would be. This is also impacted by the number of dependents you have. (3) Your upcoming expenses. Here you need to look further out into the horizon and consider the implications of larger events such as a big trip, a wedding, or education costs. (b) They recommend having at least three months of living expenses set aside, and up to six months. (c) Responses to this question will vary. What is most important is that students begin the process of considering their cash needs and developing a plan to set aside enough money to provide a cushion in the event of a financial “hiccup.” LO - BT: S Difficulty: Medium TOT: 30 min. AACSB: Analytic, Technology and Communication AICPA FC: Reporting AICPA PC: Communication

CT 12-11

FASB CODIFICATION ACTIVITY

(a) Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: a. Readily convertible to known amounts of cash b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). (b) Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise setting the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit. (c) Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale, as discussed in paragraph 230-10-45-12 and 230-10-45-21.

CT 12-11 (Continued) (d) Operating activities include all transactions and other events that are not defined as investing or financing activities (see paragraph 230-1045-12 through 45-15). Operating activities generally involve producing and delivering goods and providing services. Cash flow from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. (e) The primary objective of a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during a period. As indicated in the glossary at this same section, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made. Thus, the basis for the statement of cash flows is cash, not broader measures of liquidity, like working capital. (f)

Information about all investing and financing activities of an entity during a period that affect recognized assets or liabilities but that do not result in cash receipts or cash payments in the period shall be disclosed. Those disclosures may be either narrative or summarized in a schedule, and they shall clearly relate the cash and noncash aspects of transactions involving similar items.

LO 1 BT: S Difficulty: Hard TOT: 50 min. AACSB: Analytic, Technology and Communication AICPA FC: Reporting AICPA PC: Communication

IFRS CONCEPTS AND APPLICATION

IFRS 12-1 Under IFRS bank overdrafts are treated as part of cash and cash equivalents on the balance sheet. As a result, on the statement of cash flows they are part of the change in cash and cash equivalents. In contrast, under GAAP they are treated as a liability on the balance sheet, as a source of financing on the statement of cash flows. LO 6 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS 12-2 The treatment of these items under IFRS and GAAP is as follows:

(a) (b) (c) (d)

Interest paid Interest received Dividends paid Dividends received

IFRS

GAAP

Operating or financing Operating or investing Operating or financing Operating or investing

Operating Operating Financing Operating

LO 6 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Measurement and Reporting

IFRS 12-3 INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) The company reports interest paid as an operating activity. (b) The company reports dividends received as an operating activity. (c) Under GAAP bank overdrafts are not reported in cash and cash equivalents. Instead they are treated as a financing activity, and would be reported on the balance sheet as a liability. LO 6 BT: AN Difficulty: Medium TOT: 8 min. Reporting AICPA PC: Communication

AACSB: Analytic and Communication

AICPA FC:

CHAPTER 13 Financial Analysis: The Big Picture Learning Objectives 1. Explain the concepts of sustainable income and quality of earnings. 2. Apply horizontal analysis and vertical analysis. 3. Analyze a company's performance using ratio analysis.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

Questions 1.

11.

16.

20.

12.

17.

21.

13.

18.

22.

14.

19.

10.

15.

Brief Exercises 1.

10.

13.

11.

14.

12.

15.

Do It! Exercises 1.

Exercises 1.

12.

10.

13.

11.

Problems: Set A 1.

2, 3

*Continuing Cookie Solutions for this chapter are available online.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare vertical analysis and comment on profitability.

Moderate

20–30

Compute ratios from balance sheet and income statements.

Moderate

20–30

Perform ratio analysis, and discuss change in financial position and operating results.

Moderate

20–30

Compute ratios; comment on overall liquidity and profitability.

Moderate

40–50

Compute selected ratios, and compare liquidity, profitability, and solvency for two companies.

Moderate

50–60

ANSWERS TO QUESTIONS 1.

Sustainable income is defined as the most likely level of income to be obtained in the future. It is the amount of regular income that a company can expect to earn from its normal operations. In order to distinguish a company’s net income from its sustainable income, irregular items, such as discontinued operations, are reported separately on the income statement.

LO 1 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 2.

This would not be considered a favorable trend for Hogan Inc. The relevant earnings per share figures are the $3.26 in 2016 and the $2.99 in 2017. These figures indicate that, unless there was a sale of common stock, the earnings from the continuing operations of the company decreased during 2017. This should give the company’s management some concern because they will not always be able to count on income or gains from discontinued operations.

LO 1 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 3.

Companies report a change from FIFO to average cost pricing for inventory retroactively. That is, they report both the current period and any previous periods reported on the face of the statement using the new principle. As a result, the same principle applies in all periods. This treatment improves the ability to compare results across years.

LO 1 BT: C Difficulty: Easy TOT: 3 AACSB: None AICPA FC: Reporting 4.

Apple reported “Other comprehensive income” of $1,553 millions for year ended September 27, 2014. “Comprehensive income” was more than “Net income” by 3.9% [($41,063 – $39,510) ÷ $39,510]

LO 1 BT: AN Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 5.

(1) Use of alternative accounting methods. Variations among companies in the application of generally accepted accounting principles may hamper comparability. (2) Use of pro forma income measures that do not follow GAAP. Pro forma income is calculated by excluding items that the company believes are unusual or nonrecurring. It is often difficult to determine what was included and excluded. (3) Improper revenue and expense recognition. Many high-profile cases of inappropriate accounting involve recording items in the wrong period.

LO 1 BT: K Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 6.

(a) During a period of inflation, net income will be less under the LIFO inventory costing method than it will be using the FIFO method because LIFO results in the larger cost of goods sold amount. (b) Inflation does not affect the amount of depreciation taken (except through its effect on salvage) since the depreciable amount is based on the acquisition cost. A six-year life produces greater depreciation for the first six years (thus, less net income) and less depreciation in years 7, 8, 9 (thus, more net income in those years) than a nine-year life.

(c) Inflation does not affect the amount of depreciation taken. Use of the straight-line method results in less depreciation in the earlier years (thus, more net income) than the decliningbalance method but more depreciation in the later years. LO 1 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting 7.

Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Vertical analysis, also called common-size analysis, expresses each item within a financial statement as a percent of a relevant base amount.

LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 8.

(a) $300,000 X 1.245 = $373,500, 2017 net income. (b) $300,000 ÷ .06 = $5,000,000, 2016 revenue.

LO 2 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 9.

(a)

Gina is not correct. There are three characteristics: liquidity, profitability, and solvency.

(b) The three parties are not primarily interested in the same characteristics of a company. Shortterm creditors are primarily interested in the liquidity of the enterprise. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company. LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting 10. (a)

Comparison of financial information can be made on an intracompany basis, an intercompany basis, and an industry average basis. 1. An intracompany basis compares the same item with prior periods, or with other financial items in the same period. 2. An intercompany basis compares the same item with other companies’ published reports. 3. The industry average compares the item with the industry average as compiled by Dun & Bradstreet or by trade associations.

(b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company. The intercompany basis of comparison provides insight into a company’s competitive position. The industry average basis provides information about a company’s relative position within the industry. LO 2 BT: C Difficulty: Hard TOT: 5 min. AACSB: None AICPA FC: Reporting 11.

(a)

Liquidity ratios: Working capital, current ratio, inventory turnover, days in inventory, accounts receivable turnover, and average collection period. (b) Solvency ratios: Debt to assets ratio, times interest earned, and free cash flow.

LO 3 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

12.

Tina is correct. A single ratio by itself may not be very meaningful and is best interpreted by comparison with (1) past ratios of the same company, (2) ratios of other companies, or (3) industry norms or predetermined standards. In addition, other ratios of the company are necessary to determine overall financial well-being.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 13.

(a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (b) Solvency ratios measure the company’s ability to survive over a long period of time. (c) Profitability ratios measure the income or operating success of a company for a given period of time.

LO 3 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 14.

Working capital and the current ratio both relate current assets to current liabilities. Working capital produces a dollar amount that indicates the difference between current assets and current liabilities. The current ratio produces a ratio which indicates the proportional relationship between current assets and current liabilities.

LO 3 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 15.

Handi Mart does not necessarily have a problem. The accounts receivable turnover can be misleading in that some companies encourage credit and revolving charge sales and slow collections in order to earn a healthy return on the outstanding receivables in the form of high rates of interest.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 16.

(a) (b) (c) (d)

Asset turnover. Inventory turnover and days in inventory. Return on common stockholders’ equity. Times interest earned.

LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 17.

The price earnings (P-E) ratio is a reflection of investors’ assessments of a company’s future earnings. The P-E ratio takes into account such factors as relative risk, stability of earnings, trends in earnings, and the market’s perception of the company’s growth potential. In this question, investors favor Microsoft because it has the higher P-E ratio. The investors feel that Microsoft will be able to generate even higher future earnings and thus investors are willing to pay more for the stock.

LO 3 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 18.

The payout ratio is cash dividends declared on common stock divided by net income. In a growth company, the payout ratio is often low because the company is reinvesting earnings in the business.

LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

19.

(a)

The increase in the profit margin is good news because it means that a greater percentage of net sales is going towards income.

(b) The decrease in inventory turnover signals bad news because it is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence. (c) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (d) Earnings per share is a deceptive ratio. The decrease might be bad news to the company because it could mean a decrease in net income. Or the decrease might be good news to the company because of an increase in stockholders’ investment. (e) The increase in the price-earnings ratio is generally good news because it means that the market price per share of stock has increased and investors are willing to pay that higher price for the stock. (f)

The increase in the debt to assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.”

(g) The decrease in the times interest earned is bad news because it means that the company’s ability to meet interest payments as they come due has weakened. LO 3 BT: C Difficulty: Hard TOT: 6 min. AACSB: None AICPA FC: Reporting 20.

Net Income Return on assets = Average Total Assets (7.6%) Net Income  Preferred dividends

Return on common stockholders’ equity = Average common stockholders’ equity (12.8%) The difference between the two rates can be explained by looking at the denominator value and by remembering the basic accounting equation, A = L + SE. The asset value will clearly be the larger of the two denominator values; therefore, it will also give the smaller rate of return. LO 3 BT: AN Difficulty: Hard TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

21.

(a) Times interest earned, which is an indication of the company’s ability to meet interest charges, and the debt to assets ratio, which indicates the company’s ability to withstand losses without impairing the interests of creditors. (b) The current ratio and accounts receivable turnover, which indicate a company’s liquidity and short-term debt-paying ability. (c)

The earnings per share of common stock and the return on common stockholders’ equity, both of which indicate the earning power of the investment.

LO 3 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting 22.

Net income - Preferred dividends = Earnings per share. Average common shares outstanding $200,000 – $20,000

= $4.50

40,000 EPS of $4.50 is high relative to what? Is it high relative to last year’s EPS? The president may be comparing the EPS of $4.50 to the market price of the company’s stock, which is inappropriate. LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 FLORES CORPORATION Partial Income Statement Discontinued operations: Loss on disposal of Mexico facility, net of $160,000 ($640,000 X 25%) tax savings.........................................

($480,000)

LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-2 SILVA CORPORATION Partial Statement of Comprehensive Income Income before income taxes ...................................................... Income tax expense ($450,000 X 25%) ....................................... Net Income .................................................................................. Other comprehensive income Unrealized holding gain on available-for-sale securities, net of $17,500 income taxes ($70,000 X 25%)…………..... Comprehensive income .............................................................

$450,000 112,500 337,500 52,500 $390,000

LO 1 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-3 The change in inventory pricing for Bryce should be reported retroactively. That is, it should report both the current period and previous periods included on the face of the statement using the new principle. As a result, the same principle applies in all periods. The treatment improves the ability to compare results across years. LO 1 BT: C Difficulty: Easy TOT: 4 min. AACSB: None AICPA FC: Measurement AICPA PC: Communication

BRIEF EXERCISE 13-4 Horizontal analysis:

Dec. 31, 2017 Dec. 31, 2016 Accounts receivable $ 460,000 $ 400,000 Inventory $ 780,000 $ 650,000 Total assets $3,164,000 $2,800,000

*$60,000 = .15 $400,000

$130,000 = .20 $650,000

Increase or (Decrease) Amount Percentage* $ 60,000 15% $130,000 20% $364,000 13%

$364,000 = .13 $2,800,000

LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-5 Vertical analysis: Dec. 31, 2017 Accounts receivable Inventory Total assets

Dec. 31, 2016

Amount Percentage* Amount Percentage** $ 460,000 14.5% $ 400,000 14.3% $ 780,000 24.7% $ 650,000 23.2% $3,164,000 100% $2,800,000 100%

*$460,000 = .145 $3,164,000

**$400,000 = .143 $2,800,000

$780,000 = .247 $3,164,000

$650,000 = .232 $2,800,000

LO 2 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-6

Net income

2017 $518,400

2016 $485,000

2015 $500,000

Increase or (Decrease) Amount Percentage* ($15,000) (3%) $33,400 7%

(a) 2015–2016 (b) 2016–2017 *($15,000) = (.03) $500,000

$33,400 = .07 $485,000

LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-7

Net income .16 =

2017 $382,800

2016 X

Increase 16%

$382,800 – X X

.16X = $382,800 – X 1.16X = $382,800 X = $330,000 2016 Net Income = $330,000 (% increase in net income = ($380,000 – 2016 net income) ÷ 2016 net income) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-8

Sales revenue Cost of goods sold Expenses Net income

2017 100.0 60.5 26.0 13.5

2016 100.0 62.9 26.6 10.5

2015 100.0 64.8 27.5 7.7

Net income as a percent of sales for Palau increased over the three-year period because cost of goods sold and expenses both decreased as a percent of sales every year. LO 2 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-9 Comparing the percentages presented results in the following conclusions: The net income for Phoenix increased in 2016 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses. However, the reverse was true in 2017 as sales decreased, while both cost of goods sold and expenses increased. This resulted in a decrease in net income. LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic and Communication AICPA FC: Reporting AICPA PC: Communication

BRIEF EXERCISE 13-10 Current ratio: 2017 $80,260 Current assets = = .33:1 $245,805 Current liabilities

2016 $70,874 = .22:1 $326,203

The current ratio increased by 50% indicating that Bob Evans Farms is more liquid in 2017. LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-11 Accounts receivable turnover =

Net credit sales Average net accounts receivable

2017 (a)

$4,300,000 = 7.9 times $545,000* *($540,000 + $550,000) ÷ 2

2016 $4,000,000 = 7.5 times $530,000** **($520,000 + $540,000) ÷ 2

(b) Average collection period 365 = 46.2 days 7.9

365 = 48.7 days 7.5

Colby Company can be somewhat pleased with the effectiveness of its credit and collection policies. The company has decreased the average collection period by more than two days and the collection period of approximately 46 days almost equals the 45 days allowed in the credit terms. LO 3 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

BRIEF EXERCISE 13-12 (a) Inventory turnover =

Cost of goods sold Average inventory



2017

2016

$4,780,000*  $960,000 + $1,020,000  = 4.8 times

 $840,000 + $960,000  = 5.0 times  

 

 

$4,541,000**



2017 $ 960,000 4,840,000 5,800,000 1,020,000 $4,780,000*

Beginning inventory Purchases Goods available for sale Ending inventory Cost of goods sold





2016 $ 840,000 4,661,000 5,501,000 960,000 $4,541,000**

 (Inventory turnover = cost of goods sold ÷ Average inventory)

(b) Days in inventory 365 = 76 days 4.8

365 5.0

= 73 days

Management should be concerned with the fact that inventory moved slower in 2017 than it did in 2016. The decrease in inventory turnover could be because of poor pricing decisions or because the company is stuck with obsolete inventory. LO 3 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

BRIEF EXERCISE 13-13 Net sales

(a) Asset turnover =

Average total assets $24,275.5 $13,073.1 + $13,717.3 2 = 1.81 times =

Staples generated $1.81 of sales for each dollar it had invested in assets. (Asset turnovers =Net sales ÷ Average total assets)

(b) Profit margin =

Net income Net sales

$738.7 $24,275.5

= 3.0% Each dollar of sales resulted in about 3 cents of net income. LO 3 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-14 Payout ratio = .18 =

Cash dividends declared on common stock Net income X $72,000

X = $72,000 (.18) = $12,960 Cash dividends = $12,960 (Cash dividends = Net income × Payout ratio)

Return on assets

Net income Average total assets

.20 =

$72,000 X

.20X = $72,000 X =

$72,000 .20

X = $360,000 Average total assets = $360,000 (Average total assets = Net income ÷ Return on assets) LO 3 BT: AN Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

BRIEF EXERCISE 13-15 Free Cash Flow = Cash provided by operating activities – Capital expenditures – Cash dividends $10.4 – $3.7 – $6.2 = $.5 Topps Company generated enough cash from operating activities to maintain its current productive capacity and pay dividends. The free cash flow that remained could have been used to expand operations, pay additional dividends, or reduce debt. LO 3 BT: AN Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO DO IT! EXERCISES DO IT! 13-1 HRABIK CORPORATION Partial Statement of Comprehensive Income Income before income taxes ........................................ Income tax expense ...................................................... Income from continuing operations ............................ Discontinued operations Loss from operations of music division, net of $12,000 income tax saving ............ $48,000 Gain from disposal of music division, net of $8,000, taxes .............................. 32,000 Net income..................................................................... Other comprehensive income: Unrealized holding loss of available-for-sale securities, net of $30,000 income tax saving .......................... Comprehensive income ................................................

$500,000 100,000 400,000

16,000 384,000 120,000 $264,000

(Any gains or losses from discontinued operations should be reported net of their income tax effects) LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

DO IT! 13-2 Increase in 2017 Amount Current assets Plant assets Total assets

Percent

$ (20,000) (9.1)% [($ 200,000 – $ 220,000) ÷ $ 220,000] 260,000 33.3% [($1,040,000 – $ 780,000) ÷ $ 780,000] $240,000 24% [($1,240,000 – $1,000,000) ÷ $1,000,000]

LO 2 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement and Reporting

DO IT! 13-3 2017 (a) Current ratio: $1,380 ÷ $900 = $1,310 ÷ $790 =

1.53:1

(b) Inventory turnover: $955/ [($460 + $390) ÷ 2)] = $890/ [($390 + $340) ÷ 2)]=

2.25 times

7.7%

(d) Return on assets: $294/[($2,340 + $2,210) ÷ 2)] = $154/[($2,210 + $1,900) ÷ 2)] =

12.9%

(e) Return on common stockholders’ equity: $294/[($1,030 + $1,040) ÷ 2)] = $154/[$1,040 + $900) ÷ 2)] =

28.4%

(f)

Debt to assets ratio: $1,310 ÷ $2,340 = $1,170 ÷ $2,210 =

(g) Times interest earned: ($294 + $126 + $25) ÷ $25 = ($154 + $66 + $20) ÷ $20 =

2016

1.66:1

2.44 times

4.5%

7.5%

15.9% 56.0% 52.9% 17.8 times 12.0 times

LO 3 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO EXERCISES EXERCISE 13-1 (a)

HAAS CORPORATION Partial Statement of Comprehensive Income For the Year Ended October 31, 2017 Income before income taxes.................................................. Income tax expense ($540,000 X 20%) .................................. Income from continuing operations ...................................... Discontinued operations Loss from operations, net of $10,000 income tax savings ($50,000 X 20%) .................... 40,000 Loss on disposal, net of $14,000 income tax saving ($70,000 X 20%) ..................... 56,000 Net income ..............................................................................

$540,000 108,000 432,000

96,000 $336,000

(Any discontinued operations gains or losses should be reported net of their income tax effects)

(b)

To:

Chief Accountant

From: Your name, Independent Auditor After reviewing your income statement for the year ended 10/31/17, we believe it is misleading for the following reasons: The amount reported for income from continuing operations is overstated by $24,000. The income tax expense should be 20% of $540,000, or $108,000, not $84,000. Also, the effect of the loss on discontinued operations on net income is only $96,000, not $120,000. An income tax savings of $24,000 should be netted against the loss. LO 1 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

EXERCISE 13-2 TRAYER CORPORATION Partial Statement of Comprehensive Income For the Year Ended December 31, 2017 Income from continuing operations ...................... Discontinued operations Loss from operations, net of $2,000 income tax savings...................................... $ 8,000 Gain from disposal, net of $8,000 income taxes .............................................. 32,000 Net income .............................................................. Other comprehensive income Unrealized holding loss on available-for-sale securities, net of $16,000 income tax savings .................................. Comprehensive income..........................................................

$290,000

24,000 $314,000 64,000 $250,000

(Gains and losses from discontinued operations and other comprehensive income should be reported net of their income tax effects) LO 1 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

EXERCISE 13-3 GLITTER INC. Condensed Balance Sheet December 31 Increase or (Decrease) Amount Percentage

2017

2016

Assets Current assets Plant assets (net) Total assets

$106,000 400,000 $506,000

$ 90,000 350,000 $440,000

$16,000 50,000 $66,000

17.8% 14.3% 15.0%

Liabilities Current liabilities Long-term liabilities Total liabilities

$ 99,000 122,000 $221,000

$ 65,000 90,000 $155,000

$34,000 32,000 $66,000

52.3% 35.6% 42.6%

130,000 155,000

115,000 170,000

15,000 (15,000)

13.0% (8.8%)

285,000

–0–

$506,000

$440,000

$66,000

15.0%

Stockholders’ Equity Common stock, $1 par Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-4 JOSHUA CORPORATION Condensed Income Statement For the Years Ended December 31 2017 Sales revenue Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income taxes Income tax expense Net income

Amount $800,000 520,000 280,000 120,000 60,000 180,000 100,000 30,000 $ 70,000

2016

Percent 100.0% 65.0% 35.0% 15.0% 7.5% 22.5% 12.5% 3.7% 8.8%

Amount $600,000 408,000 192,000 72,000 48,000 120,000 72,000 24,000 $ 48,000

Percent 100.0% 68.0% 32.0% 12.0% 8.0% 20.0% 12.0% 4.0% 8.0%

LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-5 (a)

NIKE, INC. Condensed Balance Sheet May 31 ($ in millions)

Assets Current assets Property, plant, and equipment (net) Other assets Total assets

Percentage Change Increase (Decrease) from 2016

2017

2016

$ 9,734

$ 8,839

$895

10.1%

1,958 1,558 $13,250

1,891 1,713 $12,443

67 (155) $807

3.5% (9.0)% 6.5%

EXERCISE 13-5 (Continued) NIKE, INC. Condensed Balance Sheet (Continued) May 31

2017

2016

$ 3,277

$ 3,322

$ (45)

(1.4%)

1,280

1,296

(16)

(1.2%)

8,693

7,825

868

11.1%

$13,250

$12,443

$807

6.5%

$ (in millions)

Percent

Assets Current assets Property, plant, and equipment (net) Other assets Total assets

$ 9,734 1,958 1,558 $13,250

73.5% 14.8% 11.7% 100.0%

Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity

$ 3,277 1,280 8,693 $13,250

24.7% 9.7% 65.6% 100.0%

Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity

(b)

Percentage Change Increase (Decrease) from 2016

NIKE, INC. Condensed Balance Sheet May 31, 2017

LO 2 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-6 (a)

DELANEY CORPORATION Condensed Income Statement For the Years Ended December 31

Net sales Cost of goods sold Gross profit Operating expenses Net income (b)

2017 $598,000 477,000 121,000 80,000 $ 41,000

2016 $500,000 420,000 80,000 44,000 $ 36,000

Increase or (Decrease) During 2017 Amount Percentage $98,000 19.6% 57,000 13.6% 41,000 51.3% 36,000 81.8% $ 5,000 13.9%

DELANEY CORPORATION Condensed Income Statements For the Years Ended December 31 2017 Net sales Cost of goods sold Gross profit Operating expenses Net income

$ $598,000 477,000 121,000 80,000 $ 41,000

Percent 100.0% 79.8% 20.2% 13.4% 6.8%

2016 $ $500,000 420,000 80,000 44,000 $ 36,000

Percent 100.0% 84.0% 16.0% 8.8% 7.2%

LO 2 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-7 Current ratio = 2.01:1 ($4,054 ÷ $2,014) Accounts receivable turnover = 4.2 times ($8,258 ÷ $1,988.5a) Average collection period = 86.9 days (365 days ÷ 4.2) Inventory turnover = 5.9 times ($5,328 ÷ $899b) Days in inventory = 61.9 days (365 days ÷ 5.9) a

($2,035 + $1,942) ÷ 2 ($898 + $900) ÷ 2

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-8 Current ratio as of February 1, 2017 = 3.00:1 ($120,000 ÷ $40,000). Feb. 3 7 11 14 18

3.00 No change in total current assets or liabilities. 2.43 ($97,000 ÷ $40,000). 2.43 No change in total current assets or liabilities. 3.04 ($85,000 ÷ $28,000). 2.66 ($85,000 ÷ $32,000).

LO 3 BT: AP Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-9 (a) Current ratio =

$145,000 $50,000

= 2.90:1

(b) Accounts receivable turnover =

$350,000 $65,000 (1)

= 5.4 times

(1) ($70,000 + $60,000) 2 (c)

Average collection period = 365 days ÷ 5.4 = 67.6 days

(d) Inventory turnover =

$198,000 $55,000 (2)

(2)

= 3.6 times

$60,000 + $50,000 2

(e)

Days in inventory = 365 days ÷ 3.6 = 101.4 days

(f)

Free cash flow = $48,000 – $25,000 – $10,000 = $13,000

LO 3 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-10 (a) Profit margin

$75.9 $5,121.8

= 1.5%

$5,121.8 = 1.64 times $2,993.9 + $3,249.8   2  (Asset turnover = Net sales ÷ Average total assets) (b) Asset turnover

 $75.9 = 2.4% $2,993.9 + $3,249.8   2

 (Return on assets = Net income ÷ Average total assets)

(d) Return on common stockholders’ equity

$75.9 = 7.6%  $921.6 + $1,074.7   2

 (Return on common stockholders' equity = Net income ÷ Average common stockholders' equity)

(e) Gross profit rate

$5,121.8 – $3,540.6 $5,121.8

= 30.9%

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

 

EXERCISE 13-11 (a) Earnings per share

$67,000 $72,000 – $5,000 = = $1.86 36,000 32,000 + 40,000   2

 (EPS = (Net income – preferred dividends) ÷ Average number of common share outstanding)

(b) Price-earnings ratio

$14.00 $1.86

= 7.5 times

EXERCISE 13-11 (Continued) $21,000 – $5,000

= 22.2%

$72,000 (d) Times interest earned

$72,000 + $16,000 + $24,000 $112,000 = = 7.0 times $16,000 $16,000

LO 3 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-12 (a) Inventory turnover = 3.8 =

Cost of goods sold  $200,000 + $180,000    2

3.8 X $190,000 = Cost of goods sold Cost of goods sold = $722,000. (Cost of goods sold = Average inventory × inventory turnover)

(b) Accounts receivable turnover = 11.2 =

Net sales (credit)  $126,000 + $72,500    2

11.2 X $99,250 = Net sales (credit) = $1,111,600. (Net sales (credit) = Average accounts receivable × accounts receivable turnover )

(c) Return on common stockholders’ equity = 22% = Net income $400,000 + $113,500 + $400,000 + $101,000     2 .22 X $507,250 = Net income = $111,595. (Net income = Average common stockholders' equity × Return on common stockholders' equity)

EXERCISE 13-12 (Continued) (d) Return on assets = 18% =

Net income Average assets

Average assets =

$111,595 [see (c) above] Average assets

$111,595 .18

= $619,972

Total assets (Dec. 31, 2017) + $605,000 = $619,972 2 Total assets (Dec. 31, 2017) = ($619,972 X 2) – $605,000 = $634,944. (Average assets = Net income ÷ Return on assets) LO 3 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

EXERCISE 13-13 2017 (a) Current ratio: $1,390 ÷ $820 = $1,310 ÷ $790 =

1.70:1

(b) Inventory turnover: $970/[($460 + $390) ÷ 2)] = $890/[($390 + $340) ÷ 2)] =

2.28

2016 1.66:1

2.44

(Inventory turnover = Cost of goods sold ÷ Average inventory)

6.6%

(d) Return on assets: $252/[($2,340 + $2,210) ÷ 2)] = $132/[($2,210 + $1,900) ÷ 2)] =

11.1%

(Return on assets = Net income ÷ Average total assets)

3.8%

6.4%

EXERCISE 13-13 (Continued) (e) Return on common stockholders’ equity: $252/[($1,040 + $1,040) ÷ 2)] = $132/[($1,040 + $900) ÷ 2)] =

24.2% 13.6%

(Return on common stockholders' equity = Net income ÷ Average common stockholders' equity)

(f) Debt to assets ratio: ($820 + $480) ÷ $2,340 = ($790 + $380) ÷ $2,210 =

55.6%

(g) Times interest earned: ($252 + $168 + $10) ÷ $10 = ($132 + $ 88 + $20) ÷ $20 =

43 times

52.9%

12 times

LO 3 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Measurement and Reporting

SOLUTIONS TO PROBLEMS PROBLEM 13-1A

(a)

Condensed Income Statement For the Year Ended December 31, 2017 Duke Company Lord Company Dollars Percent Dollars Percent $1,849,000 100.0% $546,000 100.0% 1,063,200 57.5% 289,000 52.9% 785,800 42.5% 257,000 47.1% 240,000 13.0% 82,000 15.0% 545,800 29.5% 175,000 32.1%

Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other expenses and losses Interest expense 6,800 Income before income taxes 539,000 Income tax expense 62,000 Net income $ 477,000

.4% 3,600 29.1% 171,400 3.3% 28,000 25.8% $143,400

.7% 31.4% 5.1% 26.3%

(b) Lord Company appears to be more profitable. It has higher relative gross profit, income from operations, income before taxes, and net in$477,000  a come. Also, Duke's return on assets of 57.3%   is lower than  $832,593  b $143,400   Lord's return on assets of 67% , and Duke's return on    $214,172   $477,000  c common stockholders’ equity of 72.3% is lower than Lord's    $659,528   $143,400  d return on common stockholders’ equity of 93.1% .    $154,047 

PROBLEM 13-1A (Continued) 

$477,000 is Duke's 2017 net income. $832,593 is Duke's 2017 average assets: Current assets Plant assets Total assets

2017 2016 $325,975 $312,410 526,800 500,000 $852,775 + $812,410 =

$1, 665, 185 2

$143,400 is Lord's 2017 net income. $214,172 is Lord's 2017 average assets: Current assets Plant assets Total assets

2017 2016 $ 83,336 $ 79,467 139,728 125,812 $223,064 + $205,279 =

$428, 343 2

$477,000 is Duke's 2017 net income. $659,528 is Duke's 2017 average stockholders’ equity: 2017 2016 Common stock $500,000 $500,000 Retained earnings 172,460 146,595 Stockholders’ equity $672,460 + $646,595 =

$1, 319, 055 2

$143,400 is Lord's 2017 net income. $154,047 is Lord's 2017 average stockholders’ equity: 2017 2016 Common stock $120,000 $120,000 Retained earnings 38,096 29,998 Stockholders’ equity $158,096 + $149,998 =

$308, 094 2

LO 2, 3 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

PROBLEM 13-2A

(a) Earnings per share =

$218,000 59,000 (1)

(1)

 60,000* + 58,000**    2  



= $3.69

*$300,000 $5

**$290,000 $5





(b) Return on common stockholders’ equity =

$218,000 $465,400 + $603,400   2 $218,000 $534,400

= 40.8% (Return on common stockholders' equity = Net income ÷ Average common stockholders' equity)

$218,000 $218,000 = = 23.2% $939,850 $852,800 + $1,026,900   2

 (Return on assets = Net income ÷ Average total assets)

(d) Current ratio = $377,900 = 1.86:1 $203,500 $1,890,540 ($102,800 + $117,800)   2  $1,890,540 = = 17.1 times $110,300

(e) Accounts receivable turnover =

(Accounts receivable turnover = Net credit sales ÷ Average accounts receivable)

PROBLEM 13-2A (Continued) (f)

Average collection period = 365 days ÷ 17.1 = 21.3 days

(g) Inventory turnover =

$1,058,540 $1,058,540 = = 8.8 times $120,750 $115,500 + $126,000    2

 (Inventory turnover = Cost of goods sold ÷ Average inventory)

(h) Days in inventory = 365 days ÷ 8.8 = 41.5 days

(i)

Times interest earned = $310,000 + $22,000 = 15.1 times $22,000

(j)

Asset turnover =

    

$1,890,540 = 2.01 times $1,026,900 + $852,800 2    



 (Asset turnover = Net sales ÷ Average total assets)

(k) Debt to assets ratio = $423,500 = 41% $1,026,900 (l)

Free cash flow = $220,000 – $136,000 – $70,000 = $14,000

LO 3 BT: AP Difficulty: Medium TOT: 30 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 13-3A

(a)

2017 (1)

Profit margin. $95,000 $700,000

(2)

2016

$70,000

= 13.6%

$570,000

Gross profit rate. $220,000 = 38.6% $570,000

$275,000 = 39.3% $700,000 (3)

= 12.3%



Asset turnover.



 $700,000 = 1.06 times $600,000 + $725,000





 $570,000 = 1.01 times $533,000 + $600,000 





(Asset turnover = Net Sales ÷ Average total assets)

(4)

Earnings per share. $95,000 = $3.02 31,000 + 32,000

 (5)

(6)









Price-earnings ratio. $8.50 = 2.8 times

$7.50

$3.02

$2.30

= 3.3 times

Payout ratio. $45,000** $95,000

= 47%

**($125,000 + $95,000 – $175,000) (7)

 $70,000 = $2.30 30,000 + 31,000

$58,000* $70,000

= 83%

*($113,000 + $70,000 – $125,000)

Debt to assets ratio. ($85,000 + $145,000) = 32% $725,000

($80,000 + $85,000) = 28% $600,000

PROBLEM 13-3A (Continued) (b) The underlying profitability of the corporation appears to have improved. For example, profit margin and earnings per share have both increased. The corporation’s debt to assets ratio has increased but the improvements in profitability indicate that taking on more debt was a wise move. LO 3 BT: AN Difficulty: Medium TOT: 30 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

PROBLEM 13-4A

(a) LIQUIDITY 2016

2017

% Change

Current ratio

$383,000 = 1.81:1 $212,000

$484,000 = 1.76:1 $275,000

(3%)

Accounts receivable turnover

$790,000 = 9.0 times $882,000 = 9.1 times $88,000 $97,000

Inventory turnover

$575,000 = 4.1 times $640,000 = 3.2 times $197,500 $140,000

(22%)

An overall decrease in short-term liquidity has occurred. (Both accounts receivable and inventory turnovers have an average in their denominator)

PROFITABILITY Profit margin

$48,000 = 6.1% $790,000

$52,000 = 5.9% $882,000

(3%)

Asset turnover

$790,000 = 1.16 times $679,000

$882,000 = 1.12 times $786,000

(3%)

Return on assets

$48,000 = 7.1% $679,000

$52,000 = 6.6% $786,000

(7%)

Earnings per share

$48,000 = $2.40 20,000

$52,000 = $2.60 20,000

Profitability has decreased slightly. (Both Asset turnover and Return on assets have the same average in their denominator)

PROBLEM 13-4A (Continued) (b)

2017 1.

2018

%Change

Return on common stockholders’ equity

$52,000 $54,000 = 11.6% = 15.6% $466,000 (b) $332,500 (a)

Debt to assets ratio

$525,000 = 60% $874,000

$355,000 = 39% $900,000

(35%)

Priceearnings ratio

$9.00 = 3.5 times $2.60

$12.00 = 4.4 times $2.70 (c)

26%

(26%)

(a) ($200,000 + $149,000 + $200,000 + $116,000) ÷ 2. (b) ($380,000* + $203,000** + $200,000 + $149,000) ÷ 2. (c) $54,000 ÷ 20,000. *$200,000 + (18,000 X $10/share) **$149,000 + $54,000 (Return on common stockholders' equity has an average in its denominator) LO 3 BT: AN Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Measurement and Reporting

PROBLEM 13-5A

(a)

Ratio

Target

Wal-Mart

(All Dollars Are in Millions) (1) Current ratio 1.63:1 ($18,424 ÷ $11,327) .87:1 ($48,331 ÷ $55,561) (2) Accounts receivable 8.7 ($65,357 ÷ $7,525) 101.4 ($408,214 ÷ $4,025) turnover (3) Average collection period (in days) 42.0 (365 ÷ 8.7) 3.6 (365 ÷ 101.4) (4) Inventory turnover 6.6 ($45,583 ÷ $6,942) 9.0 ($304,657 ÷ $33,836) (5) Days in inventory 55.3 (365 ÷ 6.6) 40.6 (365 ÷ 9.0) (6) Profit margin 3.8% ($2,488 ÷ $65,357) 3.5% ($14,335 ÷ $408,214) (7) Asset turnover 1.5 ($65,357 ÷ $44,319.5a) 2.4 ($408,214 ÷ $167,067.5d) (8) Return on assets 5.6% ($2,488 ÷ $44,319.5a) 8.6% ($14,335 ÷ $167,067.5d) (9) Return on common b e stockholders’ equity 17.1% ($2,488 ÷ $14,529.5 ) 21.0% ($14,335 ÷ $68,369 ) (10) Debt to assets ratio 66% ($29,186 ÷ $44,533) 58% ($99,650 ÷ $170,706) (11) Times interest earned 6.5 ($4,579c ÷ $707) 11.4 ($23,539f ÷ $2,065) (12) Free cash flow $3,656 ($5,881 – $1,729 – $496) $9,848 ($26,249 – $12,184 – $4,217) a

($44,533 + $44,106) ÷ 2 b ($15,347 + $13,712) ÷ 2 c ($2,488 + $1,384 + $707)

($170,706 + $163,429) ÷ 2 ($71,056 + $65,682) ÷ 2 f ($14,335 + $7,139 + $2,065) e

(b) The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.63:1 is better than Wal-Mart’s .87:1. However, Wal-Mart has a better inventory turnover than Target and its accounts receivable turnover is significantly better than Target’s. Solvency—Wal-Mart betters Target in all of the solvency ratios. Thus, it is more solvent than Target. Profitability—With the exception of profit margin, Wal-Mart betters Target in all of the profitability ratios. Thus, it is more profitable than Target. LO 3 BT: AN Difficulty: Medium TOT: 60 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Communication

AICPA FC:

CT 13-1

(a)

FINANCIAL REPORTING PROBLEM

APPLE INC . Trend Analysis of Net Sales and Net Earnings For the Five Years Ended 2014 Base Period 2010—($ in millions) 2014

2013

2012

2011

2010

(1) Net sales Trend

$182,795 280%

$170,910 262%

$156,508 $108,249 240% 166%

(2) Net income Trend

$ 39,510 282%

$ 37,037 264%

$ 41,733 $ 25,922 $ 14,013 298% 185% 100%

$65,225 100%

Both net sales and net income increased significantly form, 2010–2014. They both appear to have increased at approximately the same rate, indicating that costs increased at the same rate. (b) (in millions) 1.

Debt to Assets Ratio 2014: 2013:

$120,292 ÷ $231,839 = 52% $83,451 ÷ $207,000 = 40%

Times Interest Earned 2014: 2013:

($39,510 + $13,973 + $384) ÷ $384 = 140.3 times ($37,037 + $13,118 + $136) ÷ $136 = 369.8 times

Apple's long-term solvency has decreased. The debt to assets ratio indicates that creditors are providing approximately 52% of Apple's total assets up from 40%. Also, even though the times interest earned ratio has decreased, Apple easily has the ability to pay interest payments when they come due as indicated by the times interest earned of approximately 140 times.

CT 13-1 (Continued) (c) ($ in millions) 1.

Profit Margin 2014: 2013:

Asset Turnover 2014: 2013:

$182,795 ÷ [($231,839 + $207,000) ÷ 2] = .83 times $170,910 ÷ [($207,000 + $176,064) ÷ 2] = .89 times

Return on Assets 2014: 2013:

$39,510 ÷ $182,795 = 21.6% $37,037 ÷ $170,910 = 21.7%

$39,510 ÷ [($231,839 + $207,000) ÷ 2] = 18.0% $37,037 ÷ [($207,000 + $176,064) ÷ 2] = 19.3%

Return on Common Stockholders’ Equity 2014: 2013:

$39,510 ÷ [($111,547 + $123,549) ÷ 2] = 33.6% $37,037 ÷ [($123,549 + $118,210) ÷ 2] = 30.6%

All of the profitability ratios except return on common stockholders' equity decreased in 2014. Stockholders are earning an outstanding 33.6% on their investment. Considering that Apple is primarily in a high-price business where the margin above costs is historically high, the profit margins for both 2014 and 2013 are good. (d) Substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often critical to the successful operation of a company. Financial reports in the media and publications of financial service firms (Standard & Poors, Dun & Bradstreet) will provide additional relevant information not usually found in the annual report. LO 2, 3 BT: AN Difficulty: Hard TOT: 60 min. AACSB: 60 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-2

COMPARATIVE ANALYSIS PROBLEM

(a)

Columbia Sportswear 1. (i) Percentage increase $2,100,590 – $1,684,996 (decrease) in net $1,684,996 sales

$12,154,784 – $11,302,350 = 24.7%

(ii) Percentage increase (decrease) in total stockholders’ equity 3. Basic earnings per share

= 7.5% $11,302,350

(ii) Percentage increase $137,173 – $94,341 = 45.4% (decrease) in net $94,341 income 2. (i) Percentage increase $1,792,209 – $1,605,588 (decrease) in total $1,605,588 assets

VF Corporation

$1,047,505 – $1,210,119 = (13.4%) $1,210,119 $9,980,140 – $10,315,443

= 11.6%

= (3.25% $10,315,443

$1,355,234 – $1,252,864

$5,630,882 – $6,077,038 = 8.2%

= (7.3%)

$1,252,864

1.97*

$6,077,038

2.42*

*Given on income statement

(b) Columbia's increases in net sales, net income, total assets, and total stockholders' equity were all significantly larger than VFC's. However, VFC's earnings per share was 22.8% greater than Columbia's, indicating that VFC was much more profitable than Columbia. LO 2 BT: AN Difficulty: Medium TOT: 30 min. AACSB: 60 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-3

COMPARATIVE ANALYSIS PROBLEM

(a)

Amazon.com

Wal-Mart Stores

1. (i) Percentage increase $88,988 – $74,452 (decrease) in net = 19.5% $74,452 sales

$482,229 – $473,076

(ii) Percentage increase $(241)– $274 (decrease) in net = (188%) $274 income

$16,363 – $16,022

2. (i) Percentage increase $54,505 – $40,159 (decrease) in total = 35.7% $40,159 assets

$203,706 – $204,751

(ii) Percentage increase $10,741 – $9,746 (decrease) in total = 10.2% $9,746 stockholders’ equity

$85,937 – $81,339

3. Basic earnings per share

$(0.52)*

= 1.9% $473,076

= 2.1% $16,022

= (0.5)% $204,751

= 5.7% $81,339

$5.07*

*Given on income statement

(b)

Amazon’s increases in net sales, total assets, and total stockholders’ equity were all significantly larger than Wal-Mart. However, Wal-Mart’s earnings per share was substantially greater than Amazon’s, indicating that Wal-Mart was much more profitable than Amazon.

LO 2 BT: AN Difficulty: Medium TOT: 30 min. AACSB: 60 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-4 (a)

INTERPRETING FINANCIAL STATEMENTS Liquidity Ratios

Coca-Cola

PepsiCo

(1) Current ratio

1.28:1 ($17,551 ÷ $13,721)

1.44:1 ($12,571 ÷ $8,756)

(2) Accounts receivable turnover

9.1 times ($30,990 ÷ $3,424)

9.3 times ($43,232 ÷ $4,654)

(3) Average collection period

40.1 days (365 ÷ 9.1)

39.2 days (365 ÷ 9.3)

(4) Inventory turnover

4.9 times ($11,088 ÷ $2,271)

7.8 times ($20,099 ÷ $2,570)

74.5

46.8 (365 ÷ 7.8)

(5) Days in inventory

(365 ÷ 4.9)

PepsiCo is more liquid than Coca-Cola. PepsiCo betters Coca-Cola in all of the ratios. (b)

Solvency Ratios (1) Debt to assets ratio

(2) Times interest earned

(3) Free cash flow

Coca-Cola $23,872

= 49%

PepsiCo $23,044

= 58%

$48,671

$39,848

$6,824 + $2,040 + $355

$5,946 + $2,100 + $397

$355 = 26.0 times

$397 = 21.3 times

$8,186 – $1,993 – $3,800 = $2,393

$6,796 – $2,128 – $2,732 = $1,936

Coca-Cola is more solvent than PepsiCo.

CT 13-4 (Continued) (c)

Profitability Ratios

Coca-Cola

PepsiCo

(1) Profit margin

22.0% ($6,824 ÷ $30,990)

13.8% ($5,946 ÷ $43,232)

(2) Asset turnover

.69 times ($30,990 ÷ $44,595)

1.14 times ($43,232 ÷ $37,921)

(3) Return on assets

15.3% ($6,824 ÷ $44,595)

15.7% ($5,946 ÷ $37,921)

(4) Return on common stockholders’ equity

30.1% ($6,824 ÷ $22,636)

40.8% ($5,946 ÷ $14,556)

PepsiCo, Inc. has a lower profit margin than the Coca-Cola Company. However, PepsiCo, Inc. has a higher asset turnover, return on assets, and return on common stockholders’ equity. LO 3 BT: AP Difficulty: Medium TOT: 45 min. AACSB: Analytic AICPA FC: Measurement and Reporting

CT 13-5

REAL-WORLD FOCUS

(a), (b), and (c) Answers will vary depending on the companies chosen by the student. LO 3 BT: AN Difficulty: Hard TOT: 60 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-6

RESEARCH CASE

(a) As discussed in Chapter 11, when a company does a stock split, its share price drops accordingly. If Amazon had not engaged in past stock splits its stock price at the time of the article would have been $1,166. (b) Amazon dramatically increased its capacity to handle customer orders through its spending on fulfillment centers. However, until its sales increase enough to absorb this additional capacity, the company’s return on assets will probably suffer. First, the increase in plant assets will increase the company’s depreciation expense and reduce net income. Second, increasing plant assets increases the denominator of the return on assets, which reduces the company’s return. (c) At the time of the article, Amazon’s P/E ratio was 76. Apple had a P/E ratio of 11.4, Netflix was 38 and the article says that Amazon’s was 3 1/2 times that of Wal-Mart, making it approximately 21.7. Amazon’s high value suggests that investors were expecting significant growth in Amazon’s earnings in future years. (d) The article notes that Amazon’s 2012 operating margin was about half what it had been in the typical previous year. In the past, many of Amazon’s customers did not pay sales taxes on their purchases, which effectively gave Amazon a price advantage over traditional “brick and mortar” stores that do collect sales taxes. It stated that, because Amazon’s customers might have to start paying sales taxes on their purchases, Amazon might have to reduce its prices in order to continue to compete on price. This would reduce its profitability. LO 3 BT: E Difficulty: Hard TOT: 60 min. AACSB: Analytic, Technology and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-7

DECISION MAKING ACROSS THE ORGANIZATION

(a) Lenders prefer that financial statements are audited because an audit gives independent assurance that the financial statements give a reasonable representation of the company’s financial position and results of operations. With this independent assurance they feel more comfortable making a decision. (b) The current ratio increase is a favorable indication as to liquidity, but alone tells little about the going-concern prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The change in asset turnover cannot alone tell anything about either solvency or going-concern prospects. There is no way to know the amount and the direction of the changes in the two items. An increase in sales would be favorable for going-concern prospects, while a decrease in assets could represent a number of possible scenarios and would need to be investigated further. The increase in net income is a favorable indicator for both solvency and going-concern prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements. The 32 percent [($3.30 – $2.50) ÷ $2.50] increase in earnings per share, which is identical to the percentage increase in net income, is an indication there has probably been no change in the number of shares of common stock outstanding. This in turn indicates that financing was not obtained through the issuance of common stock. It is not possible to reach conclusions about solvency and going-concern prospects without additional information about the nature and extent of financing. The collective implications of these data alone are that the client entity is about as solvent and viable as a going concern at the end of the current year as it was at the beginning although there may be a need for short-term operating cash.

CT 13-7 (Continued) Although a quick evaluation of a reporting entity can be made using only a few ratios and comparing these with past ratios and industry statistics, the creditors should realize the limitations of such analysis even from the best prepared statements carrying a CPA’s unqualified opinion. A limitation on comparisons with industry statistics or other companies within the industry exists because material differences can be created through the use of alternative (but acceptable) accounting methods. Further, when evaluating changes in ratios or percentages, the evaluation should be directed to the nature of the item being evaluated because very small differences in ratios or percentages can represent significant changes in dollar amounts or trends. The creditors should evaluate conclusions drawn from ratio analysis in light of the current status of, and expected changes in, such things as general economic conditions, the client’s competitive position, the public’s demand (for the product itself, increased quality of the product, control of noise and pollution, etc.), and the client’s specific plans. (c) 1.

Accounts receivable turnover—indicates liquidity.

Debt to assets ratio—indicates solvency.

Times interest earned—indicates ability to repay interest when due.

Other answers are possible. LO 3 BT: E Difficulty: Hard TOT: 60 min. AACSB: Analytic and Communication Measurement and Reporting AICPA PC: Interaction, Leadership and Communication

AICPA FC:

CT 13-8

COMMUNICATION ACTIVITY

To:

Larry Dundee

From:

Accounting Student

Re:

Financial Statement Analysis

There are two fundamental considerations in financial statement analysis: (1) the bases of comparison and (2) the limitations of financial statement analysis. Each of these considerations is explained below. 1.

Bases of comparison. The bases of comparison are: a.

Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.

Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.

Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms).

Three factors that affect quality of earnings are: a.

Alternative accounting methods—Variations among companies in the application of generally accepted accounting principles (GAAP) can cause variation in earnings quality across companies.

Pro forma income—Many companies now report non-GAAP income measures in addition to GAAP income. There is little guidance regarding these measures, thus the earnings quality of these measures is difficult to determine.

Improper recognition—In order to meet earnings targets, some companies record revenues and expenses in the wrong period. This directly reduces earnings quality.

LO 1, 2 BT: C Difficulty: Medium TOT: 30 min. AACSB: Analytic and Communication AICPA FC: Measurement and Reporting AICPA PC: Communication

CT 13-9

ETHICS CASE

(a) The stakeholders in this case are: René Kelly, president of RL Industries. Erin Lourdes, public relations director. You, as controller of RL Industries. Stockholders of RL Industries. Potential investors in RL Industries. Any readers of the press release. (b) The president’s press release is deceptive and incomplete and to that extent her actions are unethical. (c) As controller you should at least inform Erin, the public relations director, about the biased content of the release. She should be aware that the information she is about to release, while factually accurate, is deceptive and incomplete. Both the controller and the public relations director (if she agrees) have the responsibility to inform the president of the bias of the about-to-be-released information. LO 3 BT: E Difficulty: Medium TOT: 20 min. AACSB: Analytic, Communication and Ethics AICPA FC: Reporting AICPA PC: Communication and Professional Demeanor

CT 13-10

ALL ABOUT YOU

Student responses will vary. We suggest that in class you ask for a few students to share their responses in order to increase students understanding of the reasons why different people will choose different investment vehicles. LO - BT: AN Difficulty: Easy TOT: 20 min. AACSB: Analytic and Technology AICPA FC: Reporting

CT 13-11

FASB CODIFICATION ACTIVITY

(a) Discontinued Operations 205-20-45-1 The results of operations of a component of an entity that either has been disposed of or is classified as held for sale under the requirements of paragraph 360-10-45-9, shall be reported in discontinued operations in accordance with paragraph 205-20-45-3 if both of the following conditions are met: a. The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction. b. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

(b) Comprehensive Income The change in equity (net assets) of a business entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. LO 1 BT: S Difficulty: Medium TOT: 20 min. AACSB: Analytic and Technology AICPA FC: Reporting

IFRS 13-1 INTERNATIONAL FINANCIAL REPORTING PROBLEM

(a) The company's profit margin for 2014 was 18.4% (€5,648 ÷ €30,638) up from 11.8% (€3,436 ÷ €29,016) in 2013. (b) The 2014 operating profit was €5,431. (c) Other comprehensive gains and losses was a net decrease of €127 million. LO 5 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic, Communication and Diversity AICPA FC: Measurement and Reporting AICPA PC: Communication AICPA BB: International

CHAPTER 14 Managerial Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

A Problems

Learning Objectives

Questions

Identify the features of managerial accounting and the functions of management.

1, 2, 3, 4, 5, 6, 7, 8

1, 2

Describe the classes of manufacturing costs and the differences between product and period costs.

9, 11, 12, 13, 14

3, 4, 5, 6

2, 3, 4, 5, 6, 7, 13

Demonstrate how to compute cost of goods manufactured and prepare financial statements for a manufacturer.

10, 15, 16, 17, 18, 19, 20, 21

7, 8, 9, 10

8, 9, 10, 11, 3A, 4A, 5A 12, 13, 14, 15, 16, 17

Discuss trends in managerial accounting.

22, 23, 24, 25, 26

1A, 2A

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Classify manufacturing costs into different categories and compute the unit cost.

Simple

20–30

Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.

Moderate

30–40

Prepare a cost of goods manufactured schedule and a correct income statement.

Moderate

30–40

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises a

Kimmel, Accounting 6/e, Solutions Manual

Learning Objective 1. Identify the features of managerial accounting and the functions of management.

Knowledge

2. Describe the classes of manufacturing costs and the differences between product and period costs.

Q14-11

3. Demonstrate how to compute cost of Q14-19 goods manufactured and prepare financial statements for a manufacturer.

(For Instructor Use Only)

4. Discuss trends in managerial accounting.

Continuing Problems Broadening Your Perspective

Comprehension Application Analysis Q14-1 Q14-7 Q14-2 Q14-8 Q14-3 BE14-1 Q14-4 BE14-2 Q14-5 DI1-1 Q14-6 E14-1 Q14-9 BE14-6 E14-4 P14-1A Q14-12 DI1-2 E14-7 P14-2A Q14-13 E14-2 E14-13 Q14-14 E14-3 BE14-3 E14-5 BE14-4 E14-6 BE14-5 Q14-10 Q14-15 BE14-9 E14-13 E14-10 Q14-20 Q14-16 BE14-10 E14-14 E14-11 Q14-21 Q14-17 DI1-3 E14-16 P14-3A E14-15 Q14-18 E14-8 E14-17 P14-5A BE14-7 E14-9 P14-4A BE14-8 E14-12 Q14-22 Q14-23 Q14-24 Q14-25

Q14-26 BE1411 DI14-4 E14-18 CD14 WCP14 BYP14-1 BYP14-2 BYP14-3 BYP14-4

14-3

ANSWERS TO QUESTIONS 1.

(a) Disagree. Managerial accounting is a field of accounting that provides economic and financial information for managers and other internal users. (b) Joe is incorrect. Managerial accounting applies to all types of businesses—service, merchandising, and manufacturing.

(a) Financial accounting is concerned primarily with external users such as stockholders, creditors, and regulators. In contrast, managerial accounting is concerned primarily with internal users such as officers and managers. (b) Financial statements are the end product of financial accounting. The statements are prepared quarterly and annually. In managerial accounting, internal reports may be prepared as frequently as needed. (c) The purpose of financial accounting is to provide general-purpose information for all users. The purpose of managerial accounting is to provide special-purpose information for specific decisions.

Differences in the content of the reports are as follows: Financial

Managerial

 Pertains to business as a whole and is highly aggregated.  Limited to double-entry accounting and cost data.  Generally accepted accounting principles.

 Pertains to subunits of the business and may be very detailed.  Extends beyond double-entry accounting system to any relevant data.  Standard is relevance to decisions.

In financial accounting, financial statements are verified annually through an independent audit by certified public accountants. There are no independent audits of internal reports issued by managerial accountants. 4.

Linda should know that the management of an organization performs three broad functions: (1) Planning requires management to look ahead and to establish objectives. (2) Directing involves coordinating the diverse activities and human resources of a company to produce a smooth-running operation. (3) Controlling is the process of keeping the company’s activities on track.

Disagree. Decision making is not a separate management function. Rather, decision making involves the exercise of good judgment in performing the three management functions explained in the answer to question five above.

Employees with line positions are directly involved in the company’s primary revenue generating operating activities. Examples would include plant managers and supervisors, and the vice president of operations. In contrast, employees with staff positions are not directly involved in revenuegenerating operating activities, but rather serve in a support capacity to line employees. Examples include employees in finance, legal, and human resources.

Questions Chapter 14 (Continued) 7.

The differences between income statements are in the computation of the cost of goods sold as follows: Manufacturing company:

Beginning finished goods inventory plus cost of goods manufactured minus ending finished goods inventory = cost of goods sold.

Merchandising company:

Beginning merchandise inventory plus cost of goods purchased minus ending merchandise inventory = cost of goods sold.

The difference in balance sheets pertains to the presentation of inventories in the current asset section. In a merchandising company, only merchandise inventory is shown. In a manufacturing company, three inventory accounts are shown: finished goods, work in process, and raw materials.

Manufacturing costs are classified as either direct materials, direct labor, or manufacturing overhead.

10.

No, Mel is not correct. The distinction between direct and indirect materials is based on two criteria: (1) physical association and (2) the convenience of making the physical association. Materials which cannot be easily associated with the finished product are considered indirect materials.

11.

Product costs, or inventoriable costs, are costs that are a necessary and integral part of producing the finished product. Period costs are costs that are identified with a specific time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs.

12.

A merchandising company has beginning merchandise inventory, cost of goods purchased, and ending merchandise inventory. A manufacturing company has beginning finished goods inventory, cost of goods manufactured, and ending finished goods inventory.

13.

(a) (b)

14.

Raw materials inventory, beginning ....................................................................... Raw materials purchases ...................................................................................... Total raw materials available for use...................................................................... Raw materials inventory, ending ............................................................................ Direct materials used....................................................................................

12,000 $ 170,000 182,000 (15,000 ) $167,000

15.

Direct materials used ............................................................................................. Direct labor used ................................................................................................... Total manufacturing overhead ............................................................................... Total manufacturing costs.............................................................................

$240,000 220,000 180,000 $640,000

16.

(a) (b)

$666,000 $634,000

17.

The order of listing is finished goods inventory, work in process inventory, and raw materials inventory.

X = total cost of work in process. X = cost of goods manufactured.

Total cost of work in process ($26,000 + $640,000)...................................... Cost of goods manufactured ($666,000 – $32,000) ......................................

Questions Chapter 14 (Continued) 18.

The products differ in how each are consumed by the customer. Services are consumed immediately; the product is not put into inventory. Meals at a restaurant are the best example where they are consumed immediately by the customer. There could be a long lead time before the product is consumed in a manufacturing environment.

19.

Yes, product costing techniques apply equally well to manufacturers and service companies. Each needs to keep track of the cost of production or services in order to know whether it is generating a profit. The techniques shown in this chapter, to accumulate manufacturing costs to determine manufacturing inventory, are equally useful for determining the cost of services.

20.

The value chain refers to all activities associated with providing a product or service. For a manufacturer, these include research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations, and subsequent service.

21. An enterprise resource planning (ERP) system is an integrated software system that provides a comprehensive, centralized resource for information. Its primary benefits are that it replaces the many individual systems typically used for receivables, payables, inventory, human resources, etc. Also, it can be used to get information from, and provide information to, the company’s customers and suppliers. 22.

In a just-in-time inventory system, the company has no extra inventory stored. Consequently, if some units that are produced are defective, the company will not have enough units to deliver to customers.

23. The balanced scorecard is called “balanced” because it strives to not over emphasize any one performance measure, but rather uses both financial and non-financial measures to evaluate all aspects of a company’s operations in an integrated fashion. 24. Budgets are prepared by companies to provide future direction. Because the budget is also used as an evaluation tool, some managers try to game the budgeting process by underestimating their division’s predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet targets to receive higher compensation or in some cases to keep their jobs. 25. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition and that the company maintains an adequate system of internal controls. In addition, the composition of the board of directors and audit committees receives more scrutiny, and penalties for misconduct have increased. 26. Activity-based costing is an approach used to allocate overhead based on each product’s relative use of activities in making the product. Activity-based costing is beneficial because it results in more accurate product costing and in more careful scrutiny of all activities in the value chain.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Financial Accounting

Managerial Accounting

Primary users

External users

Internal users

Types of reports

Financial statements

Internal reports

Frequency of reports Quarterly and annually

As frequently as needed

Purpose of reports

General-purpose

Special-purpose information for specific decisions

Content of reports

Generally accepted accounting principles

Relevance to decisions

Verification process

Annual audit by certified public accountant

No independent audits

BRIEF EXERCISE 14-2 (a) 1. Planning. (b) 2. Directing. (c) 3. Controlling. BRIEF EXERCISE 14-3 (a) (b) (c) (d)

DM DL MO MO

Frames and tires used in manufacturing bicycles. Wages paid to production workers. Insurance on factory equipment and machinery. Depreciation on factory equipment.

BRIEF EXERCISE 14-4 (a) (b) (c) (d) (e) (f) (g) (h)

Direct materials. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct materials. Manufacturing overhead.

BRIEF EXERCISE 14-5 (a) (b) (c) (d) (e) (f)

Product. Period. Period. Period. Product. Product.

BRIEF EXERCISE 14-6 Product Costs Direct Materials (a) (b) (c) (d)

Direct Labor

Factory Overhead X

X X X

BRIEF EXERCISE 14-7 (a) Direct materials used............................................................ Direct labor............................................................................ Total manufacturing overhead............................................. Total manufacturing costs............................................

$180,000 209,000 208,000 $597,000

(b) Beginning work in process .................................................. Total manufacturing costs ................................................... Total cost of work in process .......................................

$ 25,000 597,000 $622,000

BRIEF EXERCISE 14-8 ROLAND COMPANY Balance Sheet December 31, 2017 Current assets Cash................................................................... Accounts receivable......................................... Inventories Finished goods.......................................... Work in process ........................................ Raw materials ............................................ Prepaid expenses ............................................. Total current assets ..........................

$ 62,000 200,000 $91,000 87,000 83,000

261,000 38,000 $561,000

BRIEF EXERCISE 14-9 Direct Materials Used (1) (2) (3)

Direct Labor Used

Factory Overhead

Total Manufacturing Costs $151,000

$81,000 $144,000

BRIEF EXERCISE 14-10 Total Manufacturing Costs (1) $151,000* (2) (3)

Work in Process (January 1)

Work in Process (December 31)

$133,000 $58,000

*$40,000 + $61,000 + $50,000 (data from BE 1-9)

Cost of Goods Manufactured $189,000

BRIEF EXERCISE 14-11 One implication of SOX was to clarify top management’s responsibility for the company’s financial statements. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition. In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate financial reports. Also, more attention is now paid to the composition of the company’s board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non-employees) and must contain at least one financial expert. Finally, to increase the likelihood of compliance with these and other new rules, the penalties for misconduct were substantially increased. SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 14-1 1. 2. 3. 4.

False False False True

DO IT! 14-2 Period costs: Advertising Salaries of sales representatives Product costs: Blank CDs (DM) Depreciation of CD image burner (MO) Salary of factory manager (MO) Factory supplies used (MO) Paper inserts for CD cases (DM) CD plastic cases (DM) Salaries of factory maintenance employees (MO) Salaries of employees who burn music onto CDs (DL)

DO IT! 14-3 TOMLIN COMPANY Cost of Goods Manufactured Schedule For the Month Ended April 30 Work in process, April 1 ................................ Direct materials .............................................. Raw materials, April 1 ............................... $ 10,000 Raw materials purchases.......................... 98,000 Total raw materials available for use........ 108,000 Less: Raw materials, April 30 .................. 14,000 Direct materials used ................................ $ 94,000 Direct labor ..................................................... 80,000 Manufacturing overhead................................ 160,000 Total manufacturing costs ............................ Total cost of work in process ........................ Less: Work in process, April 30 ................... Cost of goods manufactured ........................

DO IT! 14-4 1. 2. 3. 4. 5. 6. 7. 8.

f a c h d e b g

5,000

334,000 339,000 3,500 $335,500

SOLUTIONS TO EXERCISES EXERCISE 14-1 1. False. Financial accounting focuses on providing information to external users. 2. False. Line positions are directly involved in the company's primary revenue-generating operating activities. 3. False. Preparation of budgets is part of managerial accounting. 4. False. Managerial accounting applies to service, merchandising and manufacturing companies. 5. True. 6. False. Managerial accounting reports are prepared as frequently as needed. 7. True. 8. True. 9. False. Financial accounting reports must comply with generally accepted accounting principles. 10. False. The company treasurer reports directly to the vice president of finance/chief financial officer. EXERCISE 14-2 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

(b) (c) (c) (c) (a) (b) (c) (c) (c) (a)

Direct labor.* Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials.

*or sometimes (c), depending on the circumstances

EXERCISE 14-3 (a) Bicycle components............... DM Depreciation on plant .......... MOH Property taxes on store.....Period Labor costs of assembly line workers ............................ DL Factory supplies used ......... MOH

Advertising expense............... Period Property taxes on plant ............. MOH Delivery expense .................... Period Sales commissions ................ Period Salaries paid to sales clerks ... Period

(b) Product costs are recorded as a part of the cost of inventory because they are an integral part of the cost of producing the bicycles. Product costs are not expensed until the goods are sold. Period costs are recognized as an expense when incurred.

EXERCISE 14-4 (a) Factory utilities....................................................................... Depreciation on factory equipment ...................................... Indirect factory labor.............................................................. Indirect materials.................................................................... Factory manager’s salary ...................................................... Property taxes on factory building ....................................... Factory repairs ....................................................................... Manufacturing overhead........................................................

$ 15,500 12,650 48,900 80,800 8,000 2,500 2,000 $170,350

(b) Direct materials ...................................................................... Direct labor ............................................................................. Manufacturing overhead........................................................ Product costs .........................................................................

$137,600 69,100 170,350 $377,050

(c) Depreciation on delivery trucks............................................ $ 3,800 Sales salaries......................................................................... 46,400 Repairs to office equipment.................................................. 1,300 Advertising............................................................................. 15,000 Office supplies used.............................................................. 2,640 Period costs ........................................................................... $ 69,140

EXERCISE 14-5 1. 2.

3. 4.

(a) (c)

5. 6.

(b)* (d)

7. 8.

(a) (b)

9. 10.

*or sometimes (c), depending on the circumstances. EXERCISE 14-6 1. (b) 2. (c) 3. (a) 4. (c) 5. (c) 6. (c) 7. (c) 8. (c) 9. (c) 10. (c)

EXERCISE 14-7 (a)

(b)

Delivery service (product) costs: Indirect materials Depreciation on delivery equipment Dispatcher’s salary Gas and oil for delivery trucks Drivers’ salaries Delivery equipment repairs Total

$ 6,400 11,200 5,000 2,200 16,000 300 $41,100

Period costs: Property taxes on office building CEO’s salary Advertising Office supplies Office utilities Repairs on office equipment Total

$ 870 12,000 4,600 650 990 180 $19,290

EXERCISE 14-8 (a) Work-in-process, 1/1 ............................... Direct materials used .............................. Direct labor .............................................. Manufacturing overhead Depreciation on plant....................... Factory supplies used ..................... Property taxes on plant ................... Total manufacturing overhead ............... Total manufacturing costs...................... Total cost of work-in-process ................ Less: ending work-in-process................ Cost of goods manufactured..................

$ 12,000 $120,000 110,000 $60,000 23,000 14,000 97,000

(b) Finished goods, 1/1................................. Cost of goods manufactured ................. Cost of goods available for sale............. Less: Finished goods, 12/31.................. Cost of goods sold..................................

327,000 339,000 15,500 $323,500 $ 60,000 323,500 383,500 45,600 $337,900

EXERCISE 14-9 Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use ..............................

$180,000 22,500 $202,500

Raw materials inventory (1/1): Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use .............................. Less: Raw materials purchases...................................... Raw materials inventory (1/1) ..........................................

$180,000 22,500 202,500 158,000 $ 44,500

Total cost of work in process: Cost of goods manufactured ........................................... Add: Work in process (12/31) .......................................... Total cost of work in process ..........................................

$540,000 81,000 $621,000

EXERCISE 14-9 (Continued) Total manufacturing costs: Total cost of work in process ................................. Less: Work in process (1/1) .................................... Total manufacturing costs ...................................... Direct labor: Total manufacturing costs ...................................... Less: Total overhead ............................................... Direct materials used .................................... Direct labor...............................................................

$621,000 210,000 $411,000

$411,000 $122,000 180,000

302,000 $109,000

EXERCISE 14-10 A + $57,000 + $46,500 = $195,650 A = $92,150

$252,500 – $11,000 = F F = $241,500

$195,650 + B = $221,500 B = $25,850

$130,000 + G + $102,000 = $253,700 G = $21,700

$221,500 – C = $185,275 C = $36,225

$253,700 + H = $337,000 H = $83,300

$68,400 + $86,000 + $81,600 = D D = $236,000

$337,000 – $70,000 = I I = $267,000

$236,000 + $16,500 = E E = $252,500 Additional explanation to EXERCISE 14-10 solution: Case A (a)

Total manufacturing costs ...................................... Less: Manufacturing overhead ............................... Direct labor .................................................... Direct materials used...............................................

$195,650 $46,500 57,000

103,500 $ 92,150

EXERCISE 14-10 (Continued) (b) Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/17)..........................................

$221,500 195,650 $ 25,850

(c) Total cost of work in process ................................. Less: Cost of goods manufactured ........................ Work in process (12/31/17)......................................

$221,500 185,275 $ 36,225

Case B (d) Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead ......................................... Total manufacturing costs ......................................

$ 68,400 86,000 81,600 $236,000

(e) Total manufacturing costs ...................................... Work in process (1/1/17).......................................... Total cost of work in process .................................

$236,000 16,500 $252,500

(f)

$252,500 11,000 $241,500

Total cost of work in process ................................. Less: Work in process (12/31/17) ........................... Cost of goods manufactured ..................................

Case C (g) Total manufacturing costs ...................................... Less: Manufacturing overhead .............................. Direct materials used ................................... Direct labor...............................................................

$253,700 $102,000 130,000

232,000 $ 21,700

(h)

Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/17)..........................................

$337,000 253,700 $ 83,300

(i)

Total cost of work in process ................................. Less: Work in process (12/31/17) ........................... Cost of goods manufactured ..................................

$337,000 70,000 $267,000

EXERCISE 14-11 (a) (a) $117,000 + $140,000 + $87,000 = $344,000 (b) $344,000 + $33,000 – $360,000 = $17,000 (c) $450,000 – ($200,000 + $132,000) = $118,000 (d) $40,000 + $470,000 – $450,000 = $60,000 (e) $265,000 – ($80,000 + $100,000) = $85,000 (f)

$265,000 + $60,000 – $80,000 = $245,000

(g) $288,000 – ($70,000 + $75,000) = $143,000 (h) $288,000 + $45,000 – $270,000 = $63,000 (b)

HORIZON COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2017 Work in process, January 1 ............................... Direct materials ................................................... Direct labor.......................................................... Manufacturing overhead .................................... Total manufacturing costs.......................... Total cost of work in process ............................ Less: Work in process inventory, December 31 ............................................ Cost of goods manufactured .............................

$ 33,000 $117,000 140,000 87,000 344,000 377,000 17,000 $360,000

EXERCISE 14-12 (a)

CEPEDA CORPORATION Cost of Goods Manufactured Schedule For the Month Ended June 30, 2017 Work in process, June 1............................. Direct materials used ................................. Direct labor.................................................. Manufacturing overhead Indirect labor ....................................... Factory manager’s salary ................... Indirect materials ................................ Maintenance, factory equipment........ Depreciation, factory equipment........ Factory utilities.................................... Total manufacturing overhead..... Total manufacturing costs ......................... Total cost of work in process .................... Less: Work in process, June 30 ............... Cost of goods manufactured .....................

(b)

$ 3,000 $20,000 40,000 $4,500 3,000 2,200 1,800 1,400 400 13,300 73,300 76,300 3,800 $72,500

CEPEDA CORPORATION Income Statement (Partial) For the Month Ended June 30, 2017 Sales revenue ......................................................... Cost of goods sold Finished goods inventory, June 1 ................. Cost of goods manufactured [from (a)] ........... Cost of goods available for sale .................... Less: Finished goods inventory, June 30 .... Cost of goods sold ......................... Gross profit .............................................................

$92,100 $ 5,000 72,500 77,500 7,500 70,000 $22,100

EXERCISE 14-13 (a)

WASHINGTON CONSULTING Schedule of Cost of Contract Services Performed For the Month Ended August 31, 2017 Supplies used (direct materials) ................................... Salaries of professionals (direct labor) ........................ Service overhead: Utilities for contract operations ............................... $1,400 Contract equipment depreciation ............................ 900 Insurance on contract operations ........................... 800 Janitorial services for professional offices............. 700 Total overhead .................................................... Cost of contract services provided .........................

$ 1,700 15,600

3,800 $21,100

(b) The costs not included in the cost of contract services provided would

all be classified as period costs. As such, they would be reported on the income statement under administrative expenses. EXERCISE 14-14 (a) Work-in-process, 1/1 .............................. $ 13,500 Direct materials Materials inventory, 1/1 ................... $ 21,000 Materials purchased ........................ 150,000 Materials available for use.............. 171,000 Less: Materials inventory, 12/31..... 30,000 Direct materials used ............................. $141,000 Direct labor ............................................. 220,000 Manufacturing overhead ........................ 180,000 Total manufacturing costs..................... 541,000 Total cost of work-in-process................ 554,500 Less: Work-in-process, 12/31 ................ 17,200 Cost of goods manufactured ................. $537,300

EXERCISE 14-14 (Continued) AIKMAN COMPANY Income Statement (Partial) For the Year Ended December 31, 2017 (b) Sales revenue ....................................... Cost of goods sold Finished goods, 1/1 ........................ Cost of goods manufactured ........ Cost of goods available for sale .... Less: Finished goods, 12/31 ......... Cost of goods sold .......... Gross profit............................................

$910,000 $ 27,000 537,300 564,300 21,000 543,300 $366,700

AIKMAN COMPANY (Partial) Balance Sheet December 31, 2017 (c) Current assets Inventories Finished goods .............................................. Work in process ............................................ Raw materials.................................................

$21,000 17,200 30,000

$68,200

(d) In a merchandising company’s income statement, the only difference would be in the computation of cost of goods sold. Beginning and ending finished goods would be replaced by beginning and ending merchandise inventory, and cost of goods manufactured would be replaced by purchases. In a merchandising company’s balance sheet, there would be one inventory account (merchandise inventory) instead of three. EXERCISE 14-15 1. 2. 3. 4. 5. 6. 7. 8.

(a) (a) (a), (c) (b) (a) (a) (a) (b), (c)

9. 10. 11. 12. 13. 14. 15. 16.

(a) (a), (b) (b) (b) (a) (a) (a) (a)

EXERCISE 14-16 (a)

ROBERTS COMPANY Cost of Goods Manufactured Schedule For the Month Ended June 30, 2017 Work in process inventory, June 1 ................. $ 5,000 Direct materials Raw materials inventory, June 1 ............ $ 9,000 Raw materials purchases........................ 54,000 Total raw materials available for use ........ 63,000 Less: Raw materials inventory, June 30.... 13,100 $49,900 Direct materials used .............................. Direct labor..................................................... 47,000 Manufacturing overhead Indirect labor............................................ 5,500 Factory insurance.................................... 4,000 Machinery depreciation........................... 4,000 Factory utilities ........................................ 3,100 Machinery repairs.................................... 1,800 1,500 Miscellaneous factory costs................... 19,900 Total manufacturing overhead ......... Total manufacturing costs ............................ 116,800 Total cost of work in process ....................... 121,800 Less: Work in process inventory, June 30...... 7,000 Cost of goods manufactured ........................ $114,800

(b)

ROBERTS COMPANY (Partial) Balance Sheet June 30, 2017 Current assets Inventories Finished goods ........................................... Work in process.......................................... Raw materials .............................................

$ 8,000 7,000 13,100

$28,100

EXERCISE 14-17 (a) Raw Materials account: (5,000 – 4,650) X $15 = $5,250 Work in Process account: (4,600 X 10%) X $15 = $6,900 Finished Goods account: (4,600 X 90% X 30%) X $15 = $18,630 Cost of Goods Sold account: (4,600 X 90% X 70%) X $15 = $43,470 Selling Expenses account: 50 X $15 = $750 Proof of cost of head lamps allocated (5,000 X $15 = $75,000) Raw materials Work in process Finished goods Cost of goods sold Selling expenses Total (b) To:

$ 5,250 6,900 18,630 43,470 750 $75,000

Chief Accountant

From:

Student

Subject:

Statement Presentation of Accounts

Two accounts will appear in the income statement. Cost of Goods Sold will be deducted from net sales in determining gross profit. Selling expenses will be shown under operating expenses and will be deducted from gross profit in determining net income. Sometimes, the calculation for Cost of Good Sold is shown on the income statement. In these cases, the balance in Finished Goods inventory would also be shown on the income statement. The other accounts associated with the head lamps are inventory accounts which contain end-of-period balances. Thus, they will be reported under inventories in the current assets section of the balance sheet in the following order: finished goods, work in process, and raw materials. EXERCISE 14-18 (a) (b) (c) (d)

3. 4. 2. 1.

Balanced scorecard Value chain Just-in-time inventory Activity-based costing

PROBLEM 14-3A

(a) Case 1 A = $9,600 + $5,000 + $8,000 = $22,600 $22,600 + $1,000 – B = $17,000 B = $22,600 + $1,000 – $17,000 = $6,600 $17,000 + C = $22,000 C = $22,000 – $17,000 = $5,000 D = $22,000 – $3,400 = $18,600 E = ($24,500 – $2,500) – $18,600 = $3,400 F = $3,400 – $2,500 = $900 Case 2 G + $8,000 + $4,000 = $16,000 G = $16,000 – $8,000 – $4,000 = $4,000 $16,000 + H – $3,000 = $24,000 H = $24,000 + $3,000 – $16,000 = $11,000 (I – $1,400) – K = $7,000 (I – $1,400) – $24,800 = $7,000 I = $1,400 + $24,800 + $7,000 = $33,200 (Note: Item I can only be solved after item K is solved.) J = $24,000 + $3,300 = $27,300 K = $27,300 – $2,500 = $24,800 $7,000 – L = $5,000 L = $2,000

PROBLEM 14-3A (Continued) (b)

CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning................................. Direct materials..................................................... Direct labor............................................................ Manufacturing overhead ...................................... Total manufacturing costs ........................... Total cost of work in process .............................. Less: Work in process, ending ........................... Cost of goods manufactured ...............................

(c)

$ 1,000 $9,600 5,000 8,000 22,600 23,600 6,600 $17,000

CASE 1 Income Statement Sales revenue ....................................................... Less: Sales discounts ......................................... Net sales................................................................ Cost of goods sold Finished goods inventory, beginning.......... Cost of goods manufactured........................ Cost of goods available for sale .................. Less: Finished goods inventory, ending.... Cost of goods sold ................................ Gross profit ........................................................... Operating expenses ............................................. Net income ............................................................

$24,500 2,500 $22,000 5,000 17,000 22,000 3,400 18,600 3,400 2,500 $ 900

CASE 1 (Partial) Balance Sheet Current assets Cash ............................................................... Receivables (net)........................................... Inventories Finished goods ...................................... Work in process..................................... Raw materials ........................................ Prepaid expenses.......................................... Total current assets ..............................

$ 3,000 15,000 $3,400 6,600 600

10,600 400 $29,000

PROBLEM 14-4A

(a)

CLARKSON COMPANY Cost of Goods Manufactured Schedule For the Year Ended June 30, 2017 Work in process, July 1, 2016 ............ Direct materials Raw materials inventory, July 1, 2016 .............................. Raw materials purchases ........... Total raw materials available for use ...................................... Less: Raw materials inventory, June 30, 2017 ................... Direct materials used .................. Direct labor.......................................... Manufacturing overhead Plant manager’s salary ............... Factory utilities............................ Indirect labor ............................... Factory machinery depreciation ... Factory property taxes................ Factory insurance ....................... Factory repairs ............................ Total manufacturing overhead........................... Total manufacturing costs ................. Total cost of work in process ............ Less: Work in process, June 30........ Cost of goods manufactured .............

$ 19,800 $ 48,000 96,400 144,400 39,600 $104,800 139,250 58,000 27,600 24,460 16,000 9,600 4,600 1,400 141,660 385,710 405,510 18,600 $386,910

PROBLEM 14-4A (Continued) (b)

CLARKSON COMPANY (Partial) Income Statement For the Year Ended June 30, 2017 Sales revenues Sales revenue ............................................. Less: Sales discounts............................... Net sales ..................................................... Cost of goods sold Finished goods inventory, July 1, 2016............................................. Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods inventory, June 30, 2017 ................................. Cost of goods sold ............................. Gross profit ................................................

(c)

$534,000 4,200 $529,800 96,000 386,910 482,910 75,900 407,010 $122,790

CLARKSON COMPANY (Partial) Balance Sheet June 30, 2017 Assets Current assets Cash ............................................................ Accounts receivable .................................. Inventories Finished goods ................................... Work in process.................................. Raw materials ..................................... Total current assets ....................

$ 32,000 27,000 $75,900 18,600 39,600

134,100 $193,100

PROBLEM 14-5A

(a)

EMPIRE COMPANY Cost of Goods Manufactured Schedule For the Month Ended October 31, 2017 Work in process, October 1 .............. Direct materials Raw materials inventory, October 1 ................................ $ 18,000 Raw materials purchases ............................... 264,000 Total raw materials available 282,000 for use ..................................... Less: Raw materials inventory, October 31 ....................... 29,000 Direct materials used ................. Direct labor......................................... Manufacturing overhead 60,000 Factory facility rent .................... Depreciation on factory 31,000 equipment ............................... Indirect labor .............................. 28,000 Factory utilities* ......................... 9,000 Factory insurance**.................... 4,800 Total manufacturing overhead.......................... Total manufacturing costs ................ Total cost of work in process ........... Less: Work in process, October 31..... Cost of goods manufactured ............ *$12,000 X 75% = $9,000 **$ 8,000 X 60% = $4,800

$ 20,000

$253,000 190,000

132,800 575,800 595,800 14,000 $581,800

PROBLEM 14-5A (Continued) (b)

EMPIRE COMPANY Income Statement For the Month Ended October 31, 2017 Sales revenue ................................................... Cost of goods sold Finished goods inventory, October 1 ...... Cost of goods manufactured.................... Cost of goods available for sale .............. Less: Finished goods inventory, October 31..................................... Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Advertising expense ................................. Selling and administrative salaries.......... Depreciation expense—sales equipment.............................................. Insurance expense** ................................. Utilities expense* ...................................... Total operating expenses ................. Net income ........................................................ *$12,000 X 25% **$ 8,000 X 40%

$780,000 $ 30,000 581,800 611,800 50,000 561,800 218,200 90,000 75,000 45,000 3,200 3,000 216,200 $ 2,000

CURRENT DESIGNS CD14

The answers to parts (a) and (b) may vary from student to student. (a) What are the primary information needs of each manager? Mike Cichanowski, CEO, needs to know the overall financial picture of the company. He also needs to have a general picture of sales by territory and product line, and of cost per unit by product line. Diane Buswell, Controller, needs all accounting-related information. Deb Welch, Purchasing Manager, needs to know the costs of the components for each product. Bill Johnson, Sales Manager, needs to know sales by territory and product line. Dave Thill, Kayak Plant Manager, needs to know all the costs of producing each type of kayak. Rick Thrune, Production Manager for Composite Kayaks, needs to know the costs related to the composite kayak production.

CD14 (Continued)

(b) Name one special-purpose management accounting report that could be designed for each manager. Include the name of the report, the information it would contain, and how frequently it should be issued. Manager

Name of report

Information report would contain

Mike Cichanowski

Analysis of proposed new product line Companywide budget analysis

Projected revenues and expenses for a possible new product line Revenues, expenses, and net income compared to the budgeted amounts for each List of items purchased and most recent cost for each item Sales by product line and by customer Direct materials, direct labor, and manufacturing overhead costs assigned to each product line Detailed direct material and direct labor costs for the composite kayaks

Diane Buswell

Deb Welch

Purchasing History

Bill Johnson

Sales Summary

Dave Thill

Cost of Production Report

Rick Thrune

Cost of Production Report for Composite Kayaks

How frequently should it be issued? As needed and requested

Monthly

Monthly or available online Monthly or weekly Monthly or weekly

Weekly

CD14 (Continued) (c) When Diane Buswell, controller for Current Designs, reviewed the accounting records for a recent period, she noted the following items. Classify each item as a product cost or a period cost. If a cost is a product cost, note if it is a direct materials, direct labor, or manufacturing overhead item. Product Costs

Payee

Purpose

Period Direct Direct Manufacturing Costs Materials Labor Overhead

Winona Agency

Property insurance for the manufacturing plant

Bill Johnson (sales manager) Xcel Energy

Payroll–payment to sales manager Electricity for manufacturing plant Price lists for salespeople Sales commissions

Payroll–payment to plant manager

Winona Printing Jim Kaiser (sales representative) Dave Thill (plant manager)

Dana Schultz (kayak Payroll–payment to assembler) kayak assembler Composite One Bagging film used when kayaks are assembled. It is discarded after use. Fastenal Shop supplies–brooms, paper towels, etc. Ravago Polyethylene powder which is the main ingredient for the rotational molded kayaks Winona County Property taxes on manufacturing plant North American Kevlar fabric for Composites composite kayaks Waste Management Trash disposal for the company office building None Journal entry to record depreciation of manufacturing equipment

X X

X X X

BYP 14-1

DECISION-MAKING ACROSS THE ORGANIZATION

Ending Raw Materials Inventory Beginning raw materials + Raw materials purchased = Raw materials available for use = $19,000 + $365,000 = $384,000 Raw materials available for use – Ending raw materials inventory = Direct materials used $384,000 – Ending raw materials inventory = $350,000 Ending raw materials inventory = $384,000 – $350,000 = $34,000 Ending Work in Process Inventory Direct materials + Direct labor + Manufacturing overhead = Total manufacturing costs = $350,000 + $250,000 + ($250,000 X 60%) = $750,000 Beginning work in process inventory + Total manufacturing costs = Total cost of work in process = $25,000 + $750,000 = $775,000 Cost of goods manufactured + Beginning finished goods inventory = Cost of goods available for sale Cost of goods manufactured + $38,000 = $770,000 Cost of goods manufactured = $770,000 – $38,000 = $732,000 Total cost of work in process – Ending work in process inventory = Cost of goods manufactured $775,000 – Ending work in process inventory = $732,000 Ending work in process inventory = $775,000 – $732,000 = $43,000 Ending Finished Goods Inventory Sales – Cost of goods sold = Gross profit $1,240,000 – Cost of goods sold = $1,240,000 X 40% Cost of goods sold = $1,240,000 – $496,000 = $744,000 Cost of goods available for sale – Ending finished goods inventory = Cost of goods sold $770,000 – Ending finished goods inventory = $744,000 Ending finished goods inventory = $770,000 – $744,000 = $26,000

BYP 14-2

MANAGERIAL ANALYSIS

Since the questions were fairly open-ended, the following are only suggested results. The class may be able to think of others, or of more items for each one. (a) Jason Dennis

Needs information on sales, perhaps by salesperson and by territory.

Peggy Groneman

Needs cost information for her department.

Dave Marley

Needs all accounting information.

Kevin Carson

Needs product cost information.

Sally Renner

Needs information on component costs and costs for her department. Income statement.

(b) Jason Dennis Peggy Groneman

None.

Dave Marley

All.

Kevin Carson

Income statement and cost of goods manufactured schedule.

Sally Renner (c) Jason Dennis

None. Sales by Territory—Detailed information, possibly by product line, issued daily or weekly.

Peggy Groneman Cost of Computer Programs—Accumulated cost incurred for each major program used including maintenance and updates of program, issued monthly. Dave Marley

Cost of Preparing Reports—Detailed analysis of all reports provided, their frequency, time, and estimated cost to prepare, issued monthly.

Kevin Carson

Cost of Product—Detailed cost by product line, including a comparison with estimated costs for that product. Issued as each batch of production is completed.

Sally Renner

Cost of Product Design—Accumulated total costs of each new product, issued at end of each project.

BYP 14-3

REAL-WORLD FOCUS

(a) The IMA has more than 60,000 members. These members include business leaders, managers, and decision makers in accounting and finance. (b) Student and Associate members receive most of the benefits of Regular membership at a significant savings.  Unique access to the professional designation, the Certified Management Accountant (CMA)  Specialized learning opportunities  Educational assistance, grants, educational competitions  Around-the-Clock Networking  Career management resources (c) The answer to this question will vary by school.

BYP 14-4

COMMUNICATION ACTIVITY

Ms. Shelly Phillips President Phillips Company Dear Shelly: As you requested, I corrected the income statement for October from the information you gave me. The corrected statement is enclosed and it shows that you actually earned net income of $2,000 for October. I also noticed that you did not have a cost of goods manufactured schedule, so I prepared one for you. The income statement your assistant accountant prepared was not correct for two primary reasons. First, product costs were not separated from selling and administrative expenses. Second, and more importantly, the reported net loss did not reflect changes in inventories. This had the effect of treating these costs as expenses rather than assets. A reconciliation of the reported net loss of $23,000 to net income of $2,000 is as follows: Net loss as reported .................................................... Increase (decrease) in inventories Raw materials ($29,000 – $18,000)...................... Work in process ($14,000 – $20,000) .................. Finished goods ($50,000 – $30,000) ................... Total increase ............................................... Net income as corrected .............................................

$(23,000) $11,000 (6,000) 20,000 25,000 $ 2,000

The changes in raw materials and work in process inventories are reported in the cost of goods manufactured schedule. You will see, for example, that the cost of direct materials used was $253,000, not $264,000 as reported by your accountant in the income statement. The difference is the change in raw materials inventories. Similarly, you will see that the $6,000 decrease in work in process inventories increases total manufacturing costs of $575,800 to produce cost of goods manufactured of $581,800. The change in finished goods inventories is reported in the income statement. Notice that the change of $20,000 is subtracted from cost of goods manufactured of $581,800 to produce cost of goods sold of $561,800.

BYP 14-4 (Continued) I have also modified the form of the income statement to recognize the distinction between product costs (cost of goods sold) and period costs (operating expenses) as required by generally accepted accounting principles. Thanks for letting me help. If I can be of further assistance, don’t hesitate to call. I hope you find a replacement for your controller soon. Sincerely,

BYP 14-5

ETHICS CASE

(a) The stakeholders in this situation are:    

The users of Newton Industries’ financial statements. Steve Morgan, controller. The vice-president of finance. The president of Newton Industries.

(b) The ethical issues in this situation pertain to the adherence to sound and acceptable accounting principles. Intentional violation of generally accepted accounting principles in order to satisfy a practical short-term personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among other acceptable methods is not necessarily unethical. (c) Ethically, the management of Newton Industries should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Steve should inform management what is acceptable accounting and what is not. The basic concept to be supported in this advertising cost transaction is matching costs and revenues. Normally, advertising costs are expensed in the period in which they are incurred because it is very difficult to associate them with specific revenues.

BYP 14-6

ALL ABOUT YOU

Student responses will vary. We have provided some basic examples that may represent common responses. (a) Individuals must often make purchase decisions which involve choosing between an item that has a more expensive initial purchase price, but is expected to either last longer, or provides some form of cost savings. The question that the individual faces is whether the cost savings or additional benefit justifies the additional initial cost. For example, more expensive dishwashers and refrigerators also tend to be more energy efficient. The labels on these appliances provide information regarding the energy savings which can be used to make a break-even evaluation. (b) In order to increase control over their financial situation and reduce the probability of financial hardship, all people should prepare personal budgets. Preparation of a personal budget requires the individual to plan for the future and to prioritize expenditures. (c) Companies employ the balanced scorecard as a mechanism to ensure that their financial goals are consistent with their efforts. Use of the balanced scorecard requires clear articulation of goals, priorities, and strategies. By employing these same techniques in their everyday life, individuals can be better assured that they will expend effort on those things that really matter to them, rather than wasting efforts on less important distractions. (d) Capital budgeting involves financial evaluation of long-term assets. Companies routinely make capital budgeting decisions, but so do individuals. The purchase of a home or car is a decision that has implications for your finances for many subsequent years. Buying a house or car is a very personal decision, influenced by many personal, nonfinancial, preferences. However, these decisions should also be subjected to a financial evaluation using capital budgeting techniques to ensure that the choice makes good economic sense.

BYP 14-7

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: This is a difficult decision. While the direct costs of outsourced tax return preparation may in fact be lower, you must also consider other issues: Will the accuracy of the returns be as high? Will your relationships with your customers suffer due to the loss of direct contact? Will customers resent having their personal information shipped overseas? While you may not want to lay off six employees, you also don’t want to put your firm at risk by not remaining competitive. Perhaps one solution would be to outsource the most basic tasks, and then provide training to the six employees so they can perform higher-skilled services such as tax planning. Many of the techniques that you learn in the remaining chapters of this text will help you evaluate the merits of your various options.

CHAPTER 15 Job Order Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Do It!

Exercises

A Problems

1, 2, 3, 4, 5, 6, 7, 8

1, 2

1, 2, 3, 4, 6, 7, 8, 9, 11

1A, 2A, 3A, 5A

Use a job cost sheet to assign costs to work in process.

9, 10, 11, 12

3, 4, 5

1, 2, 3, 6, 7, 8, 10, 12

1A, 2A, 3A, 5A

Demonstrate how to determine and use the predetermined overhead rate.

13, 14, 15

6, 7

2, 3, 5, 6, 7, 8, 11, 12, 13

1A, 2A, 3A, 4A, 5A

Prepare entries for manufacturing and service jobs completed and sold.

8, 9

2, 3, 6, 7, 8, 10, 11, 12

1A, 2A, 3A, 5A

Distinguish between underand overapplied manufacturing overhead.

17, 18

4, 5, 9, 13

1A, 2A, 3A, 4A, 5A

Learning Objectives

Questions

Describe cost systems and the flow of costs in a job order system.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare entries in a job order cost system and job cost sheets.

Simple

30 40

Prepare entries in a job order cost system and partial income statement.

Moderate

30 40

Prepare entries in a job order cost system and cost of goods manufactured schedule.

Simple

30 40

Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.

Simple

20 30

Analyze manufacturing accounts and determine missing amounts.

Complex

30 40

ANSWERS TO QUESTIONS 1.

(a) Cost accounting involves the measuring, recording, and reporting of product costs. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the general ledger of a company. (b) An important feature of a cost accounting system is the use of a perpetual inventory system that provides immediate, up-to-date information on the cost of a product.

(a) The two principal types of cost accounting systems are: (1) job order cost system and (2) process cost system. Under a job order cost system, costs are assigned to each job or batch of goods; at all times each job or batch of goods can be separately identified. A job order cost system measures costs for each completed job, rather than for set time periods. Under a process cost system, product-related costs are accumulated by or assigned to departments or processes for a set period of time. Job order costing lends itself to specific, special-order manufacturing or servicing while process costing is better suited to similar, largevolume products and continuous process manufacturing. (b) A company can use both types of systems. For example, General Motors uses process costing for standard model cars and job order costing for custom-made vehicles.

A job order cost system is most likely to be used by a company that receives special orders, or custom builds, or produces heterogeneous items or products; that is, the product manufactured or the service rendered is tailored to the customer or client’s requests, needs, or situation. Examples of industries that use job order systems are custom home builders, commercial printing companies, motion picture companies, construction contractors, repair shops, accounting and law firms, hospitals, shipbuilders, and architects.

A process cost system is most likely to be used by manufacturing firms with continuous production flows usually found in mass production, assembly line, large-volume, uniform, or relatively similar product industries. Companies producing appliances, chemicals, pharmaceuticals, rubber and tires, plastics, cement, petroleum, and automobiles utilize process cost systems.

The major steps in the flow of costs in a job order cost system are: (1) accumulating the manufacturing costs incurred and (2) assigning the accumulated costs to work done.

The three inventory control accounts and their subsidiary ledgers are: Raw materials inventory—materials inventory records. Work in process inventory—job cost sheets. Finished goods inventory—finished goods records.

The source documents used in accumulating direct labor costs are time tickets and time cards.

Disagree. Entries to Manufacturing Overhead are also made at the end of an accounting period. For example, there will be adjusting entries for factory depreciation, property taxes, and insurance.

The source document for materials is the materials requisition slip and the source document for labor is the time ticket. The entries are: Materials Work in Process Inventory Manufacturing Overhead Raw Materials Inventory

Labor XX XX XX

Work in Process Inventory Manufacturing Overhead Factory Labor

XX XX XX

Questions Chapter 15 (Continued) 10.

The purpose of a job cost sheet is to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.

11.

The source documents for charging costs to specific jobs are materials requisition slips for direct materials, time tickets for direct labor, and the predetermined overhead rate for manufacturing overhead.

12.

The materials requisition slip is a business document used as an authorization to issue materials from inventory to production. It is approved and signed by authorized personnel so that materials may be removed from inventory and charged to production, to specific jobs, departments, or processes. The materials requisition slip is the basis for posting to the materials inventory records and to the job cost sheet.

13.

Disagree. Actual manufacturing overhead cannot be determined until the end of a period of time. Consequently, there could be a significant delay in assigning overhead and in determining the total cost of the completed job.

14.

The relationships for computing the predetermined overhead rate are the estimated annual overhead costs and an expected activity base such as direct labor hours. The rate is computed by dividing the estimated annual overhead costs by the expected annual operating activity.

15.

At any point in time, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. Alternatively, posting to Work in Process Inventory may be compared with the sum of the postings to the job cost sheets for each of the manufacturing cost elements.

16.

Jane is incorrect. There is a difference in computing total manufacturing costs. In job order costing, manufacturing overhead applied is used, whereas in Chapter 1, actual manufacturing overhead is used.

17.

Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Manufacturing Overhead will have a debit balance when overhead is underapplied and a credit balance when overhead is overapplied.

18.

Under- or overapplied overhead is not closed to Income Summary. The balance in Manufacturing Overhead is eliminated through an adjusting entry. Under- or overapplied overhead generally is considered to be an adjustment of Cost of Goods Sold.

BRIEF EXERCISE 15-2 Jan. 31 31

Raw Materials Inventory ...................................... Accounts Payable.........................................

4,000

Factory Labor ....................................................... Factory Wages Payable................................ Employer Payroll Taxes Payable.................

6,000

Manufacturing Overhead ..................................... Utilities Payable ............................................

2,000

4,000 5,200 800 2,000

BRIEF EXERCISE 15-3 Jan. 31

Work in Process Inventory .................................. Manufacturing Overhead ..................................... Raw Materials Inventory...............................

2,800 600 3,400

BRIEF EXERCISE 15-4 Jan. 31

Work in Process Inventory .................................. Manufacturing Overhead ..................................... Factory Labor ...............................................

5,200 800 6,000

BRIEF EXERCISE 15-5

Date 1/31 1/31

Job 1 Direct Materials 900

Direct Labor

Date 1/31 1/31

2,200

Date 1/31 1/31

Job 3 Direct Materials 700

Job 2 Direct Materials 1,200

Direct Labor 1,400

Direct Labor 1,600

BRIEF EXERCISE 15-6 Overhead rate per direct labor cost is 180%, or ($900,000 ÷ $500,000). Overhead rate per direct labor hour is $18, or ($900,000 ÷ 50,000 DLH). Overhead rate per machine hour is $9, or ($900,000 ÷ 100,000 MH). BRIEF EXERCISE 15-7 Jan. 31

Feb. 28

Mar. 31

Work in Process Inventory ............................. Manufacturing Overhead ($40,000 X 70%)....................................

28,000

Work in Process Inventory ............................. Manufacturing Overhead ($30,000 X 70%)....................................

21,000

Work in Process Inventory ............................. Manufacturing Overhead ($50,000 X 70%)....................................

35,000

28,000

21,000

35,000

BRIEF EXERCISE 15-8 Mar. 31 31 31

Finished Goods Inventory .............................. Work in Process Inventory......................

50,000

Cash ................................................................. Sales Revenue .........................................

35,000

Cost of Goods Sold......................................... Finished Goods Inventory.......................

20,000

50,000 35,000 20,000

BRIEF EXERCISE 15-9 Service Contracts in Process ......................... Operating Overhead........................................ Service Salaries and Wages ................... Service Contracts in Process ($28,000 X .25) .......................................... Operating Overhead ................................

28,000 8,000 36,000 7,000 7,000

BRIEF EXERCISE 15-10 Dec. 31

Dec. 31

Shimeca Company Cost of Goods Sold......................................... Manufacturing Overhead ........................

1,200

Garcia Company Manufacturing Overhead ................................ Cost of Goods Sold .................................

900

1,200

900

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 15-1 (a) Raw Materials Inventory............................................ Accounts Payable ............................................... (Purchases of raw materials on account)

18,000

(b) Factory Labor............................................................. Factory Wages Payable ...................................... Employer Payroll Taxes Payable........................ (To record factory labor costs)

40,000

(c) Manufacturing Overhead .......................................... Accumulated Depreciation—Buildings.............. Utilities Payable................................................... Prepaid Property Taxes ...................................... (To record overhead costs)

15,300

18,000

31,000 9,000

9,500 3,100 2,700

DO IT! 15-2 The three summary entries are: Work in Process Inventory ($7,200 + $9,000) .................. Raw Materials Inventory ............................................ (To assign materials to jobs)

16,200

Work Process Inventory ($4,000 + $8,000) ...................... Factory Labor............................................................. (To assign labor to jobs)

12,000

Work in Process Inventory ($5,200 + $9,800) .................. Manufacturing Overhead .......................................... (To assign overhead to jobs)

15,000

16,200

12,000

15,000

DO IT! 15-3 The predetermined overhead for Washburn Company is: $200,000  2,500 hours = $80.00 The amount of overhead assigned to number 551 would be: 90 hours  $80.00 = $7,200 The entry to record the assignment of overhead to job number 551 on January 15th is: January 15

Work in Process Inventory......................... Manufacturing Overhead ....................... (To assign overhead to jobs)

7,200 7,200

DO IT! 15-4 Finished Goods Inventory ................................................ Work in Process Inventory........................................ (To record completion of Job 310, costing $70,000 and Job 312, costing $50,000)

120,000

Accounts Receivable ........................................................ Sales Revenue ......................................................... (To record sale of Job 312)

90,000

Cost of Goods Sold........................................................... Finished Goods Inventory......................................... (To record cost of goods sold for Job 312)

50,000

120,000

90,000

50,000

DO IT! 15-5 Manufacturing overhead applied = 130% X $85,000 = $110,500 Underapplied manufacturing overhead = $115,000 – $110,500 = $4,500

SOLUTIONS TO EXERCISES EXERCISE 15-1 (a) Factory Labor.......................................................... Factory Wages Payable .................................. Employer Payroll Taxes Payable.................... Employer Fringe Benefits Payable.................

90,000

(b) Work in Process Inventory ($90,000 X 85%) ......... Manufacturing Overhead........................................ Factory Labor ..................................................

76,500 13,500

76,000 8,000 6,000

90,000

EXERCISE 15-2 (a) May 31

Work in Process Inventory .................... Manufacturing Overhead....................... Raw Materials Inventory ................

10,400 800

Work in Process Inventory .................... Manufacturing Overhead....................... Factory Labor..................................

12,500 1,200

Work in Process Inventory ($12,500 X 60%) .................................. Manufacturing Overhead ............... Finished Goods Inventory ..................... Work in Process Inventory.............

11,200

13,700 7,500 7,500 7,540 7,540

($2,000 + $2,500 + $1,900 + $1,140*)

*$1,900 X 60% (b) May 1 Balance 31 31 31 May 31 Balance

Work in Process Inventory 3,500 May 31 10,400 12,500 7,500 26,360

7,540

EXERCISE 15-2 (Continued) Job Cost Sheets Job No. 430 431

Beginning Work in Process $1,500 0 $1,500

Direct Material $3,500 4,400 $7,900

Direct Labor $ 3,000 7,600 $10,600

Manufacturing* Overhead $1,800 4,560 $6,360

Total $ 9,800 16,560 $26,360

*Direct labor X .60 EXERCISE 15-3 (a) 1.

$15,200, or ($5,000 + $6,000 + $4,200).

2. Last year 70%, or ($4,200 ÷ $6,000); this year 80% (either $6,400 ÷ $8,000 or $3,200 ÷ $4,000). (b) Jan. 31 31

Work in Process Inventory ...................... Raw Materials Inventory ...................

8,000

Work in Process Inventory ...................... Factory Labor ....................................

12,000

Work in Process Inventory ...................... Manufacturing Overhead..................

9,600

Finished Goods Inventory ....................... Work in Process Inventory ...............

44,800

31 31

EXERCISE 15-4 (a) + $50,000 + $42,500 = $145,650 (a) = $53,150 $145,650 + (b) = $201,500 (b) = $55,850 $201,500 – (c) = $192,300 (c) = $9,200

8,000 12,000 9,600 44,800

EXERCISE 15-4 (Continued) [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labor cost, and the rate is the same in all cases. From Case A, a student should note the overhead rate to be 85%, or ($42,500 ÷ $50,000).] (d) = .85 X $140,000 (d) = $119,000 $83,000 + $140,000 + $119,000 = (e) (e) = $342,000 $342,000 + $15,500 = (f) (f) = $357,500 $357,500 – $11,800 = (g) (g) = $345,700 [Note: (h) and (i) are solved together.] (i) = .85(h) $63,150 + (h) + .85(h) = $213,000 1.85(h) = $149,850 (h) = $81,000 (i) = $68,850 (j) = $213,000 + $18,000 (j) = $231,000 $231,000 – (k) = $222,000 (k) = $9,000 EXERCISE 15-5 (a) $2.40 per machine hour ($300,000 ÷ 125,000 MH). (b) ($322,000) – ($2.40 x 130,000 Machine Hours) $322,000 – $312,000 = $10,000 underapplied (c) Cost of Goods Sold .................................................. Manufacturing Overhead ..................................

10,000 10,000

EXERCISE 15-6 (a) (1) The source documents are: Direct materials—Materials requisition slips. Direct labor—Time tickets. Manufacturing overhead—Predetermined overhead rate. (2) The predetermined overhead rate is 125% of direct labor cost. For example, on July 15, the computation is $550 ÷ $440 = 125%. The same result is obtained on July 22 and 31. (3) The total cost is: Direct materials ............................................................ Direct labor ................................................................... Manufacturing overhead..............................................

$4,700 1,360 1,700 $7,760

The unit cost is $3.10 ($7,760 ÷ 2,500). (b) July 31

Finished Goods Inventory............................ Work in Process Inventory ...................

7,760

Raw Materials Inventory................................................ Accounts Payable ..................................................

46,300

Work in Process Inventory............................................ Manufacturing Overhead............................................... Raw Materials Inventory ........................................

29,200 6,800

Factory Labor................................................................. Factory Wages Payable ......................................... Employer Payroll Taxes Payable ..........................

59,900

Work in Process Inventory............................................ Manufacturing Overhead............................................... Factory Labor .........................................................

54,000 5,900

7,760

EXERCISE 15-7 1. 2.

46,300

36,000 51,000 8,900

59,900

EXERCISE 15-7 (Continued) 5. 6. 7.

8. 9.

Manufacturing Overhead....................................... Accounts Payable ..........................................

80,500

Depreciation Expense ........................................... Accumulated Depreciation—Building...........

8,100

Work in Process Inventory ($54,000 X 150%) ...... Manufacturing Overhead ...............................

81,000

Finished Goods Inventory..................................... Work in Process Inventory ............................

88,000

Accounts Receivable............................................. Sales Revenue................................................

103,000

Cost of Goods Sold ............................................... Finished Goods Inventory .............................

75,000

80,500 8,100 81,000 88,000 103,000 75,000

EXERCISE 15-8 1.

Raw Materials Inventory ........................................ Accounts Payable ..........................................

192,000

Factory Labor......................................................... Factory Wages Payable .................................

87,300

Work in Process Inventory.................................... Manufacturing Overhead....................................... Raw Materials Inventory ................................

153,530 4,470

Work in Process Inventory.................................... Manufacturing Overhead....................................... Factory Labor .................................................

80,000 7,300

Manufacturing Overhead....................................... Accounts Payable ..........................................

49,500

192,000 87,300

158,000

87,300 49,500

EXERCISE 15-8 (Continued) 4.

Manufacturing Overhead....................................... Accumulated Depreciation—Equipment ......

14,550

Depreciation Expense ............................................ Accumulated Depreciation—Building ...........

14,300

Work in Process Inventory..................................... Manufacturing Overhead (90% X $80,000) ...........................................

72,000

Finished Goods Inventory...................................... Work in Process Inventory .............................

240,930

14,550

14,300

72,000

240,930

Computation of cost of jobs finished: Job A20 A21 A23

Direct Materials $35,240 42,920 39,270

Direct Labor $18,000 22,000 25,000

Manufacturing Overhead $16,200 19,800 22,500

Total $ 69,440 84,720 86,770 $240,930

EXERCISE 15-9 (a)

LOPEZ COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2017 Work in process, May 1 ........................................ Direct materials used ........................................... Direct labor............................................................ Manufacturing overhead applied......................... Total manufacturing costs ........................... Total cost of work in process .............................. Less: Work in process, May 31........................... Cost of goods manufactured ...............................

$ 14,700 $62,400 50,000 40,000 152,400 167,100 15,900 $151,200

EXERCISE 15-9 (Continued) (b)

LOPEZ COMPANY (Partial) Income Statement For the Month Ended May 31, 2017 Sales revenue..................................................... Cost of goods sold Finished goods, May 1 ............................... Cost of goods manufactured..................... Cost of goods available for sale................ Less: Finished goods, May 31.................. Cost of goods sold ............................. Gross profit ........................................................

(c)

$215,000 $ 12,600 151,200 163,800 9,500 154,300 $ 60,700

LOPEZ COMPANY (Partial) Balance sheet May 31, 2017 Current assets: Finished goods inventory.......................... Work in process inventory ........................ Raw materials inventory ............................

$ 9,500 15,900 7,100

$32,500

EXERCISE 15-10 (a) Work in Process Inventory April 30 $ 9,300 (#10, $5,200 + #11, $4,100) May 31 $18,600 (#11, $8,000 + #13, $4,700 + #14, $5,900) June 30 $ 9,500 (#14, $5,900 + $3,600) (b) Finished Goods Inventory April 30 $ 1,200 (#12) May 31 $ 9,600 (#10) June 30 $19,200 (#11, $10,000 + #13, $9,200) (c) Gross Profit Month May June July

Job Number 12 10 11/13

Sales $ 1,500 12,000 24,000

Cost of Goods Sold $ 1,200 9,600 19,200

Gross Profit $ 300 2,400 4,800

EXERCISE 15-11 (a) 1. 2.

4. 5.

(b) 2. 3. 5.

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

1,800

Service Contracts in Process .......... Operating Overhead ......................... Supplies .....................................

720 480

Service Contracts in Process .......... Operating Overhead ......................... Service Salaries and Wages .....

56,000 14,000

Operating Overhead ......................... Cash ...........................................

40,000

1,800

1,200

70,000

40,000

Service Contracts in Process ($56,000 X 90%) ............................. Operating Overhead ..................

50,400

Cost of Completed Service Contracts ....................................... Service Contracts in Process ...

75,000

Service Contracts in Process 720 75,000 56,000 50,400 32,120

50,400

75,000

(6)

EXERCISE 15-12 (a) Direct materials Auditor labor costs Applied overhead Total cost

Lynn $ 600 5,400 3,600 $9,600

Brian $ 400 6,600 4,400 $11,400

Mike $ 200 3,375 2,250 $5,825

(b) The Lynn job is the only incomplete job, therefore, $9,600. (c) Actual overhead Applied overhead Balance

$11,000 (DR) 10,250 (CR) $ 750 (DR)

EXERCISE 15-13 (a) Predetermined overhead rate = Estimated overhead ÷ Estimated decorator hours = $960,000 ÷ 40,000 decorator hours = $24 per decorator hour (b) Service Contracts in Process (40,500 hrs X $24) ......... 972,000 Operating Overhead..................................... 972,000 (c)

Actual overhead Applied overhead Balance

$982,800 972,000 $ 10,800 underapplied

SOLUTIONS TO PROBLEMS PROBLEM 15-1A

(a) $840,000 ÷ $700,000 direct labor costs = 120% of direct labor costs (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory............................................ Accounts Payable ..............................................

90,000

Factory Labor............................................................. Factory Wages Payable ..................................... Employer Payroll Taxes Payable ......................

70,000

Manufacturing Overhead........................................... Accounts Payable .............................................. Accumulated Depreciation—Equipment .......... Raw Materials Inventory .................................... Factory Labor .....................................................

65,000

(d) Work in Process Inventory........................................ Raw Materials Inventory ($10,000 + $39,000 + $30,000) ........................

79,000

Work in Process Inventory........................................ Factory Labor ($5,000 + $25,000 + $20,000) ..........................

50,000

Work in Process Inventory........................................ Manufacturing Overhead ................................... ($50,000 X 120% of direct labor costs)

60,000

90,000 54,000 16,000 16,000 12,000 17,000 20,000

79,000

50,000

See solution to part (e) for postings to job cost sheets.

60,000

PROBLEM 15-1A (Continued) (b)&(e)

Job Cost Sheets

Job No. 50 Date Direct Materials Beg. $20,000 Jan. 10,000 $30,000

Direct Labor $12,000 5,000 $17,000

Manufacturing Overhead $16,000 6,000* $22,000

Cost of completed job Direct materials .............................................................. Direct labor ..................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................

$30,000 17,000 22,000 $69,000

*$5,000 X 120% Job No. 51 Date Jan.

Direct Materials $39,000 $39,000

Direct Labor $25,000 $25,000

Manufacturing Overhead $30,000** $30,000

$39,000 25,000 30,000 $94,000

**$25,000 X 120% Job No. 52 Date Direct Materials Jan. $30,000 ***$20,000 X 120%

Direct Labor $20,000

Manufacturing Overhead $24,000***

PROBLEM 15-1A (Continued)

(f)

Finished Goods Inventory...................................... Work in Process Inventory ($69,000 + $94,000)......................................

163,000

Accounts Receivable.............................................. Sales Revenue ($122,000 + $158,000) ............

280,000

Cost of Goods Sold ................................................ Finished Goods Inventory ($90,000 + $69,000)......................................

159,000

(g) Beginning balance Cost of completed jobs 50 and 51 Ending balance

Finished Goods Inventory 90,000 159,000 163,000 94,000

163,000

280,000

159,000

Cost of jobs 49 and 50 sold

The balance in this account consists of the cost of completed Job No. 51 which has not yet been sold. (h) Manufacturing Overhead Actual Applied 65,000 60,000 5,000 The balance in the Manufacturing Overhead account is underapplied.

PROBLEM 15-2A

(a) 1/1

12/31

Work in Process Inventory Balance (1) 128,400 Completed work (5) (c) Direct materials (2) 131,000 Direct labor (3) 139,000 Manufacturing overhead (4) 166,800 Balance 179,000

386,200

(1)

Job 7640 Job 7641

$ 77,800 50,600 $128,400

(3)

Job 7640 Job 7641 Job 7642

$ 36,000 48,000 55,000 $139,000

(2)

Job 7640 Job 7641 Job 7642

$ 30,000 43,000 58,000 $131,000

(4)

Job 7640 Job 7641 Job 7642

$ 43,200 57,600 66,000 $166,800

(5) (a) Job 7640 Beginning balance................................................ Direct materials..................................................... Direct labor............................................................ Manufacturing overhead ......................................

(b) Job 7641 Beginning balance................................................ Direct materials..................................................... Direct labor............................................................ Manufacturing overhead ......................................

(c) Total cost of completed work Job 7640 ................................................................ Job 7641 ................................................................

$ 77,800 30,000 36,000 43,200 $187,000

$ 50,600 43,000 48,000 57,600 $199,200

$187,000 199,200 $386,200

PROBLEM 15-2A (Continued) Work in process balance..............................................

$179,000

Unfinished job No. 7642 ...............................................

$179,000 (a)

(a) Current year’s cost Direct materials................................. $ 58,000 Direct labor ....................................... 55,000 Manufacturing overhead ....................... 66,000 $179,000 (b) Actual overhead costs Incurred on account.............................................. Indirect materials .................................................. Indirect labor ......................................................... Depreciation .......................................................... Applied overhead costs Job 7640................................................................. Job 7641................................................................. Job 7642.................................................................

Actual overhead............................................................ Applied overhead.......................................................... Overapplied overhead .................................................. Manufacturing Overhead ................................................. 6,800 Cost of Goods Sold............................................... (c) Sales revenue (given)........................................ Cost of goods sold Add: Job 7638 ................................................... Job 7639 ................................................... Job 7641 ................................................... Less: Overapplied overhead ............................ Gross profit ........................................................

$120,000 14,000 18,000 8,000 $160,000 $ 43,200 57,600 66,000 $166,800 $160,000 166,800 $ 6,800

6,800 $530,000

$ 87,000 92,000 199,200 378,200 6,800

371,400 $158,600

PROBLEM 15-3A

(a) (1)

(2)

(3)

Raw Materials Inventory ........................................... Accounts Payable .............................................

4,900

Factory Labor............................................................ Cash ...................................................................

4,800

Manufacturing Overhead.......................................... Accumulated Depreciation—Equipment ......... Accounts Payable .............................................

1,300

Work in Process Inventory....................................... Manufacturing Overhead.......................................... Raw Materials Inventory ...................................

4,900 1,500

Work in Process Inventory....................................... Manufacturing Overhead.......................................... Factory Labor ....................................................

3,600 1,200

Work in Process Inventory ($3,600 X 1.25) ............. Manufacturing Overhead ..................................

4,500

Finished Goods Inventory........................................ Work in Process Inventory ...............................

14,740

Job

Direct Materials

Direct Labor

Manufacturing Overhead*

Total Costs

Rogers Stevens Linton

$1,700 1,300 2,200

$1,560 900 1,780

$1,950 1,125 2,225

$ 5,210 3,325 6,205 $14,740

4,900 4,800 900 400

6,400

4,800 4,500 14,740

*125% X direct labor amount Cash........................................................................... Sales revenue ....................................................

18,900

Cost of Goods Sold .................................................. Finished Goods Inventory ................................

14,740

18,900 14,740

PROBLEM 15-3A (Continued) (b) 6/1

6/30

Work in Process Inventory Balance 5,540 June Completed work Direct materials 4,900 Direct labor 3,600 Overhead applied 4,500 Balance 3,800

(c) Work in Process Inventory........................................................ Job: Koss (Direct materials $2,000 + Direct labor $800 + Manufacturing overhead $1,000) ................................. (d)

14,740

$3,800 $3,800

CASE INC. Cost of Goods Manufactured Schedule For the Month Ended June 30, 2017 Work in process, June 1.......................................... Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead applied............................ Total manufacturing costs .............................. Total cost of work in process ................................. Less: Work in process, June 30 ............................ Cost of goods manufactured ..................................

$ 5,540 $4,900 3,600 4,500 13,000 18,540 3,800 $14,740

PROBLEM 15-4A

(a) Department D: Department E: Department K:

$1,200,000 ÷ $1,500,000 = 80% of direct labor cost. $1,500,000 ÷ 125,000 = $12.00 per direct labor hour. $900,000 ÷ 120,000 = $7.50 per machine hour.

(b) Manufacturing Costs Direct materials Direct labor Overhead applied Total

D $140,000 120,000 96,000* $356,000

Department E $126,000 110,000 132,000** $368,000

K $ 78,000 37,500 78,000*** $193,500

D $99,000 96,000 $ 3,000

Department E $124,000 132,000 $ (8,000)

K $79,000 78,000 $ 1,000

*$120,000 X 80% **11,000 X $12.00 ***10,400 X $7.50 (c) Manufacturing Overhead Incurred Applied Under (over) applied

PROBLEM 15-5A

(a) $7,600

($16,850 + $7,975 – $17,225).

(b) $36,000

[$9,750 + $15,000 + (75% X $15,000)]. (Given in other data).

($16,850 – $2,900).

(d) $6,300

($8,400 X 75%).

(e) $12,200

[Given in other data—$3,800 + $4,800 + (75% X $4,800)].

(f)

($36,000 + $13,950 + $8,400 + $6,300 – $12,200).

$52,450

(g) $5,000

(Given in other data).

(h) $52,450

(See (f) above).

(i)

$53,450

($5,000 + $52,450 – $4,000).

(j)

$4,000

(Given in other data).

(k) $12,025

(Equal to factory labor incurred).

(l)

($12,025 – $8,400).

$3,625

(m) $6,300

($7,770* – $1,470) or (Same as (d)).

*$2,900 + $3,625 + $1,245

CD15

CURRENT DESIGNS

Cost for one kayak: Direct Materials Polyethylene powder Finishing kit

54 pounds @ $1.50 per pound 1 kit @ $170

Direct Labor More skilled Less skilled

2 hours @ $15 per hour 3 hours @ $12 per hour

81 170 30 36

Manufacturing overhead 150% of direct labor costs 150% * $66 Total cost for one kayak

99 $ 416

Cost for order of 20 kayaks $416 per kayak * 20 kayaks

$8,320

BYP 15-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The manufacturing cost element that is responsible for the fluctuating unit costs is manufacturing overhead. Manufacturing overhead is being included as incurred rather than being applied on a predetermined basis. Direct materials and direct labor are not the cause as they have the same unit cost per batch in each quarter. (b) The solution is to apply overhead using a predetermined overhead rate based on a relevant basis of production activity. Based on actual overhead incurred and using batches of product TC-1 as the activity base, the overhead rate is $16,000 per batch [($105,000 + $153,000 + $97,000 + $125,000) ÷ 30]. Another approach would be to use direct labor cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 133 1/3% of direct labor cost ($480,000 ÷ $360,000) could be used. Either approach will provide the same result. (c) The quarterly results using a predetermined overhead rate based on batches produced are as follows: Quarter Costs Direct materials Direct labor Manufacturing overhead Applied ($16,000 X batches) Total (a)

1 $100,000 60,000

2 $220,000 132,000

3 $ 80,000 48,000

4 $200,000 120,000

80,000 $240,000

176,000 $528,000

64,000 $192,000

160,000 $480,000

Production in batches (b)

$ 48,000

Unit cost (per batch) (a) ÷ (b)

(Note: The unit cost of a batch remains the same in each quarter. Both sales and production should be pleased with this solution to fluctuating unit costs.)

BYP 15-2

MANAGERIAL ANALYSIS

(a) Work in Process Inventory ............................. Raw Materials Inventory..........................

25,000 25,000

(b) If not corrected, the balance sheet is affected. Cash is understated and Raw Materials Inventory is overstated. 2.

(a) Sales Bonus Expense..................................... Cash .........................................................

12,000 12,000

(b) Both the income statement and the balance sheet are affected. In the income statement, Sales Bonus Expense is understated, Income Tax Expense is overstated, and net income is overstated. The error causes the underapplied overhead to be overstated or the overapplied overhead to be understated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Goods Sold also has an effect on Retained Earnings. Also, Retained Earnings is overstated because of the overstatement of net income, and Income Taxes Payable is overstated.

(a) Factory Labor .................................................. Factory Wages Payable........................... Employer Payroll Taxes Payable............

120,000 102,000 18,000

(b) If not corrected, both the income statement and the balance sheet are affected. On the income statement, Cost of Goods Sold is understated and Wages Expense is overstated. On the balance sheet, Cash, Factory Wages Payable, and Employer Payroll Taxes Payable are understated.

BYP 15-2 (Continued) 4.

(a) Manufacturing Overhead................................. Raw Materials Inventory ..........................

3,000 3,000

(b) Both the income statement and balance sheet are affected. If units that were in process during the month have been sold, then in the income statement Cost of Goods Sold is overstated, Income Tax Expense is understated, and net income is understated. This causes the Retained Earnings and Income Taxes Payable in the balance sheet to be understated. Also the error causes underapplied overhead to be understated or overapplied overhead to be overstated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Good Sold also has an affect on Retained Earnings.

BYP 15-3

REAL-WORLD FOCUS

(a) Candidates for the CMA or CFM Certificate must complete two continuous years of professional experience in management accounting or financial management. This requirement may be completed prior to or within seven years of passing the examination. (b) CMAs, CFMs, and candidates who have completed the CMA and/or the CFM examination but have not yet met the experience requirement, are required to maintain their proficiency in the fields of management accounting and financial management. This includes knowledge of new concepts and techniques as well as their application in the management accounting and financial management professions. The objective is to maintain the professional competence of the individual and to enhance one’s ability to perform job-related requirements. Persons who have retired need not meet continuing education requirements. The continuing requirement is 30 hours per year and at least 2 of those hours must be ethics-related. A broad range of subjects may be included in the programs for which hours of credit will be given. The subjects should be related to the topics covered on the CMA/CFM examination and/or to an individual’s job responsibilities. Illustrative of the subjects that may qualify are: all aspects of accounting, financial management, business applications of mathematics and statistics, computer science, economics, management, production, marketing, business law, and organizational behavior.

BYP 15-4

COMMUNICATION ACTIVITY

Williams Company Date Nancy Kopay 123 Cedar Lane Altoona, Kansas 66651 Dear Ms. Kopay: Thank you for your prompt payment! I am very glad that you found the cost information helpful. Thank you also for your questions about our overhead costs. We do try to provide our customers with as much information as possible, but we cannot give detailed information on overhead costs. The cost of providing such information is prohibitive. You asked why we do not use actual overhead costs when we bill our customers. We estimate overhead costs, rather than use actual costs, for several reasons. One of the most important reasons for you is that we could not prepare bills in a timely manner if we had to use actual overhead. We would have to wait until we were billed for such things as electricity and telephone service. A second reason is that some costs we include in overhead are only payable once or twice a year, such as insurance and taxes. When we use an estimated rate, we are able to allow for those costs. A third reason is that some costs are fixed, which means that they stay the same in dollar amount from month to month. This category includes items such as rent. If we billed you based on our actual costs, you would be billed a higher amount if your work was done during a slow time (because we would have fewer jobs to spread the costs over). An estimated overhead rate allows us to level out these costs.

BYP 15-4 (Continued) I hope this answers some of your questions. I’m glad you are interested in our company and that you took the time to write. I am sending a copy of our annual report under separate cover. It contains some details on the information you asked about. Thanks again for your letter and for having Williams make your new cabinets! Sincerely, Student

BYP 15-5

ETHICS CASE

(a) The stakeholders in this situation are: ⯈ Alice Reiley, controller for LRF Printing. ⯈ The president of LRF Printing. ⯈ The customers of LRF Printing. ⯈ The competitors of LRF Printing. (b) Padding cost-plus contracts is both unethical and illegal. Alice is faced with an ethical dilemma. She will be in trouble with the president if she doesn’t follow his directive, and she will be committing an unethical act if she does follow his instructions. (c) Alice should continue to accurately account for cost-plus contracts and, if challenged by the president, she should say that she is doing her very best to charge each and every legitimate cost to the cost-plus contracts. Let the president perform the unethical act if he continues to persist in padding costs.

BYP 15-6

(a)

ALL ABOUT YOU

Your chances of success in small business are increased if you have the following characteristics: You are a self-starter, you get along with many different kinds of people, you are good at making decisions, you have physical and emotional stamina, you are well organized, you have a strong desire to succeed and you will receive family support during the start up phase.

(b) The top ten reasons why businesses fail as cited in the books Small Business Management by Michael Ames, and The Do it Yourself Business Book by Gustav Berle are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Lack of experience Insufficient capital (money) Poor location Poor inventory management Over-investment in fixed assets Poor credit arrangements Personal use of business funds Unexpected growth Competition Low sales

BYP 15-7

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: The situation presented is a difficult one because you are presently receiving some help for free. It would seem that the best strategy is to price your services based on what it would cost you to do the landscape business without any free help. In the long run, it is going to be impossible to continue unless you can cover these costs. In addition, if you underprice your services today, your customers may expect your prices will remain as low in the future. That probably cannot happen, given that your costs will increase substantially after the first two years. However, we should note that it is not unusual to start a small business with some assets available to you. Then, as your business grows, you acquire additional assets to meet your needs. After all, you may need a low price to get started, and as you gain experience you will be able to charge more or become more efficient. So what to do? Let’s address your old truck first. You should treat the truck as an asset owned by your business. Put it on your books at its fair value, and depreciate it over a reasonable life. This will result in an overhead charge. You need to cover the cost of that truck, as you will have to buy another one some day. The land, barn, and your mother’s services are a little more difficult. If you rented the land and barn and if you paid an assistant, all of these costs would be charged to overhead. (The assistant would be indirect labor.) You are currently getting all these services for free. This is a good situation now, and you may need this situation early in your business to help you get started. But you should recognize that even if you run your business profitably for the first two years, you may have problems beginning in the third year. Thus, it would seem prudent to establish a budget based on both scenarios for the first two years. If you can charge based on your expected costs in the future, do so. If that is not realistic, because you need to establish yourself and get more experience, then charge less. But be sure from the start to cover a reasonable amount of your costs, or the business does not make sense for you financially.

CHAPTER 16 Process Costing ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Discuss the uses of a 1, 2, 3, 4, 5, process cost system and 20 how it compares to a job order system.

Explain the flow of costs in a process cost system and the journal entries to assign manufacturing costs.

6, 7

Compute equivalent units.

*5.

Brief Exercises

Do It!

Exercises

A Problems

1, 2, 3

2, 3, 4

10, 11, 12, 13

4, 5

3, 5, 6, 7, 8, 9, 2A, 3A, 4A, 10, 11, 13, 14, 5A, 6A 15

Complete the four steps to prepare a production cost report.

8, 9, 14, 15, 16, 17, 18, 19

6, 7, 8, 9

3, 5, 6, 7, 8, 9, 2A, 3A, 4A, 10, 11, 12, 13, 5A, 6A 14, 15

Compute equivalent units using the FIFO method.

21, 22

10, 11, 12

16, 17, 18, 19, 20

*Note: All asterisked Brief Exercises, Exercises, and Problems relate to material contained in the appendix to the chapter.

ASSIGNMENT CHARACTERISTICS TABLE Description

Difficulty Level

Time Allotted (min.)

Journalize transactions.

Moderate

20–30

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Complete four steps necessary to prepare a production cost report.

Simple

30–40

Assign costs and prepare production cost report.

Moderate

20–30

Determine equivalent units and unit costs and assign costs.

Moderate

20–30

Compute equivalent units and complete production cost report.

Moderate

15–25

*7A

Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.

Moderate

30–40

Problem Number

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and P Learning Objective

Knowledge Comprehension

Kimmel, Accounting, 6/e, Solutions Manual

1. Discuss the uses of a process cost system and how it compares to a job order system. 2. Explain the flow of costs in a process cost system and the journal entries to assign manufacturing costs. 3. Compute equivalent units.

Q16-1 Q16-2 Q16-3 Q16-6

4. Complete the four steps to prepare a production cost report.

Q16-8 Q16-16 Q16-17 Q16-19

Q16-4 Q16-5 Q16-20

Q16-10 Q16-11

Q16-9

(For Instructor Use Only)

*5. Compute equivalent units using the FIFO method.

Broadening Your Perspective

BYPI16-3

Application

Analysis

E16-1 DI16-1 Q16-7 BE16-1 BE16-2 Q16-12 Q16-13 BE16-4 BE16-5 DI16-3 E16-3 E16-5 Q16-14 Q16-15 Q16-18 BE16-6 BE16-7 BE16-8 BE16-9 DI16-4 Q16-21 Q16-22 BE16-10 BE16-11 CD-16

BE16-3 DI16-2 E16-2 E16-6 E16-7 E16-8 E16-9 E16-10 E16-11 E16-13 E16-3 E16-5 E16-6 E16-7 E16-8 E16-9 E16-10 E16-11 BE16-12 E16-16 E16-17 E16-18

E16-3 E16-4 P3-1A E16-14 E16-15 P3-2A P3-3A P3-4A P3-5A P3-6A E16-13 E16-14 E16-15 P3-2A P3-3A P3-4A P3-5A P3-6A E16-19 E16-20 P3-7A

E16-12

BYPI16-1 BYPI16-2 BYPI16-6

BYPI16

16-3

ANSWERS TO QUESTIONS 1.

(a) (b) (c) (d)

Process cost. Process cost. Job order. Job order.

The primary focus of job order cost accounting is on the individual job. In process cost accounting, the primary focus is on the processes involved in producing homogeneous products.

The similarities are: (1) all three manufacturing cost elements—direct materials, direct labor, and overhead—are the same; (2) the accumulation of the costs of materials, labor, and overhead is the same; and (3) the flow of costs is the same.

The features of process cost accounting are: (1) separate work in process accounts for each process, (2) production cost reports, (3) product costs computed for each accounting period, and (4) unit costs computed based on total manufacturing costs.

Sam is correct. The flow of costs is the same in process cost accounting as in job order cost accounting. The method of assigning costs, however, is significantly different.

(a) (1) Materials are charged to production on the basis of materials requisition slips. (2) Labor is usually charged to production on the basis of the payroll register or departmental payroll summaries. (b) The criterion used in assigning overhead to processes is to identify the activity that “drives” or causes the cost. In many companies this activity is machine time, not direct labor.

The entry to assign overhead to production is: July 31

Work in Process—Machining .................................................... Work in Process—Assembly ..................................................... Manufacturing Overhead ...................................................

15,000 12,000 27,000

To prepare a production cost report, four steps are followed: (a) compute the physical unit flow, (b) compute equivalent units of production, (c) compute unit production costs, and (d) prepare a cost reconciliation schedule.

Physical units to be accounted for consist of units in process at the beginning of the period plus units started (or transferred) into production during the period. Units accounted for consist of units completed and transferred out during the period plus units in process at the end of the period.

10.

Equivalent units of production measure the work done during the period, expressed in fully completed units.

11.

Equivalent units of production are the sum of: (1) units completed and transferred out and (2) equivalent units of ending work in process.

12.

Units started into production were 9,600, or (9,000 + 600).

Questions Chapter 16 (Continued)

13. Units transferred out Work in process 500 X 100% 500 X 20% Total equivalent units 14. Units transferred out were 3,200* Units to be accounted for Work in process (beginning) Started into production Total units Units accounted for Completed and transferred out Work in process (ending) Total units *3,500 – 300

Equivalent Units Materials Conversion Costs 12,000 12,000 500 12,500

100 12,100

500 3,000 3,500 3,200* 300 3,500

15. (a) (b)

The cost of the units transferred out is $112,000, or (14,000 X $8). The cost of the units in ending inventory is $8,500, or [(2,000 X $3) + (500 X $5)].

16. (a) (b)

Ann is incorrect. The report is an internal report for management. There are four sections in a production cost report: (1) number of physical units, (2) equivalent units determination, (3) unit costs, and (4) cost reconciliation schedule.

17. The production cost report provides the basis for evaluating: (1) the productivity of a department, (2) whether unit and total costs are reasonable, and (3) whether current performance is meeting planned objectives. 18. The per unit conversion cost is $11.25. [Conversion costs = $6,000 – $2,400 = $3,600. Equivalent units for conversion costs are 320 (800 X 40%); $3,600 ÷ 320 = $11.25.] 19. Operations costing is similar to process costing in that standardized methods are used to manufacture the product. At the same time, the product may have some customized individual features that require the use of a job order cost system. 20. In deciding which system to use, a cost-benefit tradeoff occurs. In a job order system, detailed information related to the cost of the product is involved. The cost of implementing this system is often expensive. In a process cost system, an average cost of the product will suffice and therefore the cost to implement is less. In summary, the cost of implementing the system must be balanced against the benefits provided from the additional information. *21. Units transferred out were 2,800 (2,000 + 800). *22. (a) (b)

The cost of the units transferred out is $120,000 (12,000 X $10). The cost of the units in ending inventory is $9,500 [(2,000 X $3) + (500 X $7)].

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16-1 Mar. 31 31

Raw Materials Inventory ................................. Accounts Payable....................................

50,000

Factory Labor .................................................. Wages Payable ........................................

60,000

50,000 60,000

BRIEF EXERCISE 16-2 Mar. 31

Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Raw Materials Inventory..........................

24,000 26,000

Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Factory Labor...........................................

35,000 25,000

50,000

60,000

BRIEF EXERCISE 16-3 Mar. 31

Work in Process—Assembly Department ($35,000 X 160%) ......................................... Work in Process—Finishing Department ($25,000 X 160%) ......................................... Manufacturing Overhead.........................

56,000 40,000 96,000

BRIEF EXERCISE 16-4

January March July

Materials 45,000 (35,000 + 10,000) 48,000 (40,000 + 8,000) 61,000 (45,000 + 16,000) a. 10,000 X 40% b. 8,000 X 75% c. 16,000 X 25%

Conversion Costs 39,000 (35,000 + 4,000a) 46,000 (40,000 + 6,000b) 49,000 (45,000 + 4,000c)

BRIEF EXERCISE 16-5

Units transferred out Work in process, November 30 Materials (7,000 X 100%) Conversion costs (7,000 X 40%) Total equivalent units

(a) Materials 9,000

(b) Conversion Costs 9,000

7,000 2,800 11,800

16,000

BRIEF EXERCISE 16-6 Total materials costs $33,000 Total conversion costs $54,000 Unit materials cost $3.30

Equivalent units of materials 10,000

Equivalent units of conversion costs 12,000

Unit conversion cost $4.50

Unit materials cost $3.30

Unit conversion cost $4.50

Total manufacturing cost per unit $7.80

BRIEF EXERCISE 16-7 Assignment of Costs Transferred out Transferred out Work in process, 4/30 Materials Conversion costs Total costs

Equivalent Units

Unit Cost

40,000

$11

5,000 2,000

$ 4 $ 7

$440,000

$20,000 14,000

34,000 $474,000

BRIEF EXERCISE 16-8 Total materials costs $12,000 Total conversion costs* $47,500

Equivalent units of materials 20,000

Equivalent units of conversion costs 19,000

Unit materials cost $.60

Unit conversion cost $2.50

*$29,500 + $18,000 BRIEF EXERCISE 16-9 Costs accounted for Transferred out Work in process Materials Conversion costs Total costs

(18,000 X $3.10) (2,000 X $.60) (1,000* X $2.50)

$55,800 $1,200 2,500

3,700 $59,500

*2,000 X 50%

*BRIEF EXERCISE 16-10 Costs to Be Assigned Assignment of Costs

Equivalent Units

Unit Cost

Total Costs Assigned

Transferred out Work in process, 3/1 Started and completed

0 30,000

$ 0 $16

Work in process, 3/31 Materials Conversion costs

5,000 2,000

$ 6 $10

0 480,000 480,000

$530,000 $ 30,000 20,000

50,000 $530,000

*BRIEF EXERCISE 16-11 Equivalent Units Conversion Materials Costs Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work in process, March 31 Total units

-030,000 5,000 35,000

-030,000 2,000 32,000

PIX COMPANY (Partial) Production Cost Report For the Month Ended March 31 COSTS Materials Unit costs Total costs (a) Equivalent units (b) Unit costs (a) ÷ (b) Costs to be accounted for In process, March 1 Started into production Total costs Costs accounted for Transferred out In process, March 1 Started and completed (30,000 units X $16) In process, March 31 Materials (5,000 X $6) Conversion costs (2,000 X $10) Total costs

$210,000* 35,000 $ 6

*35,000 equivalent units X $6 per unit **32,000 equivalent units X $10 per unit

Conversion Costs

Total

$320,000** $530,000 32,000 $ 10 $ 16 $

0 530,000 $530,000

0 480,000

$ 30,000 20,000

50,000 $530,000

*BRIEF EXERCISE 16-12 Total materials costs $75,0001 1

Equivalent units of materials 20,000

Unit materials cost $3.75

Unit conversion cost $2.00

$8,000 + $67,000 = $75,000

Total conversion costs $38,0002 2

Equivalent units of conversion costs 19,000

$20,000 + $18,000 SOLUTIONS FOR DO IT! REVIEW EXERCISES

DO IT! 16-1 1. 2. 3. 4.

False False True False

DO IT! 16-2 Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Raw Materials Inventory ............................................. (To record materials used)

10,000 28,000

Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Factory Labor.............................................................. (To assign factory labor to production)

8,000 36,000

Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Manufacturing Overhead............................................ (To assign overhead to production)

12,000 54,000

38,000

44,000

66,000

DO IT! 16-2 (Continued) Work in Process—Packaging .................................................21,000 Work in Process—Mixing........................................... (To record transfer of units to the Packaging Department) Finished Goods Inventory .................................................... 106,000 Work in Process—Packaging .................................... (To record transfer of units to finished goods)

21,000

106,000

DO IT! 16-3 (a) Since materials are entered at the beginning of the process, the equivalent units of ending work in process are 10,000. 20,000 units + 10,000 units = 30,000 equivalent units of production for materials. (b) Since ending work in process is only 70% complete as to conversion costs, the equivalent units of ending work in process for conversion costs are 7,000 (70% X 10,000 units). 20,000 units + 7,000 units = 27,000 equivalent units of production for conversion costs. DO IT! 16-4 (a) 0 (Work in process, March 1) + 26,000* (Started into production) = 26,000 *22,000 + 4,000 (b) Equivalent units of production:

Units transferred out ................. Work in process, March 31 ....... Total............................................

Materials 22,000 4,000 26,000

Conversion 22,000 1,600 (4,000 X 40%) 23,600

DO IT! 16-4 (Continued) (c) Cost reconciliation schedule Costs accounted for Transferred out (22,000 X $18) ............ Work in process, March 31 Materials (4,000 X $10) ................. Conversion costs (1,600 X $8) ..... Total costs..................................................

$396,000 $40,000 12,800

52,800 $448,800

SOLUTIONS TO EXERCISES EXERCISE 16-1 1. True. 2. True. 3. False. Companies that produce soft drinks and computer chips would use process cost accounting. 4. False. In a job order cost system, costs are tracked by individual jobs. 5. False. Job order costing and process costing track the same three manufacturing cost elements. 6. True. 7. True. 8. False. In a process cost system, multiple work in process accounts are used. 9. False. In a process cost system, costs are summarized in a production cost report for each department. 10. True.

EXERCISE 16-2 April 30

Work in Process—Cooking .............................. Work in Process—Canning .............................. Raw Materials Inventory ...........................

21,000 9,000

Work in Process—Cooking .............................. Work in Process—Canning .............................. Factory Labor ............................................

8,500 7,000

Work in Process—Cooking .............................. Work in Process—Canning .............................. Manufacturing Overhead ..........................

31,500 25,800

Work in Process—Canning .............................. Work in Process—Cooking ......................

53,000

30,000

15,500

57,300 53,000

EXERCISE 16-3 (a) Work in process, May 1 Started into production Total units to be accounted for Less: Transferred out Work in process, May 31 (b) and (c) Units transferred out Work in process, May 31 300 X 100% 300 X 40%

Work in process, May 1 Costs added Total costs Equivalent units Unit costs

400 1,600 2,000 1,700 300 Equivalent Units Materials Conversion Costs 1,700 1,700 300 2,000

120 1,820

Direct Materials $2,040 5,160 $7,200 2,000 $3.60

Conversion Costs $1,550 3,910* $5,460 1,820 $3.00

*$2,530 + $1,380 (d) Transferred out (1,700 X $6.60) (e) Work in process Materials (300 X $3.60) Conversion costs (120 X $3.00)

$11,220 $ 1,080 360 $ 1,440

EXERCISE 16-4 1. 2. 3.

7. 8.

Raw Materials Inventory.......................................... Accounts Payable ............................................

62,500

Factory Labor........................................................... Wages Payable .................................................

60,000

Manufacturing Overhead......................................... Cash .................................................................. Accounts Payable ............................................

70,000

Work in Process—Cutting....................................... Work in Process—Assembly .................................. Raw Materials Inventory ..................................

15,700 8,900

Work in Process—Cutting....................................... Work in Process—Assembly .................................. Factory Labor ...................................................

33,000 27,000

Work in Process—Cutting (1,680 X $18) ................ Work in Process—Assembly (1,720 X $18) ............ Manufacturing Overhead .................................

30,240 30,960

Work in Process—Assembly .................................. Work in Process—Cutting ...............................

67,600

Finished Goods Inventory....................................... Work in Process—Assembly...........................

134,900

Cost of Goods Sold ................................................. Finished Goods Inventory ...............................

150,000

Accounts Receivable............................................... Sales Revenue..................................................

200,000

62,500 60,000 40,000 30,000

24,600

60,000

61,200

67,600 134,900 150,000 200,000

EXERCISE 16-5 (a)

January

May

Units to be accounted for Beginning work in process Started into production Total units

0 13,000 13,000

0 21,000 21,000

Units accounted for Transferred out Ending work in process Total units

11,000 2,000 13,000

14,000 7,000 21,000

(b)

(1) January March May July

Materials 13,000 (11,000 + 2,000) 15,000 (12,000 + 3,000) 21,000 (14,000 + 7,000) 11,500 (10,000 + 1,500)

(2)

Conversion Costs 12,200 (11,000 + 1,200) 12,900 (12,000 + 900) 19,600 (14,000 + 5,600) 10,600 (10,000 + 600)

EXERCISE 16-6 (a)

(1) Materials

(2) Conversion Costs

12,000

Units transferred out Work in process, July 31 3,000 X 100% 3,000 X 60% Total equivalent units

3,000 15,000

1,800 13,800

(b) Materials: $45,000 ÷ 15,000 = $3.00 Conversion costs: ($16,200 + $18,300) ÷ 13,800 = $2.50 Costs accounted for Transferred out (12,000 X $5.50) Work in process, July 31 Materials (3,000 X $3.00) Conversion costs (1,800 X $2.50) Total costs

$66,000 $9,000 4,500

13,500 $79,500

EXERCISE 16-7 QUIK FURNITURE COMPANY Sanding Department Production Cost Report For the Month Ended March 31, 2017

Quantities

Physical Units

Units to be accounted for Work in process, March 1 Started into production Total units

0 10,000 10,000

Units accounted for Transferred out Work in process, March 31 Total units

7,000 3,000 10,000

Equivalent Units Conversion Materials Costs

7,000 3,000 10,000

7,000 600 7,600

Costs

Materials

Conversion Costs

Unit costs Total cost Equivalent units Unit costs (a) ÷ (b)

$33,000 10,000 $3.30

$57,000* 7,600 $7.50

Costs to be accounted for Work in process, March 1 Started into production Total costs

(3,000 X 20%)

Total $90,000 $10.80

0 90,000 $90,000

Cost Reconciliation Schedule Costs accounted for Transferred out (7,000 X $10.80) Work in process, March 31 Materials (3,000 X $3.30) Conversion costs (600 X $7.50) Total costs

*$21,000 + $36,000

$75,600 $9,900 4,500

14,400 $90,000

EXERCISE 16-8 (a)

(1)

Units transferred out Work in process, April 30 1,000 X 100% 1,000 X 40%

(2) Conversion Costs 17,000

Materials 17,000 1,000

400 17,400

18,000 (b) Total cost Equivalent units Unit costs (1)

Materials $900,000(1) 18,000 $ 50

Conversion Costs $435,000(2) 17,400 $ 25

Total $1,335,000 $

$100,000 + $800,000

(2)

$ 70,000 + $365,000

$1,275,000 $50,000 10,000

EXERCISE 16-9 (a) Materials: 30,000* + 6,000 = 36,000 Conversion costs: 30,000* + (6,000 X 40%) = 32,400 *36,000 – 6,000 (b) Materials: $72,000/36,000 = $2.00 Conversion costs: ($61,000 + $101,000)/32,400 = $5.00 (c) Transferred out: 30,000 X $7.00 = $210,000 Ending work in process: Materials (6,000 X $2.00) Conversion costs (2,400 X $5.00) Total

= =

$12,000 12,000 $24,000

60,000 $1,335,000

EXERCISE 16-10 (a) Beginning work in process Units started into production

Units transferred out Ending work in process

Physical Units 20,000 164,000 184,000

Equivalent Units

Conversion Materials Costs 160,000 160,000 24,000 14,400 (60% X 24,000) 184,000 174,400

160,000 24,000 184,000

(b) Costs incurred Equivalent units Unit costs

Materials $101,200 184,000 $0.55

Conversion Costs $348,800 174,400 $2.00

(c) Assignment of costs: Transferred out (160,000 X $2.55) Ending work in process Materials (24,000 X $.55) Conversion costs (14,400 X $2.00) Total costs

Work in process, September 1 Units started into production Units transferred out Work in process, September 30

$2.55

$408,000 $13,200 28,800

EXERCISE 16-11 (a)

Total $450,000

Physical Units 1,600 42,900 44,500 39,500 5,000 44,500

42,000 $450,000

EXERCISE 16-11 (Continued)

Units transferred out Work in process 5,000 X 100% 5,000 X 10%

Equivalent Units Materials Conversion Costs 39,500 39,500 5,000 500 40,000

44,500 (b)

Materials Work in process, September 1 Direct materials

$ 20,000

Costs added to production during September Total materials cost

175,800 $195,800

$195,800 ÷ 44,500 = $4.40 (Materials cost per unit) Conversion Costs Work in process, September 1 Conversion costs

$ 43,180

Costs added to production during September Conversion costs ($125,680 + $257,140) Total conversion costs

382,820 $426,000

$426,000 ÷ 40,000 = $10.65 (Conversion cost per unit) (c) Costs accounted for Transferred out (39,500 X $15.05) Work in process, September 30 Materials (5,000 X $4.40) Conversion costs (500 X $10.65) Total costs

$594,475 $22,000 5,325

27,325 $621,800

EXERCISE 16-12 To:

David Skaros

From:

Student

Re:

Ending inventory

The reason for any confusion related to your department’s ending inventory quantity stems from the fact that the quantity can be measured in two different ways, depending on what the information is used for. The ending inventory quantity can be measured in physical units or equivalent units. Physical units are actual units present without regard to the stage of completion. Your department’s ending inventory in physical units is at least double the amount reported as equivalent units. Equivalent units measure the work done on the physical units, expressed in terms of fully completed units. Therefore, if your ending inventory contains 4,000 units which are 50% complete, that is equivalent to having 2,000 completed units at month end. Therefore, the ending inventory could be expressed as containing 4,000 physical units or 2,000 equivalent units. I hope this clears up any misunderstandings. Please contact me if you have any further questions.

EXERCISE 16-13 HEALTHY COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2017

Quantities

Physical Units

Equivalent Units Conversio Materials n Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, February 1 Started into production Total units

15,000 51,000 66,000

Units accounted for Transferred out Work in process, February 28 Total units

55,000 11,000 66,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

55,000 11,000 66,000

55,000 2,200 57,200

Materials

Conversion Costs

(a) $198,000(1) (b) 66,000 $3.00

$143,000(2) 57,200 $2.50

Costs to be accounted for Work in process, February 1 Started into production Total costs

(11,000 X 20%)

Total $341,000 $5.50

$ 32,175 308,825 $341,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (55,000 X $5.50) Work in process, February 28 Materials (11,000 X $3.00) Conversion costs (2,200 X $2.50) Total costs (1)

$18,000 + $180,000 $14,175 + $67,380 + $61,445

(2)

$302,500 $33,000 5,500

38,500 $341,000

EXERCISE 16-14 (a)

Containers in transit, April 1 Containers loaded Total containers

0 1,200 1,200

Containers off-loaded Containers in transit, April 30 Total containers

850 350 1,200

(b) Containers off-loaded Containers in transit, April 30 Total equivalent units *350 x 40% = 140 **350 x 20% = 70

Equivalent Units Physical Direct Conversion Materials Units Costs 850 850 850 350 140* 70** 990 920

EXERCISE 16-15 (a) Applications transferred out Work in process, September 30 Equivalent units

Materials 800 300* 1,100

Conversion Costs 800 180** 980

*100 + 1,000 – 800 = 300 **300 X 60% = 180 (b) Materials: $5,500 ÷ 1,100 = $5.00 Conversion costs: $25,480* ÷ 980 = $26.00 Costs accounted for: Transferred out (800 X $31.00) Work in process, September 30 Materials (300 X $5.00) Conversion costs (180 X $26.00) Total costs *($3,960 + $12,000 + $9,520)

$24,800 $1,500 4,680

6,180 $30,980

*EXERCISE 16-16

(a) Applications completed: Work in process, September 1 Started and completed Work in process, September 30 Total units

Physical Units 100 700 300 1,100

Equivalent Units Conversion Materials Costs 0 700 300 1,000

60 700 180 940

(b) Materials: $4,500 ÷ 1,000 = $4.50 Conversion costs: $21,620* ÷ 940 = $23.00 *($12,000 + $9,620) Costs accounted for: Applications completed: Work in process, September 1 Conversion costs (60 x $23.00) Started and completed (700 x $27.50) Work in process, September 30: Materials (300 x $4.50) Conversion costs (180 x $23.00) Total costs

$4,960 1,380

$ 6,340 19,250 1,350 4,140

$25,590 5,490 $31,080*

*Total costs to be accounted for: $1,000 + $3,960 + $4,500 + $12,000 + $9,620 = $31,080

*EXERCISE 16-17 (a) (1) Materials: Production Data

Physical Units

Materials Added This Period

Equivalent Units

Work in process, August 1 Started and completed Work in process, August 31 Total

0 10,000 2,000 12,000

0 100% 100%

0 10,000 2,000 12,000

(2) Conversion Costs: Production Data

Physical Units

Work Added This Period

Equivalent Units

Work in process, August 1 Started and completed Work in process, August 31 Total

0 10,000 2,000 12,000

0 100% 40%

0 10,000 800 10,800

(b) Unit costs are: Materials Conversion costs Total

$45,000 ÷ 12,000 = $3.75 $29,700* ÷ 10,800 = 2.75 $6.50

*$13,600 + $16,100 Costs to Be Assigned

Equivalent Units

Unit Cost

Total mfg. costs Transferred out Work in process, August 1 $74,700 (1) Started and completed

0 10,000

$ 0 $6.50

Work in process, August 31 Materials Conversion costs

2,000 800

$3.75 $2.75

$ 7,500 2,200

Assignment of Costs

(1) $45,000 + $13,600 + $16,100.

Total Costs Assigned 0 65,000

$65,000

9,700 $74,700

*EXERCISE 16-18 (a) (1) Materials Work in process, September 1 Started and completed Work in process, September 30 Total (2) Conversion Costs Work in process, September 1 Started and completed Work in process, September 30 Total

(b) Materials Conversion costs

(c)

Costs to Be Assigned Total mfg. costs

$207,200*

Physical Units

Materials Added This Period

Equivalent Units

2,000 9,000

0% 100%

0 9,000

1,000 12,000

100%

1,000 10,000

Physical Units

Work Added This Period

Equivalent Units

2,000 9,000

80% 100%

1,600 9,000

1,000 12,000

40%

400 11,000

Unit Cost

Total Costs Assigned

$ 60,000 ÷ 10,000 = $ 6 $132,000 ÷ 11,000 = 12 $18

Assignment of Costs

Equivalent Units

Transferred out 0 Work in process, 9/1 Conversion costs 1,600 Started and completed 9,000 Total costs transferred out Work in process, 9/30 Materials 1,000 Conversion costs 400 Total costs

$ 0 $12 $18

$15,200 19,200

$ 6 $12

$6,000 4,800

$ 34,400 162,000 196,400

10,800 $207,200

*Work in process, September 1, $15,200 + materials costs $60,000 + labor and overhead costs $132,000.

*EXERCISE 16-19 (a) Work in process, March 1 Started into production Total units to be accounted for Less: Transferred out Work in process, March 31

800 1,100 1,900 1,500 400

(b) Materials: Physical Materials Added Equivalent Production Data Units This Period Units Work in process, March 1 800 0 0 Started and completed 700 100% 700 Work in process, March 31 100% 400 400 Total 1,900 1,100 Unit cost = $6,600 ÷ 1,100 = $6.00. (c) Conversion costs: Physical Production Data Units Work in process, March 1 800 Started and completed 700 Work in process, March 31 400 Total 1,900

Work Added This Period 70% 100% 40%

Equivalent Units 560 700 160 1,420

Unit cost = $2,400 + $1,150 = $3,550 ÷ 1,420 = $2.50. (d) In process, March 1 ......................................................... $3,680 Conversion costs (560 X $2.50) ...................................... 1,400 Total cost.......................................................................... $5,080 (e) 700 X ($6.00 + $2.50) = $5,950. (f)

Materials (400 X $6.00) .................................................... Conversion costs (160 X $2.50) ...................................... Total cost of work in process, March 31 ........................

$2,400 400 $2,800

*EXERCISE 16-20 MAJESTIC COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2017

Quantities

Equivalent Units Conversion Materials Costs (Step 2)

Physical Units (Step 1)

Units to be accounted for Work in process, February 1 Started into production Total units

15,000 64,000 79,000

Units accounted for Completed and transferred out Work in process, February 1 Started and completed Total Work in process, February 28 Total units

15,000 39,000* 54,000 25,000 79,000

0 39,000 39,000 25,000 64,000

13,500 (15,000 X 90%) 39,000 52,500 5,000 (25,000 X 20%) 57,500

*(64,000 – 25,000)

Costs Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b) Costs to be accounted for Work in process, February 1 Started into production Total costs

Materials (a) (b)

$192,000 (1) 64,000 $3.00

Conversion Costs $103,500 (2) 57,500 $1.80

Total $295,500 $4.80

$ 32,175 295,500 $327,675

*EXERCISE 16-20 (Continued) Cost Reconciliation Schedule Costs accounted for (Step 4) Transferred out Work in process, February 1 Costs to complete beginning work in process Conversion costs (13,500 X $1.80) Total costs Units started and completed (39,000 X $4.80) Total costs transferred out Work in process, February 28 Materials (25,000 X $3.00) Conversion costs (5,000 X $1.80) Total costs

$32,175

24,300

(1) Cost of materials added $57,000 plus costs transferred in $135,000. (2) Labor $35,100 plus overhead $68,400.

$ 56,475 187,200 $243,675 75,000 9,000

84,000 $327,675

SOLUTIONS TO PROBLEMS PROBLEM 16-1A

1. 2.

3. 4.

5. 6.

7. 8.

Raw Materials Inventory .................................. Accounts Payable ....................................

300,000

Work in Process—Mixing ................................ Work in Process—Packaging ......................... Raw Materials Inventory ..........................

210,000 45,000

Factory Labor................................................... Wages Payable .........................................

278,900

Work in Process—Mixing ................................ Work in Process—Packaging ......................... Factory Labor ...........................................

182,500 96,400

Manufacturing Overhead................................. Accounts Payable ....................................

810,000

Work in Process—Mixing (28,000 X $23)........ Work in Process—Packaging (6,000 X $23) ................................................. Manufacturing Overhead .........................

644,000

300,000

255,000 278,900

278,900 810,000

138,000 782,000

Work in Process—Packaging ......................... Work in Process—Mixing ........................

979,000

Finished Goods Inventory............................... Work in Process—Packaging ..................

1,315,000

Accounts Receivable....................................... Sales Revenue..........................................

2,500,000

Cost of Goods Sold ......................................... Finished Goods Inventory .......................

1,604,000

979,000 1,315,000 2,500,000 1,604,000

PROBLEM 16-2A

(a) Physical units Units to be accounted for Work in process, June 1 Started into production Total units

0 22,000 22,000

Units accounted for Transferred out Work in process, June 30 Total units

20,000 2,000 22,000

(b) Equivalent units Units transferred out Work in process, June 30 2,000 X 100% 2,000 X 40% Total equivalent units (c) Materials Conversion costs Total unit cost

Materials 20,000

Conversion Costs 20,000

2,000 800 20,800

22,000 Unit Costs $9.00 ($198,000 ÷ 22,000) $8.00 ($166,400* ÷ 20,800) $17.00 ($9.00 + $8.00)

*$53,600 + $112,800 (d) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs

$340,000 $18,000 6,400

24,400 $364,400

PROBLEM 16-2A (Continued) (e)

ROSENTHAL COMPANY Molding Department Production Cost Report For the Month Ended June 30, 2017

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, June 1 Started into production Total units

0 22,000 22,000

Units accounted for Transferred out Work in process, June 30 Total units

20,000 2,000 22,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

20,000 2,000 22,000

20,000 800 (2,000 X 40%) 20,800

Materials

Conversion Costs

(a) $198,000 (b) 22,000 $9.00

$166,400 20,800 $8.00

Costs to be accounted for Work in process, June 1 Started into production Total costs

Total $364,400 $17.00

$ 0 364,400 $364,400

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs

$340,000 $18,000 6,400

24,400 $364,400

PROBLEM 16-3A

(a) (1) Physical units T12 Tables

C10 Chairs

Units to be accounted for Work in process, July 1 Started into production Total units

0 20,000 20,000

0 18,000 18,000

Units accounted for Transferred out Work in process, July 31 Total units

17,000 3,000 20,000

17,500 500 18,000

(2) Equivalent units

Units transferred out Work in process, July 31 (3,000 X 100%) (3,000 X 60%) Total equivalent units

Units transferred out Work in process, July 31 (500 X 100%) (500 X 80%) Total equivalent units

T12 Tables Conversion Materials Costs 17,000 17,000 3,000 20,000

1,800 18,800

C10 Chairs Conversion Materials Costs 17,500 17,500 500 18,000

400 17,900

PROBLEM 16-3A (Continued) (3) Unit costs

Materials ($380,000 ÷ 20,000) ($288,000 ÷ 18,000) Conversion costs ($338,400(a) ÷ 18,800) ($214,800(b) ÷ 17,900) Total (a)

C10 Chairs $16

18 $37

12 $28

$234,400 + $104,000

(b)

(4)

T12 Tables $19

$110,000 + $104,800

T12 Tables Costs accounted for Transferred out (17,000 X $37) Work in process Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs

$629,000 $57,000 32,400

89,400 $718,400

C10 Chairs Costs accounted for Transferred out (17,500 X $28) Work in process Materials (500 X $16) Conversion costs (400 X $12) Total costs

$490,000 $8,000 4,800

12,800 $502,800

PROBLEM 16-3A (Continued) (b)

THAKIN INDUSTRIES INC. Cutting Department—Plant 1 Production Cost Report For the Month Ended July 31, 2017

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

0 20,000 20,000

Units accounted for Transferred out Work in process, July 31 Total units

17,000 3,000 20,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

17,000 3,000 20,000

17,000 1,800 (3,000 X 60%) 18,800

Materials

Conversion Costs

(a) $380,000 (b) 20,000 $ 19

$338,400 18,800 $ 18

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $718,400 $

0 718,400 $718,400

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (17,000 X $37) Work in process, July 31 Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs

$629,000 $57,000 32,400

89,400 $718,400

PROBLEM 16-4A

(a) Physical Units Units to be accounted for Work in process, November 1 Started into production Total units

35,000 660,000 695,000

Units accounted for Transferred out Work in process, November 30 Total units

670,000 25,000 695,000

Equivalent Units Conversion Materials Costs

670,000 25,000 695,000

670,000 10,000* 680,000

*25,000 X 40%

Beginning work in process Added during month Total Equivalent units Cost per unit

Materials cost

Conversion costs

$ 79,000 1,589,000 $1,668,000

$ 48,150 563,850 $612,000

695,000

680,000

$2.40

$.90

($225,920 + $337,930)

(b) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs

$2,211,000 $60,000 9,000

69,000 $2,280,000

PROBLEM 16-4A (Continued) (c)

RIVERA COMPANY Assembly Department Production Cost Report For the Month Ended November 30, 2017

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, November 1 Started into production Total units

35,000 660,000 695,000

Units accounted for Transferred out Work in process, November 30 Total units

670,000 25,000 695,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

670,000 25,000 695,000

670,000 10,000 (25,000 X 40%) 680,000

Materials

Conversion Costs

(a) $1,668,000 (b) 695,000 $2.40

$612,000 680,000 $.90

Costs to be accounted for Work in process, November 1 Started into production Total costs

Total $2,280,000 $3.30

$ 127,150 2,152,850 $2,280,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs

$2,211,000 $60,000 9,000

69,000 $2,280,000

PROBLEM 16-5A

(a)

(1) Physical Units Units to be accounted for Work in process, July 1 Started into production Total units

500 1,000 1,500

Units accounted for Transferred out Work in process, July 31 Total units

900 600 1,500

Equivalent Units Conversion Materials Costs

900 600 1,500

900 240* 1,140

*600 X 40% (2)

Materials cost

Conversion costs

Beginning work in process Added during month Total

$ 750 2,400 $3,150

$ 600 2,820 $3,420

Equivalent units

1,500

1,140

Cost per unit

$2.10

$3.00

($1,580 + $1,240)

(3) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (240 X $3.00) Total costs

$4,590 $1,260 720

1,980 $6,570

PROBLEM 16-5A (Continued) (b)

POLK COMPANY Basketball Department Production Cost Report For the Month Ended July 31, 2017

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

500 1,000 1,500

Units accounted for Transferred out Work in process, July 31 Total units

900 600 1,500

Costs Unit costs (Step 3) Total costs Equivalent units Unit costs (a) ÷ (b)

(a) (b)

900 600 1,500

900 240 1,140

Materials

Conversion Costs

$3,150 1,500 $2.10

$3,420 1,140 $3.00

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $6,570 $5.10

$1,350 5,220 $6,570

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (240 X $3.00) Total costs

$4,590 $1,260 720

1,980 $6,570

PROBLEM 16-6A

(a) Computation of equivalent units:

Units accounted for Transferred out Work in process, October 31 (60% materials, 40% conversion costs) Total units

Physical Units

Equivalent Units Conversion Materials Costs

120,000

50,000 170,000

30,000 150,000

20,000 140,000

Computation of October unit costs Materials: $240,000 ÷ 150,000 equivalent units = $1.60 Conversion cost: $105,000 ÷ 140,000 equivalent units = .75 Total unit cost, October $2.35

(b) Cost Reconciliation Schedule Costs accounted for Transferred out (120,000 X $2.35) Work in process, October 31 Materials (30,000 X $1.60) Conversion costs (20,000 X $0.75) Total costs

$282,000 $48,000 15,000

63,000 $345,000

*PROBLEM 16-7A

(a) Bicycles (1) Equivalent units—Materials Materials Added This Period

Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

200 700 (1,000 – 300) 300 1,200

Equivalent Units

0%* 100% 100%

0 700 300 1,000

*All materials are added at the beginning of the production process

Equivalent units—Conversion costs Conversion Added This Period

Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

200 700 (1,000 – 300) 300 1,200

Equivalent Units

20% (1 – .8) 100% 40%

40 700 120 860

(2) Unit costs

Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)

Materials $50,000 1,000 $ 50

Conversion Costs $55,900** 860 $ 65

**Direct Labor $25,900 + Manufacturing Overhead $30,000

*PROBLEM 16-7A (Continued) (3) Assignment of costs to units transferred out and in process Costs to Be Assigned Total mfg. costs $125,180***

Assignment of Costs

Equivalent Unit Units Cost

Transferred out Work in process, March 1 Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs

40 700

$ 65 $115

Total Costs Assigned $19,280 2,600 80,500 $102,380

300 120

$50 $65

15,000 7,800

22,800 $125,180

***Work in process, March 1, $19,280 + Materials $50,000 + Labor $25,900 + Overhead $30,000

Tricycles (1) Equivalent units—Materials Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

100 940 (1,000 – 60) 60 1,100

Materials Added This Period 0%* 100% 100%

Equivalent Units 0 940 60 1,000

*All materials are added at the beginning of the production process

Equivalent units—Conversion costs Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total

100 940 (1,000 – 60) 60 1,100

Conversion Added This Period 25% (1 – .75) 100% 25%

Equivalent Units 25 940 15 980

*PROBLEM 16-7A (Continued) (2) Unit costs

Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)

Conversion Costs $34,300** 980 $ 35

Materials $30,000 1,000 $ 30

**Direct Labor $14,300 + Manufacturing Overhead $20,000 (3) Assignment of costs to units transferred out and in process Costs to Be Assigned

Assignment of Costs

Total mfg. costs Transferred out Work in process, March 1 $70,425*** Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs

Equivalent Unit Units Cost

25 940

$35 $65

Total Costs Assigned $ 6,125 875 61,100 $68,100

60 15

$30 $35

1,800 525

2,325 $70,425

***Work in process, March 1, $6,125 + Materials $30,000 + Labor $14,300 + Overhead $20,000

*PROBLEM 16-7A (Continued) (b)

OWEN COMPANY Production Cost Report—Bicycles For the Month Ended March 31

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, March 1 Started into production Total units

200 1,000 1,200

Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work In process, March 31 Total units

200 700 300 1,200

0 700 300 1,000

Costs

Materials

Conversion Costs

Unit costs (Step 3) Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)]

$50,000 1,000 $ 50

$ 55,900 860 $ 65

Costs to be accounted for Work in process, March 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out Work in process, March 1 Conversion costs to complete beginning inventory (40 X $65) Started and completed (700 X $115) Work in process, March 31 Materials (300 X $50) Conversion costs (120 X $65) Total costs

*($50,000 + $25,900 + $30,000)

$ 19,280 105,900* $125,180

$19,280 2,600 80,500 15,000 7,800

$102,380

22,800 $125,180

40 700 120 860 Total $105,900 $

115

CD-16

DECISION-MAKING AT CURRENT DESIGNS

CURRENT DESIGNS Fabrication Department Production Cost Report For the Month Ended April 30, 2017

Quantities

Physical Units Materials

Equivalent Units Conversion Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, April 1 Started into production Total units

30 72 102

Units accounted for Transferred out Work in process, April 30 Total units

67 35 102

Costs Unit costs (Step 3) Total cost* Equivalent units Unit costs [(a) ÷ (b)]

67 7 (35 X 20%) 74

Materials

Conversion Costs

(a) $25,900 (b) 74 $ 350

$48,600 81 $ 600

Costs to be accounted for Work in process, April 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (67 X $950) Work in process, April 30 Materials (7 X $350) Conversion costs (14 X $600) Total costs

*Material costs = $8,400 + $17,500 Conversion costs = $9,000 + $39,600

67 14 (35 X 40%) 81

Total $74,500 $

950

$17,400 57,100 $74,500

$63,650 $ 2,450 8,400

10,850 $74,500

BYP 16-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The unit cost suggests that Joe took the highest total costs and divided these costs by the units started into production. The highest total costs would be the total costs charged to the Mixing Department ($88,000 + $573,000 + $765,000) divided by the units started during July (100,000 gallons), which results in a per unit cost of $14.26 ($1,426,000 ÷ 100,000). (b) The principal errors made by Joe were: (1) he did not compute equivalent units of production; (2) he did not use the weighted-average costing method; and (3) he did not assign costs to ending work-in-process.

BYP 16-1 (Continued) (c)

FLORIDA BEACH COMPANY Mixing Department Production Cost Report For the Month Ended July 31, 2017

Quantities

Physical Units

Equivalent Units Conversion Materials Costs

(Step 1)

(Step 2)

Units to be accounted for Work in process, July 1 Started into production Total units

8,000 100,000 108,000

Units accounted for Transferred out Work in process, July 31 Total units

103,000 5,000 108,000

Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)

103,000 5,000 108,000

103,000 1,000 (5,000 X 20%) 104,000

Materials

Conversion Costs

(a) $594,000 (b) 108,000 $5.50

$832,000 104,000 $8.00

Costs to be accounted for Work in process, July 1 Started into production Total costs

Total $1,426,000 $13.50

88,000 1,338,000 $1,426,000

Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (103,000 X $13.50) Work in process, July 31 Materials (5,000 X $5.50) Conversion costs (1,000 X $8.00) Total costs

$1,390,500 $27,500 8,000

35,500 $1,426,000

BYP 16-2

MANAGERIAL ANALYSIS

(a) The unit cost of materials is $150 ($450,000 ÷ 3,000). (b) The materials cost of the goods transferred out is $375,000 (2,500 X $150). Conversion costs, therefore, are $225,000 ($600,000 – $375,000), and per unit conversion cost is $90 ($225,000 ÷ 2,500). (c) There are 500 units in ending work-in-process inventory (3,000 started – 2,500 transferred out). The materials cost is $75,000 (500 X $150). Thus, the conversion costs in the inventory are $36,000 ($261,000 – $225,000). $36,000 divided by $90 per unit conversion cost equals 400 equivalent units or 80% (400 ÷ 500) complete.

BYP 16-3

REAL-WORLD FOCUS

(a) The outer shell of the paintballs is made from a mixture that includes water, sweeteners, food ingredients, and most importantly, gelatin. All of the ingredients used to make paintballs are food grade, biodegradable products. The “paint” filling inside a paintball is comprised of the same inert ingredient used in cough syrup, as well as crayon wax. After mixing the gelatin and other materials, the mixture is heated, and then spread on rolling drums which create thin gelatin ribbons. Each of the ribbons then passes over a rotating die. The dies are designed so that they can form round capsules. The dies press against each other as they rotate. As the dies meet, both shells are filled with paint, which is injected into the area between the sheets. The two halves then seal as they press against each other to form a filled capsule. Once the capsules are sealed they drop out of the machine to become paintballs. They pass along a conveyor belt to a tumble drier, then onto a drying rack. Once they are dry, they go into a counting machine, then into a packing machine which packs exactly the correct number of balls into each container. (b) Materials: water, sweeteners, food ingredients, gelatin, “cough syrup material”, crayon wax, and food coloring. Labor: People would be needed run the various machines. Overhead: Depreciation and maintenance of the various machines. It would appear that overhead would be by far the highest cost because the process is very automated. Machines are needed for mixing the gelatin, heating it, rolling it into ribbons, making the capsules, filling the capsules, sorting and drying the capsules, counting the capsules and packing them. (c) This would appear to be a perfect situation for the use of process costing. Paintballs are a high volume product, and the paintballs are very homogenous. While there may be some differences in various types of paintballs that would merit keeping track of specific costs to make the various types, the primary method of cost determination would be process costing.

BYP 16-4

COMMUNICATION ACTIVITY

To:

Diane Barone, Regional Sales Manager

From:

Student, Accounting Manager

Re:

Production Cost Reports

Diane, congratulations again on your promotion! It’s going to be great working with you. It kind of reminds me of our days at Dairy-Freeze after school (although this work is more fun, and it certainly pays better!). I’ll try to clear up some of the questions you raised in your email. Here in the Snack Foods Division we use process costing rather than the job order system that Special Projects uses. The reason for this is that we produce all our products in a more or less continuous process, even when we run occasional special orders. You see, all our workers are assigned a particular part of the process to control. One might be in charge of making sure the mixing machines work properly, while another verifies the weight of the finished products. Whichever job a worker is assigned, he or she stays with it to completion, or at least the completion of that particular process. That’s different from what you had in Special Projects, where workers moved from job to job. That’s why we don’t usually track the orders separately. Our special orders are for various quantities of the foods we produce, so only the Packing Department needs to be concerned with the particular set of products shipped to the particular customer—which is its ordinary concern anyway. Your next question was about what an equivalent unit is. Well, you know already that Special Projects bids on various jobs, and then costs are recorded when the jobs are complete. The costs accumulated on jobs that aren’t complete are reflected in Work in Process inventory. We in Snack Foods can’t use that method for a simple reason—we produce our products in huge batches that we keep going fairly continuously. Or, in other words, we don’t have a “job” that we can record as “complete.” A batch may contain enough of our product to fill thirty or more orders, so we may have thirty or more “jobs” in each batch. One job may happen to be filled from two batches. Since the cost of each batch is about the same, it isn’t worth keeping track of separately.

BYP 16-4 (Continued) At the end of the month, we need to record what we finished and what still remains undone. Equivalent units are the way we measure the amount of work we have done on our work in process. It’s kind of like comparing the contents of 4-ounce cups with the contents of 12-ounce cups. It doesn’t make sense to compare by counting the number of cups you have. You need to find out how many ounces you have in one set; then you can get a meaningful comparison with the ounces you have in the other set. We compare by the number of “units” of materials or labor that are required to finish a product completely. If it requires 12 ounces of flour and 15 minutes of labor for a finished bag of pretzels, for example, then the 12 ounces and 15 minutes are “finished equivalents.” If we have enough pretzels to fill 30 bags, but we’ve only spent 5 minutes (or 1/3 of the total required) of labor on them at the end of the month, we could have used the same amount of time and completely finished 10 bags. Thus, we have the “equivalent” of 10 bags worth of labor. Your last question is the easiest to answer. You get four reports because we use four processes here in Snack Foods Division. Each process has to report its status at the end of every month. It’s kind of like we have four miniature factories, each reporting “completion” of a certain number of products. The products from one department are used as raw materials for other departments, so we have a chain of reports. Notice that the units and costs transferred out of Process 1 are the same as the units and costs transferred in to Process 2, and so on. I hope this helps. Call, write, or email me any time!

BYP 16-5

ETHICS CASE

(a) The stakeholders in this situation are: ⯈ ⯈ ⯈ ⯈

Jan Wooten, molding department head. Tony Ferneti quality control inspector. Customers of R. B. Dillman Company. The department manager of the assembly department.

(b) Tony is placed in an ethical dilemma. He can offend his department head by disregarding Jan’s instructions and lose the support of his supervisor, and maybe lose his job. He can follow Jan’s instructions and be in violation of company policy. He can also report Jan’s instructions to supervisors (plant superintendent or vice-president of production). The company should make the position of quality control inspector responsible to someone other than the department head. Tony should not report to Jan.

BYP 16-6

CONSIDERING PEOPLE, PLANET, AND PROFIT

(a) Some of the costs that the company now faces include:  Monetary damages: The company paid $21.4 million in fines as a result of an OSHA investigation; $1.6 billion to compensate those affected by the accident; and $1 billion to repair and update its refinery (plus an additional $250 million to install safety valves)  Bad publicity  Lost sales  Cost of cleaning up the affected area including transporting workers to the site; housing workers near the site; per diem for cleanup workers; safety equipment for the workers  Transportation and storage/disposal fees for any contaminants removed from the area  Legal fees associated with lawsuits/settlements  Reimburse the Coast Guard for any oil containment equipment provided  Possible air/water testing for an extensive time following the accident (b) Some steps that the company could have taken to reduce the environmental failure costs include:    

Install up to date safety equipment Increase the frequency and efficacy of inspections Increase maintenance on older facilities Be responsive to and investigate thoroughly complaints by neighbors and regulators  Invest in research to discover safer means of boosting octane  Locate plants further away from population centers to the extent possible

CHAPTER 17 Activity-Based Costing ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Exercises

A Problems

Discuss the difference between traditional costing and activity-based costing.

1, 2, 3, 4, 5

1, 2

1, 2, 3, 4, 5, 10, 11

1A, 3A, 4A, 5A

Apply activity-based costing to a manufacturer.

6, 7, 9, 10, 11, 12

3, 4, 5, 6, 7

1, 3, 4, 5, 6, 7, 8, 9, 10, 11

1A, 2A, 3A, 4A, 5A

Explain the benefits and limitations of activity-based costing.

8, 13, 14, 15, 16, 17, 19

8, 9, 10, 11, 12

9, 10, 11, 12, 13, 16

1A, 5A

Apply activity-based costing to service industries.

9, 12

14, 15, 17

*5.

Explain just-in-time (JIT) processing.

Do It!

*Note: All asterisked Brief Exercises, Exercises, and Problems relate to material contained in the appendix to the chapter.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added.

Moderate

35–45

Assign overhead to products using ABC and evaluate decision.

Moderate

25–35

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

35–45

Assign overhead costs using traditional costing and ABC; compare results.

Moderate

40–50

Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.

Moderate

35–45

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises a Learning Objective

Knowledge

Comprehension

Application

Kimmel, Accounting, 6/e, Solutions Manual

1. Discuss the difference Q17-1 between traditional costing and Q17-2 activity-based costing. Q17-3 Q17-4 Q17-5 DI17-1

BE17-1 BE17-2 E17-1 E17-2

E17-10 E17-11 P17-1A

2. Apply activity-based costing to Q17-6 a manufacturer. Q17-7 Q17-9 Q17-10 Q17-11 Q17-12

BE17-3 BE17-4 BE17-5 BE17-6 BE17-7

DI17-2 E17-1 E17-9 E17-10 E17-11

BE17-11 BE17-12

Analysis

(For Instructor Use Only)

E17-3 E17-4 E17-5

P17-3A P17-4A P17-5A

P17-1A P17-2A

E17-3 E17-4 E17-5 E17-6 E17-7

E17-8 P17-3A P17-4A P17-5A

E17-9 E17-10

E17-11 P17-1A

BE17-8 BE17-9 BE17-10 E17-12

E17-13 E17-16 P17-5A

4. Apply activity-based costing to Q17-18 service industries.

BE17-12 E17-14 DI17-4 E17-15

E17-17

BE17-9 P17-5A

*5. Explain just-in-time (JIT) processing. Broadening Your Perspective

BYP17-2

3. Explain the benefits and limitations of activity-based costing.

Q17-8 Q17-13 Q17-14 A4-15 Q17-16 Q17-17 Q17-19

DI17-3

Synth

Q17-20 BYP17-3 BYP17-6

BYP17-1 BYP17-4 BYP17-7

17-3

ANSWERS TO QUESTIONS 1.

Direct labor is a valid basis for allocating overhead when: (a) direct labor constitutes a significant part of total product cost, and (b) there is a high correlation between direct labor and changes in the amount of overhead costs.

The amount of direct labor in many industries has greatly decreased, due to advances in computerized systems, technological innovation, global competition and automation. Total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have significantly increased. Many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environment.

In many automated manufacturing environments, machine hours is a more relevant basis on which to allocate overhead.

Under a traditional volume-based costing system where overhead cost is allocated on the basis of units of output, the high-volume product will undoubtedly absorb more overhead than the lowvolume product.

The principal differences are: (1) Primary focus (2) Bases of allocation

Activity-Based Costing Activities performed in making products Multiple cost drivers

Traditional Costing Units of production Single unit-level base

Activity-based overhead rates are computed using the following formula: Estimated Overhead per Activity Expected Use of Cost Drivers per Activity

The four steps involved in developing an ABC system are: 1. Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to appropriate cost pools. 2. Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool. 3. Compute the overhead rate for each cost driver. 4. Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver).

A value-added/non-value-added activity flowchart is based on a systematic analysis of all the activities (resource-consuming actions and transactions) performed to manufacture a product or render a service. The flowchart documents each activity and the time involved in each activity. The flow chart also documents management’s proposed reengineering of the manufacturing process.

An activity cost pool is the overhead cost attributed to a distinct type of activity.

10.

A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.

Questions Chapter 17 (Continued)

11.

A cost driver is accurate and appropriate if it measures the actual consumption of the activity in manufacturing a product or rendering a service and the data relating to the cost driver is available and easily obtained.

12.

The formula for assigning activity cost pools to products is: Activity-based overhead rate X Expected use of cost drivers per product

13.

The primary benefit of ABC is more accurate product costing. This results from using more cost pools and enhanced control over overhead costs, and leads to better management decisions.

14.

The limitations of ABC are: (a) increased costs that accompany multiple-activity cost pools and cost drivers and (b) the necessity still to allocate some costs arbitrarily.

15.

ABC is the superior costing system when: (1) product lines differ greatly in volume and manufacturing complexity; (2) product lines are numerous, diverse, and require differing degrees of support services; (3) overhead costs constitute a significant portion of total costs; (4) the manufacturing process or the number of products has changed significantly; and (5) data from the existing system is being ignored.

16.

Basic ABC has been enhanced by identifying activities as value-added and non-value-added.

17.

Identifying non-value-added activities highlights for managers the activities that should be reduced or eliminated because they are not essential and they add no value to the product.

18.

The overall objective of ABC in service firms is no different than for manufacturing companies; that is, improved costing of services rendered (by job, service, contract, or customer). The general approach to costing is the same—analyze operations, identify activities, assign overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the services.

19.

Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some activities are affected (driven) by changes in the number of units produced, while other activities are affected only by changes in the number of batches or the number of products, and some, facility-level activities, are unaffected by changes in either units, batches, or products produced.

*20. (a) Just-in-time processing has a just-in-time philosophy and a pull approach to eliminate inventory. It is dedicated to having the right amount of materials, parts, or products just as they are needed. (b) There are three important elements in JIT processing: (1) A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications. (2) A multiskilled workforce must be developed. (3) A total quality control system must be established.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17-1

(a)

Estimated annual overhead costs = Predetermined overhead rate Expected annual operating activity $975,000 100,000

= $9.75 per direct labor hour

(b)

92,000 direct labor hours X $9.75 = $897,000 overhead applied

(c)

If the manufacturing process is complex, then multiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider an overhead cost allocation method that uses multiple bases. That method is activitybased costing.

BRIEF EXERCISE 17-2 Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons: 1. Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product. 2. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labor hours is usually a poor cost driver for assigning overhead costs to low-volume products. As a result, for Finney, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it under an ABC system.

BRIEF EXERCISE 17-3 An appropriate cost driver for each activity is: Activity Materials handling Machine setups Factory machine maintenance Factory supervision Quality control

Cost Driver Number of requisitions Number of setups Machine hours used Number of employees Number of inspections

BRIEF EXERCISE 17-4 (a) (b) (c) (d) (e) (f) (g)

Number of parts or assemblies Number of setups Number of employees Number of inspections Number of purchase orders Machine hours Square footage occupied

BRIEF EXERCISE 17-5 Machine setups Machining Inspections

$150,000 ÷ 2,500 = $60 per setup $375,000 ÷ 25,000 = $15 per machine hour $ 87,500 ÷ 1,750 = $50 per inspection

BRIEF EXERCISE 17-6 Activity Cost Pool Designing Sizing and cutting Stitching and trimming Wrapping and packing

Estimated Expected Use of Overhead ÷ Cost Drivers per Activity = $ 450,000 4,000,000 1,440,000 336,000

10,000 designer hours 160,000 machine hours 80,000 labor hours 32,000 finished units

Activity-Based Overhead Rates $45.00 per designer hour $25.00 per machine hour $18.00 per labor hour $10.50 per finished unit

BRIEF EXERCISE 17-7 Activity Cost Pool Ordering and receiving Food processing Packaging

Estimated Expected Use of Overhead ÷ Cost Drivers per Activity = $

Cost Drivers 11,000 orders 50,000 machine hours 500,000 labor hours

84,000 480,000 1,760,000

12,000 orders 60,000 machine hours 440,000 labor hours

Activity-Based Overhead Rates $7.00 per order $8.00 per machine hour $4.00 per labor hour

Overhead Total Overhead Rates = Applied $7.00 $ 77,000 $8.00 400,000 $4.00 2,000,000 $2,477,000

BRIEF EXERCISE 17-8 (a) (b) (c) (d) (e) (f)

Non-value-added Value-added Non-value-added Non-value-added Non-value-added Value-added

BRIEF EXERCISE 17-9 Value-added Activities (1) Designing and drafting (3) On-site supervision (5) Consultation with client

Hours

Non-value-added Activities (2) Staff meetings (4) Lunch (6) Entertaining a prospective client

Hours 1 1 2 4

3.0 2.0 1.5 6.5

BRIEF EXERCISE 17-10 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)

Batch- or unit-level Unit-level Unit-level Batch- or unit-level Facility-level Batch- or product-level Batch- or product-level Unit-level Facility-level Batch-level

BRIEF EXERCISE 17-11 (a) (b) (c) (d) (e) (f) (g) (h)

Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level

BRIEF EXERCISE 17-12 (a) Initial concept formation

(b)

$40,000 = $2,000 per project change 20

Design

$300,000 = $2 per square foot 150,000

Construction oversight

$100,000 = $1,000 per month 100

Initial concept formation—product-level Design—unit-level Construction oversight—batch-level

SOLUTIONS TO DO IT! REVIEW EXERCISES

DO IT! 17-1 (a) True (b) False (c) False (d) True (e) True DO IT! 17-2 (a) Computations of activity-based overhead rates per cost driver: Activity Cost Pools Machine setup Machining Packing

Estimated Overhead $ 16,000 110,000 30,000 $156,000

Expected Use of Cost Activity-Based Drivers per Activity Overhead Rates 40 setups $400 per setup 5,000 machine hours $ 22 per machine hr. 500 orders $ 60 per order

(b) Assignment of each activity’s overhead cost to products using ABC: BC113

AD908

Expected Use of Cost Activity Cost Drivers per Activity-Based Cost Pools Product Overhead Rates Assigned Machine setup 25 $400 $10,000 Machining 1,000 $ 22 22,000 Packing 150 $ 60 9,000 Total assigned costs $41,000

Expected Use of Activity-Based Cost Drivers per Overhead Cost Product Rates Assigned 15 $400 $ 6,000 4,000 $ 22 88,000 350 $ 60 21,000 $115,000

(a) (b) (a) ÷ (b)

BC113 $41,000 3,000 $13.67

AD908 $115,000 1,500 $76.67

DO IT! 17-2 (Continued) (d) These computations show that the total overhead assigned to Product AD908 is more than two and a half times that assigned to BC113. On a per unit basis, the overhead assigned to AD908 is close to six times that assigned to each BC113. DO IT! 17-3 (a) (b) (c) (d) (e) (f) (g) (h)

unit-level product-level facility-level batch-level unit-level batch-level facility-level unit-level

DO IT! 17-4 (a) The activity based overhead rates would be: Estimated Overhead Loading and unloading Travel Logistics

$ 90,000 $450,000 $ 75,000



Expected Use of Cost Driver Per Activity 90,000 600,000 3,000

(b) The overhead applied to job XZ3275 is: (150  $1.00)  (200  $.75)  (.75  $25) = $318.75

Activity-Based Overhead Rate $1.00 per piece $0.75 per mile $25 per hour

SOLUTIONS TO EXERCISES EXERCISE 17-1 (a)

Estimated overhead = Predetermined overhead rate Direct labor costs $240,000 = 160% of direct labor cost $50,000 + $100,000

(b) Activity cost pools Machining Machine setup

Cost drivers Machine hours Set up hours

Estimated overhead $140,000 100,000

Activity-based overhead rates Machining: Machine setup: $140,000 $100,000 = $70 per machine hour = $200 per setup hour 1,000 + 1,000 400 + 100 (c) Traditional costing $50,000 X 160% $100,000 X 160%

Standard $80,000 $80,000

Activity-based costing Machining: 1,000 X $70 1,000 X $70 Machine setup: 100 X $200 400 X $200

Custom $160,000 $160,000

$70,000 $70,000

20,000 $90,000

80,000 $150,000

EXERCISE 17-2 (a)

Traditional costing system

Sales Costs Operating income (b)

Product 540X

Product 137Y

Product 249S

$180,000 55,000 $125,000

$160,000 50,000 $110,000

$70,000 15,000 $55,000

Product 540X

Product 137Y

Product 249S

$180,000 50,000 $130,000

$160,000 35,000 $125,000

$70,000 35,000 $35,000

Activity-based costing system

Sales Costs Operating income (c) Product 540X:

($130,000 – $125,000) ÷ $125,000 = 4.00%

Product 137Y

($125,000 – $110,000) ÷ $110,000 = 13.64%

Product 249S

($35,000 – $55,000) ÷ $55,000 = (36.36%)

(d) These costs are similar probably because the cost drivers are essentially the same; that is, they are based on a unit volume concept.

EXERCISE 17-3 (a)

Activity cost pools

Cost drivers

Estimated overhead

Cutting

Machine hours

$360,000

Design

Number of setups

585,000

Activity-based overhead rates Cutting $360,000 = $1.80 per machine hour 200,000

Design $585,000 = $390 per setup 1,500 Wool

Activity-based costing Cutting 100,000 X $1.80 100,000 X $1.80

$180,000 $180,000

Design 1,000 X $390 500 X $390 Total cost allocated

390,000 195,000 $375,000

$570,000

(b) Estimated overhead = $945,000 Direct labors hours 450,000

= $2.10 per direct labor hour

Wool Traditional costing 225,000 X $2.10 225,000 X $2.10

Cotton

$472,500 $472,500

The wool product line is allocated $97,500 ($570,000 – $472,500) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $97,500 ($472,500 – $375,000) less.

EXERCISE 17-4 (a)

Direct labor hours for car wheels (40,000 X 1) = 40,000 Direct labor hours for truck wheels (10,000 X 3) = 30,000 Total direct labor hours 70,000 $770,000 (total estimated overhead) 70,000 (total direct labor hours)

= $11 per direct labor hour.

Overhead assigned Car wheels Truck wheels Total overhead

(40,000 X $11) (30,000 X $11)

(b)

= $440,000 = 330,000 $770,000

Expected Use of Cost Drivers

ABC Overhead = Rate

Activity Cost Pool

Estimated Overhead

Setting up machines Assembling Inspection

$220,000 280,000 270,000

Activity Cost Pools

Car Wheels Expected Use Activity-Based of Cost Driver Overhead per Product X Rates =

(c)

Setting up machines Assembling Inspection Total cost assigned

200 40,000 100

1,000 70,000 1,200

$220 $ 4 $225

Cost Assigned $ 44,000 160,000 22,500 $226,500

EXERCISE 17-4 (Continued) (c)

Truck Wheels

Activity Cost Pools Setting up machines Assembling Inspection Total cost assigned (d)

Expected use of Cost Driver X per Product

ActivityBased Overhead Rates

800 30,000 1,100

$220 $ 4 $225

Cost Assigned $176,000 120,000 247,500 $543,500

Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.

EXERCISE 17-5 (a) Traditional costing: $260,000 ÷ 2,500 (800 + 1,700) hours = $104 per direct labor hour (1) One mobile safe: 800 hours X $104 = $83,200 $83,200 ÷ 200 = $416 each (2) One walk-in safe: 1,700 hours X $104 = $176,800 $176,800 ÷ 50 = $3,536 each

EXERCISE 17-5 (Continued) (b) Activity-based costing: (1) Material handling costs $160,000 ÷ 500 (300 + 200) moves = $320 per move (a) One mobile safe: 300 moves X $320 = $96,000 $96,000 ÷ 200 = $480 each (b) One walk-in safe: 200 moves X $320 = $64,000 $64,000 ÷ 50 = $1,280 each (2) Purchasing activity costs $100,000 ÷ 800 (450 + 350) orders = $125 per order (a) One mobile safe: 450 orders X $125 = $56,250 $56,250 ÷ 200 = $281.25 each (b) One walk-in safe: 350 orders X $125 = $43,750 $43,750 ÷ 50 = $875 each (c) The total amount of overhead allocated to each unit of the two products under the two allocation approaches is:

Mobile safe Walk-in safe *$480 + $281.25 **$1,280 + $875

Traditional Costing $ 416 $3,536

Activity-Based Costing $761.25* $ 2,155**

EXERCISE 17-6 Budgeted Costs

Activity Cost Pool

Cost Driver

Engineering design Engineering prototypes

Engineering

Engineering hours

Depreciation, machinery Electricity, machinery

Machinery

Machine hours

Machine setup

Number of setups

Inspections Tests

Quality control

Number of tests or inspections

Depreciation, plant Insurance, plant Property taxes Oil, heating Electricity, plant lighting

Factory utilities

Square feet or Machine hours

Machine maintenance wages

Maintenance

Machine setup, indirect labor Machine setup, indirect materials

Number of machines or Machine hours

EXERCISE 17-7 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.

Labor hours Labor hours Labor hours Gallons of chemicals Number of cartfuls or labor hours Number of cartfuls Gallons of juice Gallons of juice

9. 10. 11. 12. 13. 14. 15.

Gallons of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of gallons processed Number of gallons processed

EXERCISE 17-8 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.

Number of engineering change orders; hours of designing Number of orders processed Number of parts in stock Weight of material; number of boxes or cartons Employee turnover; number of employees hired Machine hours; direct labor hours Number of employees; number of parts; direct labor hours Number of employees Book or market value of assets Cost of goods manufactured, direct labor hours; number of employees Machine hours; number of machines Gallons of paint; number of appliances

EXERCISE 17-9 (a) The overhead rates are: Activity Cost Pools

Expected Use Estimated of Cost Drivers Activity-Based Overhead ÷ Overhead Rates per Activity =

Materials handling Machine setups Quality inspections

$40,000 21,500 33,000

1,000 500 600

$40 43 55

(b) The assignment of the overhead costs to products is as follows: Instruments Cost Driver Number Cost Requisitions ($40) 400 $16,000 Machine setups ($43) 200 8,600 Inspections ($55) 200 11,000 Total costs assigned (a) $35,600 Units produced (b) Overhead cost per Unit (a) ÷ (b) *Rounded to nearest dollar

Gauges Number Cost 600 $24,000 300 12,900 400 22,000

Cost Assigned $40,000 21,500 33,000

$58,900

$94,500

50 $

712

300 $

196*

EXERCISE 17-9 (Continued) (c)

MEMO To:

President, Air United, Inc.

From:

Student

Re:

Benefits of activity-based costing (ABC)

ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.

EXERCISE 17-10 (a) (1) Traditional product costing system: $400,000 X .70 = $280,000 Selling costs assigned in March to the “high intensity” product line. (2) Activity-based costing system:

Activity Cost Pools Sales commissions Advertising—TV Advertising—Internet Catalogs Cost of catalog sales Credit and collection Total assigned cost for March

ActivityBased Cost Drivers Overhead Cost Overhead Used X Assigned Rates = $900,000 250 2,000 60,000 9,000 $900,000

$.05 $300 $10 $2.50 $1.00 $.03

$ 45,000 75,000 20,000 150,000 9,000 27,000 $326,000

(b) As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the “high intensity” product line. The difference of $46,000 ($326,000 – $280,000) in the month of March is a 14.1% understatement.

EXERCISE 17-11 (a) 1.

Traditional product costing system: Quality-control overhead costs assigned in June to the low-calorie breakfast line are $11,900 ($70,000 X .17).

Activity-based costing system:

Activity Cost Pools Inspections of material received In-process inspections FDA certification Total assigned cost for June

ActivityBased Cost Drivers Overhead Cost Overhead Used Rate Assigned X = 6,000 10,000 420

$ .90 $ .33 $12.00

$ 5,400 3,300 5,040 $13,740

(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie breakfast line by $1,840 ($13,740 – $11,900) in the month of June. That is a 13.4% understatement. (c) All three activities, as quality-control related activities, are non-valueadded activities. EXERCISE 17-12 Activity Cost Pools Engineering Machinery Machine setup Quality control Factory utilities Maintenance

Activity Level Product-level Unit-level Batch-level Depends on frequency. Could be unit, batch, or product-level Facility-level Facility-level

EXERCISE 17-13 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Facility-level activity Product-level activity Batch-level activity Product-level activity Product-level activity Batch-level activity Facility-level activity Batch-level or unit-level activity Unit-level activity Unit-level activity

EXERCISE 17-14

(a) Activity Cost Pools Scheduling and travel Setup time Supervision

Estimated Overhead $85,000 $90,000 $60,000

Expected use ÷ of Cost Drivers = ABC Overhead Rates 1,250 $ 68.00 600 $150.00 $400,000* $ .15

*$100,000 + $300,000 Commercial Activity Cost Pools Scheduling and travel Setup time Supervision

Expected use of Cost Drivers per Product X ABC Overhead Rates = 750 $ 68.00 350 $150.00 $100,000 $ .15

Total assigned costs

Cost Assigned $ 51,000 52,500 15,000 $118,500

Residential Activity Cost Pools Scheduling and travel Setup time Supervision Total assigned costs

Expected use of Cost Drivers per Product X ABC Overhead Rates = 500 $ 68.00 250 $150.00 $300,000 $ .15

Cost Assigned $ 34,000 37,500 45,000 $116,500

EXERCISE 17-14 (Continued) (b) Revenues Direct material costs Direct labor costs Overhead costs Operating income (loss)

(c)

Commercial $300,000 $ 30,000 100,000 118,500

248,500 $ 51,500

Residential $480,000 $ 50,000 300,000 116,500

466,500 $ 13,500

EXERCISE 17-15 The following activities might be identified at Snap Prints Company from your analysis of its operations and a discussion with the owner-manager, Terry Morton. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Hiring and training personnel Purchasing supplies and materials Selling, promoting, and marketing Billing and collecting Designing Offset printing Copying Faxing Collating Cutting and folding Maintenance and repairs Delivery Accounting

EXERCISE 17-16 Value-Added Activities Writing contracts and letters Taking depositions Contemplating legal strategy Litigating a case in court

Hours 1.5 1.0 1.0 2.5 6.0

Non-Value-Added Activities Attending staff meetings Doing research Traveling to/from court Eating lunch Entertaining a prospective client

Hours 0.5 1.0 1.0 1.0 1.5 5.0

Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-value-added if it is something the attorney should already have known and is not billable to the client.

EXERCISE 17-17 (a)

The predetermined overhead rate under traditional costing would be: $42,000  1,500 hours  $28

(b)

The amount of overhead allocated to the average residential job would be: $28  .5 hours  $14

(c)

The activity-based overhead rates for each cost pool would be

Activity Cost Pools Plowing Snowthrowing

(d)

$38,000 $ 4,000

Expected Use of Cost Drivers per Activity



 200,000 square yards  50,000 linear feet

Activity Based Overhead Rate  $0.19 per square yard  $0.08 per linear foot

The amount of overhead allocated to the average residential job under activity based costing would be:

Plowing Snowthrowing

(e)

Estimated Overhead

Expected use of Cost Driver Per Job



Activity Based Overhead Rate



Cost Allocated

20 60

 

$0.19 $0.08

 

$3.80 4.80 $8.60

The amount of overhead allocated to the average residential job under traditional costing is $14, versus $8.60 under ABC. This means that too much overhead is being allocated to residential jobs, and too little to commercial jobs under traditional costing. This would make the residential jobs appear less profitable than they actually are, and would overstate the profitability of the commercial jobs.

SOLUTIONS TO PROBLEMS PROBLEM 17-1A

(a) Computation of unit costs—traditional costing. Products Manufacturing Costs

Home Model

Commercial Model

Direct materials Direct labor Overhead Total unit cost

$18.50 19.00 24.68* $62.18

$26.50 19.00 24.68* $70.18

*$16.45 X 1.5 = $24.68

(b) Estimated Overhead ÷

Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping

80,400 150,500 412,300 51,000 52,580 837,500 $1,584,280

Expected Use of Cost Drivers

Activity-Based Overhead Rate

335,000 Pounds 35,000 Machine hours 217,000 Parts 25,500 Tests 5,258 Gallons 335,000 Pounds

$ .24 per pound $ 4.30 per machine hour $ 1.90 per part $ 2.00 per test $10.00 per gallon $ 2.50 per pound

Activity Cost Pool

Receiving 215,000 Forming 27,000 Assembling 165,000 Testing 15,500 Painting 3,680 Packing and shipping 215,000 Total costs assigned (a) Units produced

$ .24 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.50

51,600 116,100 313,500 31,000 36,800 537,500 $1,086,500

120,000 8,000 52,000 10,000 1,578 120,000

$ .24 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.50

$ 28,800 34,400 98,800 20,000 15,780 300,000 $497,780

54,000

(b)

Overhead cost per unit [(a) ÷ (b)]

Commercial Model ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned

20.12

10,200 $

48.80

PROBLEM 17-1A (Continued) (d) ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit

Home Model $18.50 19.00 20.12 $57.62

Commercial Model $26.50 19.00 48.80 $94.30

(e)

Activity Receiving Forming Assembling Testing Painting Packing and shipping

Value- vs. Non-Value-Added Non-value-added Value-added Value-added Non-value-added Value-added Value-added

(f)

(1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($48.80 ÷ $20.12) times as much overhead per unit as the home model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $24.68 but rather $20.12 for the home model and $48.80 for the commercial model. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $24.12 on an assignment of $24.68. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.

PROBLEM 17-2A

(a) The allocation of total manufacturing overhead using activity-based costing is as follows:

Overhead Rate

Royale Drivers Cost Used Assigned

Majestic Drivers Cost Used Assigned

17,000 5,000 75,000 11,000

23,000 13,000 45,000 17,000

Purchase orders @ $30 Machine setups @ $50 Machine hours @ $40 Inspections @ $25 Total assigned costs (a)

$ 510,000 250,000 3,000,000 275,000 $4,035,000

Units produced (b) Cost per unit (a) ÷ (b)

$ 690,000 650,000 1,800,000 425,000 $3,565,000

25,000 $

Total Overhead $1,200,000 900,000 4,800,000 700,000 $7,600,000

10,000

161.40

356.50

(b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit

Royale $ 700.00 120.00 161.40 $ 981.40

Majestic $ 420.00 100.00 356.50 $ 876.50

Sales price per unit Cost per unit Gross profit

$1,600.00 981.40 $ 618.60

$1,300.00 876.50 $ 423.50

(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $195.10 ($618.60 – $423.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic. But, by applying ABC and activity-based management analysis, Schultz may determine how to reduce the costs of producing the Majestic model.

PROBLEM 17-3A

(a) Predetermined overhead rate using machine hours: $868,000 ÷ 100,000 hrs. = $8.68 per machine hour (b) Manufacturing cost per stairway under traditional costing: Direct materials ............................................................... Direct labor...................................................................... Overhead (14,500 X $8.68).............................................. Total cost of 250 stairs............................................

$ 103,600 112,000 125,860 $ 341,460

Cost per stairway ($341,460 ÷ 250) ................................

$1,365.84

(c) Manufacturing cost per stairway under activity-based costing: Computation of Activity-Based Overhead Rates Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities

Estimated Expected Use of Cost Overhead ÷ Drivers per Activity = $ 75,000 82,000 210,000 105,000 90,000 126,000 180,000 $868,000

600 Orders 8,000 Moves 100,000 D/L Hours 1,250 Setups 6,000 Inspections 168,000 Components 90,000 Sq. ft.

Activity-Based Overhead Rate $125 per order $10.25 per move $2.10 per D/L hour $84 per setup $15 per inspection $.75 per component $2.00 per sq. ft.

Assignment of Overhead to Order of 250 Stairs Activity Cost Pools

Expected Use of Cost Drivers

Purchasing 60 Orders Handling materials 800 Moves Production 5,000 D/L Hours Setting up machines 100 Setups Inspecting 450 Inspections Inventory control 16,000 Components Utilities 8,000 Sq. ft. Total overhead assigned

Activity-Based X Overhead Rates = Cost Assigned $125 $10.25 $2.10 $84 $15 $.75 $2.00

$ 7,500 8,200 10,500 8,400 6,750 12,000 16,000 $69,350

PROBLEM 17-3A (Continued) Total manufacturing cost per stairway under ABC: Direct materials...................................................................... Direct labor............................................................................. Overhead ................................................................................ Total cost of 250 stairs ..................................................

$ 103,600 112,000 69,350 $ 284,950

Total cost per stairway ($284,950 ÷ 250) ..............................

$1,139.80

(d) The difference between the traditional cost and the activity-based cost per unit, $1,365.84 versus $1,139.80, is not great in amount but $226.04 ($1,365.84 – $1,139.80) is 19.8% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volumebased system.

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

PROBLEM 17-4A

(a) Computation of unit costs—traditional costing Overhead cost per direct labor hour is $1,241,660 ÷ (150,000 + 27,000) = $7.015 Products Manufacturing Costs Direct materials Direct labor Overhead

CoolDay $0.400 0.500 0.351* $1.251

LiteMist $1.200 0.900 0.631** $2.731

*$7.015 X .05 **$7.015 X .09 (b) Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment

(c)

Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Total costs assigned (a) Liters produced

(b)

Overhead cost per liter [(a) ÷ (b)]

Estimated Expected Use Overhead ÷ of Cost Drivers = $ 145,860 396,000 270,000 189,000

6,600 6,600,000 900,000 900,000

240,800 $1,241,660

800

CoolDay Expected ActivityUse of Based Cost Cost Overhead Drivers X Rates = Assigned 6,000 $22.10 $132,600 3,000,000 $ 0.06 180,000 600,000 $ 0.30 180,000 600,000 $ 0.21 126,000 350

$301

105,350 $723,950

Activity-Based Overhead Rates $22.10 per cart $ 0.06 per month $ 0.30 per bottle $ 0.21 per bottle $301 per inspection

LiteMist Expected ActivityUse of Based Cost Cost Overhead Drivers X Rates = Assigned 600 $22.10 $ 13,260 3,600,000 $ 0.06 216,000 300,000 $ 0.30 90,000 300,000 $ 0.21 63,000 450

$301

135,450 $517,710

3,000,000

300,000

$0.241

$1.726

PROBLEM 17-4A (Continued) (d)

Products Manufacturing Costs Direct materials Direct labor Overhead

(e) To:

CoolDay $0.400 0.500 0.241 $1.141

LiteMist $1.200 0.900 1.726 $3.826

Mr. Jack Eller

From:

Student

Subject:

Product costs using traditional approach versus ABC

The memorandum covers the following points: a.

ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.

Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.

In the case of the Benton Corporation, the LiteMist product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product.

PROBLEM 17-5A

(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labor dollars Overhead assigned to audit: Overhead assigned to tax:

.40 X $1,100,000 = $440,000 .40 X $700,000 = $280,000

(b) (1) Computation of activity-based overhead rates:

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel

Estimated Overhead ÷

Expected Use of Cost Drivers per Activity

$216,000 76,200 204,000 142,500 81,300 $720,000

$1,800,000 Direct labor dollars 2,500 Reports/forms 60,000 Minutes 40 Employees Direct

Activity-Based Overhead Rates

$.12 per DL dollar $30.48 per report/form $3.40 per minute $3,562.50 per employee Direct

(2) Assignment of overhead to audit and tax services:

Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel Overhead costs assigned

Audit Expected ActivityUse of Based Cost Cost Overhead Driver X Rate = Assigned

Tax Expected ActivityUse of Based Cost Cost Overhead Driver X Rate = Assigned

$1,100,000 800 27,000 22 56,000

$700,000 1,700 33,000 18 25,300

$.12 $30.48 $3.40 $3,562.50 Direct

$132,000 24,384 91,800 78,375 56,000 $382,559

$.12 $30.48 $3.40 $3,562.50 Direct

$ 84,000 51,816 112,200 64,125 25,300 $337,441

PROBLEM 17-5A (Continued) (c) Overhead is assigned to the two service lines as follows:

Traditional costing ABC Difference

Audit $440,000 382,559 $ 57,441

Tax $280,000 337,441 $ 57,441

The $57,441 difference for audits is 13% lower under ABC costing, while the $57,441 difference for tax is 20.5% higher under ABC costing. Clearly, ABC costing should be used to determine the relative profitability of each service.

CD17

CURRENT DESIGNS

(a) Directly assigned Remaining amount ($832,000) allocated 50% to each product line Total Number of units Cost assigned per unit

Composite $ 28,000

Rotomolded $ 40,000

$416,000 $444,000 1,000 $ 444.00

$416,000 $456,000 4,000 $ 114.00

Composite $ 28,000

Rotomolded $ 40,000

$374,400* $402,400 1,000 $ 402.40

$457,600** $497,600 4,000 $ 124.40

(b) Directly assigned Remaining amount ($832,000) allocated based on direct labor costs Total Number of units Cost assigned per unit

*Overhead rate = $832,000 ÷ ($234,000 + $286,000) = $160% of direct labor cost Composite: 160% X $234,000 = 374,400. **Using overhead rate calculated in* Rotomolded: 160% X $286,000 = $457,600

CD17 (Continued) (c) Activity Cost Pools Design Prototypes Molds Supervision Curing time

Activity Cost Pool Design Prototypes Molds Supervision Curing time Total amount allocated Directly assigned Total cost (a) Number of units (b) Cost assigned per unit (a) ÷ (b)

Estimated Overhead $121,100 152,000 188,500 180,000 190,400

Expected Use of Drivers 3 6 12 12 15,000

Expected Use of Cost Drivers 4 8 13 24 17,000

Activity-Based Overhead Rates $30,275 per model $19,000 per prototype $14,500 per mold $7,500 per employee $11.20 per day

Composite

Rotomolded

Expected Overhead Cost Use of Rates Assigned Drivers $30,275 $ 90,825 1 $19,000 114,000 2 $14,500 174,000 1 $ 7,500 90,000 12 $ 11.20 168,000 2,000

Overhead Rates $30,275 $19,000 $14,500 $ 7,500 $ 11.20

Cost Assigned $ 30,275 38,000 14,500 90,000 22,400

636,825

195,175

28,000 $664,825

40,000 $235,175

1,000

4,000

$ 664.83

58.79

(d) Activity-based costing assigns significantly more costs to the composite kayaks. Since the cost is divided into pools and each pool is allocated using a cost driver that is related to those particular costs, it provides a more accurate way to allocate the costs. Current Designs would need to weigh the additional costs of implementing an ABC system against the benefits that it provides.

BYP 17-1

DECISION-MAKING ACROSS THE ORGANIZATION

The following activities and cost drivers might be submitted: (a) Activities Laundering Housekeeping Dietary Computing information technology Nursing care Surgery Clinical lab Imaging (X-ray, etc.) Pharmacy Emergency room Maintenance Billing and collecting

(b) Cost Drivers Pounds of linen Square footage; number of beds Number of meals Minutes of computer usage; or number of work stations Number of patients Number of procedures or operations Number of tests Number of images Number of prescriptions Number of cases or patients Square footage Number of invoices

BYP 17-2

MANAGERIAL ANALYSIS

(a) Computation of activity-based overhead rate:

Activity Cost Pools

Total Estimated Overhead ÷

Expected Use of Cost Drivers Per Activity

Market analysis Product design Product development Prototype testing

$1,050,000 2,350,000 3,600,000 1,400,000

15,000 Hours 2,500 Designs 90 Products 500 Tests

Activity-Based Overhead Rates $ 70 per hour $ 940 per design $40,000 per product $ 2,800 per test

(b) Charges to in-house manufacturing department: In-House Manufacturing Department

Activity Cost Pools

Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned

Market analysis 1,800 Hours Product design 280 Designs Product development 10 Products Prototype testing 92 Tests Total overhead assigned

$ 70 $ 940 $40,000 $ 2,800

$ 126,000 263,200 400,000 257,600 $1,046,800

Activity Cost Pools

Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned

Market analysis 800 Hours Product design 178 Designs Product development 3 Products Prototype testing 70 Tests Total overhead assigned

$ 70 $ 940 $40,000 $ 2,800

$ 56,000 167,320 120,000 196,000 $539,320

BYP 17-2 (Continued) (d) Activity-based costing permits the company to identify its R&D costs by the activities that cause the costs; that is, ABC allows closer scrutiny of the causes for cost incurrences; hence, greater control. By charging in-house manufacturing departments for their fair share of the company’s R&D costs, these departments may exert their own control over such costs. Activity-based costing allows Ideal to compile realistic costs for bidding and charging outside users of its R&D department’s services.

BYP 17-3

REAL-WORLD FOCUS

(a) Some of the benefits of ABC for the financial services industry include: Identification of the most profitable customers More accurate product and service pricing Increased product profitability Well-organized process costs (b) Three things that the company’s original costing method did not take into account were: (1) The same servicing and administrative expenses were applied equally to all accounts, including fixed and adjustable rate mortgages. (2) No consideration was given to “seasoning”, that is, the amount of time a loan had been on the books. (3) It did not take credit quality into account. (c) Some of the cost drivers used under the new approach were: Average number of accounts that were at least 60 days delinquent. Average number of accounts outstanding. Average number of bankrupt accounts plus the average number of real estate owned accounts.

BYP 17-4

REAL-WORLD FOCUS

(a) According to the authors, “ABC loses power in large-scale operations, and can be difficult to implement and maintain.” They suggest, though, that ABC should not be abandoned but, rather, improved because it provides many potential benefits. They cite as benefits that ABC “has helped many companies identify important cost- and profit-enhancement opportunities through repricing of unprofitable customer relationships, process improvement on the shop floor, lower-cost product designs, and rationalized product variety.” (b) One way to estimate practical capacity is to simply use a rule of thumb, such as practical capacity is 80 to 85% of theoretical capacity. The authors suggest that estimates for people be put at the lower end of the range and for machines at the upper end of the range. A more systematic approach would be to review past activity levels during a month where a high level of orders was processed with a high degree of success. The authors say that it is not important to be extremely precise, as long as you are within 5 to 10% of the actual number. (c) After practical capacity is determined in terms of total time available, the cost per unit of time is determined by dividing the total cost of that capacity by the total capacity in units of time. This results in a cost per unit of time. Next, managers determine the amount of time it takes to carry out each type of activity. Then the cost per time unit can be multiplied by the time it takes to perform each activity so that the cost of the activity is determined. This then enables the company to assign costs to the activities performed for specific customers or in making specific products.

BYP 17-4 (Continued) (d) One of the primary benefits of the report provided by “ABC, the TimeDriven Way” is that it highlights the difference between capacity supplied and capacity used. This enables management to evaluate its effectiveness in its use of the company’s resources and to evaluate decisions regarding increasing or decreasing capacity. As an example, the authors discuss the experience of Lewis-Goetz, a hose and belt fabricator. It found that one of its plants was operating at only 27% of capacity. It was able to use this information in making decisions regarding how it planned to meet the production requirements of a very large order it was anticipating for later in the year.

BYP 17-5

ETHICS CASE

(a) The stakeholders (parties affected by Curtis’s and Ed’s actions) in this case are:  Curtis as cost accountant.  Ed and all personnel employed in the production of the Supercut Model of lawn tractor.  Hi-Power Mower management.  Hi-Power Mower owners (stockholders).  The stakeholder group may be expanded to include Hi-Power Mower’s suppliers and customers. (b) The objective of cost accounting is to provide useful, accurate information for decision making by managers. Ed is coercing Curtis to massage the data to save the product line and, thus, Ed’s job. Ed is advocating knowingly providing false data, deceiving management, and jeopardizing Curtis’s job. (c) Curtis is a management accountant employed by Hi-Power Mower Company. His first job responsibility is to his employer to: (1) communicate information fairly and objectively and (2) disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Curtis’s obligation is to provide management with timely, truthful information.

BYP 17-6

ALL ABOUT YOU

(a) The three main tools for time management for students are: Term calendar—records quizzes, exams, project due dates and other major events. Weekly schedule—records your scheduled time for learning for each course. Daily to do list—lists the tasks that must be accomplished each day in order to identify priorities. (b) Studies show that students are most inclined to waste time during the morning and afternoon. Your brain is best prepared for learning during day-light hours. Therefore, it is important to schedule your time so that you tackle your most difficult topics during daylight hours. (c) Many students resent time management practices because they think they will be constraining. In fact, time management practices can be liberating because they help you to get control of your life so that you have more time to devote to those things that are really important to you. (d) Goal setting is important because if you have clearly defined goals you will be more likely to accomplish those things that are important to you. Good goals are clearly defined, with as much detail as possible. They also should be realistic. To help you develop your goals, you should discuss your goals and objectives with a mentor or advisor.

BYP 17-7

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: In part, the response to this question depends on how broadly you apply the term “value-added activity” when looking at one’s life. For example, some value-added activities relate to goals and objectives for school and work. It is important to try to manage your time effectively to maximize your chance of achieving these objectives. But it is also important to identify the other things in life that are important. These would include time with friends, family, your health, and hobbies and activities that you value. When identifying personal value-added activities, it is important to identify all the things, school-related and otherwise, that matter most to you. In applying the activity-based concepts that you learned in this chapter to your life, try to eliminate the non-value-added activities that reduce your ability to focus on those aspects of life that are really important to you.

CHAPTER 18 Cost-Volume-Profit ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

1, 2, 3, 4, 5, 6

Explain variable, fixed, and mixed costs and the relevant range.

Brief Exercises

Do It!

Exercises

A Problems

1, 2

1, 2, 3, 4, 5, 6

1A, 6A

2. Apply the high-low method to 7, 8 determine the components of mixed costs.

1, 3, 4, 5

3, 5,

Prepare a CVP income statement to determine contribution margin.

6, 7

7, 8, 9, 10, 11, 1A, 2A, 4A, 12, 13, 17 5A, 6A

Compute the break-even 12, 13, 14 point using three approaches.

8, 9

4, 5

8, 9, 10, 11, 12, 13, 14, 16, 17

1A, 2A, 3A, 4A, 5A

Determine the sales required 15, 16 to earn target net income and determine margin of safety.

10, 11, 12

14, 15, 16, 17

2A, 4A, 5A, 6A

9, 10, 11, 17

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income.

Simple

20–30

Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.

Moderate

30–40

Compute break-even point under alternative courses of action.

Simple

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Compute contribution margin, fixed costs, break-even point, sales for target net income, and margin of safety ratio.

Moderate

20–30

Determine contribution margin ratio, break-even point, and margin of safety.

Moderate

20–30

ANSWERS TO QUESTIONS 1.

(a) Cost behavior analysis is the study of how specific costs respond to changes in the level of activity within a company. (b) Cost behavior analysis is important to management in planning business operations and in deciding between alternative courses of action.

(a) The activity index identifies the activity that causes changes in the behavior of costs. Once the index is determined, it is possible to classify the behavior of costs in response to changes in activity levels into three categories: variable, fixed, or mixed. (b) Variable costs may be defined in total or on a per-unit basis. Variable costs in total vary directly and proportionately with changes in the activity level. Variable costs per unit remain the same at every level of activity.

Fixed costs remain the same in total regardless of changes in the activity level. In contrast, fixed costs per unit vary inversely with activity. As volume increases, fixed costs per unit decline and vice versa.

(a) The relevant range is the range of activity over which a company expects to operate during the year. (b) Disagree. The behavior of both fixed and variable costs are linear only over a certain range of activity. CVP analysis is based on the assumption that both fixed and variable costs remain linear within the relevant range.

This is true. Most companies operate within the relevant range. Within this range, it is possible to establish a linear (straight-line) relationship for both variable and fixed costs. If a relevant range cannot be established, segregation of costs into fixed and variable becomes extremely difficult.

Apartment rent is fixed because the cost per month remains the same regardless of how much Adam uses the apartment. Rent on a Hertz rental truck is a mixed cost because the cost usually includes a per day charge (a fixed cost) plus an activity charge based on miles driven (a variable cost).

For CVP analysis, mixed costs must be classified into their fixed and variable elements. One approach to the classification of mixed costs is the high-low method.

Variable cost per unit is $1.30, or [($165,000 – $100,000) ÷ (90,000 – 40,000)]. At any level of activity, fixed costs are $48,000 per month [$165,000 – (90,000 X $1.30)].

No. Only two of the basic components of cost-volume-profit (CVP) analysis, unit selling prices and variable cost per unit, relate to unit data. The other components, volume, total fixed costs, and sales mix, are not based on per-unit amounts.

10.

There is no truth in Faye’s statement. Contribution margin is sales less variable costs. It is the revenue that remains to cover fixed costs and to produce income (profit) for the company.

11.

Contribution margin is $14 ($40 – $26). The contribution margin ratio is 35% ($14 ÷ $40).

Questions Chapter 18 (Continued) 12.

Disagree. Knowledge of the break-even point is useful to management in deciding whether to introduce new product lines, change sales prices on established products, and enter new market areas.

13.

$26,000 ÷ 25% = $104,000

14.

(a) The break-even point involves the plotting of three lines over the full range of activity: the total revenue line, the total fixed cost line, and the total cost line. The break-even point is determined at the intersection of the total revenue and total cost lines. (b) The break-even point in units is obtained by drawing a vertical line from the break-even point to the horizontal axis. The break-even point in sales dollars is obtained by drawing a horizontal line from the break-even point to the vertical axis.

15.

Margin of safety is the difference between actual or expected sales and sales at the break-even point. 1,250 X $12 = $15,000; $15,000 – $13,200 = $1,800; $1,800 ÷ $15,000 = 12%.

16.

At break-even sales, the contribution margin is equal to the fixed costs. The contribution margin ratio is: $180,000

= 36%

$500,000 The sales volume to achieve net income of $90,000 is as follows: $180,000 + $90,000 = $750,000 .36 17.

PACE COMPANY CVP Income Statement Sales ................................................................................................. Variable expenses Cost of goods sold ($600,000 X .70) .......................................... Operating expenses ($200,000 X .70)........................................ Total variable expenses ..................................................... Contribution margin ...........................................................................

$900,000 $420,000 140,000 560,000 $340,000

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18-1 Indirect labor is a variable cost because it increases in total directly and proportionately with the change in the activity level. Supervisory salaries is a fixed cost because it remains the same in total regardless of changes in the activity level. Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level.

BRIEF EXERCISE 18-2 VARIABLE COST Relevant Range

FIXED COST Relevant Range

$10,000

8,000

6,000

4,000

2,000

2,000 0

80 100

Activity Level

80 100

Activity Level

BRIEF EXERCISE 18-3

$60,000 Total Cost Line

COST

45,000

Variable Cost Element

30,000

15,000 Fixed Cost Element 0

500

1,000

1,500

2,000

2,500

Direct Labor Hours

BRIEF EXERCISE 18-4 High Low Difference $15,000 – $13,500 = $1,500 8,500 – 7,500 = 1,000 $1,500 ÷ 1,000 = $1.50—Variable cost per mile.

Total cost Less: Variable costs 8,500 X $1.50 7,500 X $1.50 Total fixed costs

High $15,000

Low $13,500

12,750 $ 2,250

11,250 $ 2,250

The mixed cost is $2,250 plus $1.50 per mile.

BRIEF EXERCISE 18-5 High Low Difference $74,500 – $36,000 = $38,500 40,000 – 18,000 = 22,000 $38,500 ÷ 22,000

= $1.75 per unit.

Total cost Less: Variable costs 40,000 X $1.75 18,000 X $1.75 Total fixed costs

Activity Level High Low $74,500 $36,000 70,000 $ 4,500

31,500 $ 4,500

BRIEF EXERCISE 18-6 1.

(a) (b)

$288 = ($640 – $352) 45% ($288 ÷ $640)

$207 = ($300 – $93) 31% ($93 ÷ $300)

(e) (f)

$1,300 = ($325 ÷ 25%) $975 ($1,300 – $325)

BRIEF EXERCISE 18-7 RUSSELL INC. CVP Income Statement For the Quarter Ended March 31, 2017 Sales.................................................................................. Variable costs ($920,000 + $70,000 + $86,000) ............... Contribution margin ......................................................... Fixed costs ($440,000 + $45,000 + $98,000).................... Net income ........................................................................

$2,200,000 1,076,000 1,124,000 583,000 $ 541,000

BRIEF EXERCISE 18-8 (a) $520Q – $286Q – $163,800 = $0 $234Q = $163,800 Q = 700 units (b) Contribution margin per unit $234, or ($520 – $286) X = $163,800 ÷ $234 X = 700 units

BRIEF EXERCISE 18-9 Contribution margin ratio = [($300,000 – $180,000) ÷ $300,000] = 40% Required sales in dollars = $110,000 ÷ 40% = $275,000

BRIEF EXERCISE 18-10 If variable costs are 70% of sales, the contribution margin ratio is ($1 – $0.70) ÷ $1 = .30. Required sales in dollars = ($195,000 + $75,000) ÷ .30 = $900,000 BRIEF EXERCISE 18-11 Margin of safety = $1,000,000 – $800,000 = $200,000 Margin of safety ratio = $200,000 ÷ $1,000,000 = 20%

BRIEF EXERCISE 18-12 Contribution margin per unit $1.60 is ($6.00 – $4.40) Required sales in units = ($480,000 + $1,500,000) ÷ $1.60 = 1,237,500.

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 18-1 Variable costs: Indirect labor, direct labor, and direct materials. Fixed costs: Property taxes and depreciation. Mixed costs: Utilities and maintenance. DO IT! 18-2 ($18,580 – $16,200) ÷ (10,500 – 8,800) = $1.40 per unit $18,580 – ($1.40 X 10,500 units) = $3,880 or $16,200 – ($1.40 X 8,800) = $3,880

(a)

Variable cost: Fixed cost:

(b)

Total cost to produce 9,200 units: $3,880 + ($1.40 X 9,200) = $16,760

DO IT! 18-3 Cedar Grove Industries CVP Income Statement For the Month Ended May 31, 2017 Sales Variable costs Contribution margin Fixed costs Net income

Total $360,000 176,000 184,000 120,000 $ 64,000

Per Unit $45 22 $23

DO IT! 18-4 (a)

The formula is $250Q – $170Q – $160,000 = 0. Therefore, 80Q = $160,000, and the breakeven point in units is 2,000 ($160,000 ÷ $80).

(b)

The contribution margin per unit is $80 ($250 – $170). The formula therefore is $160,000 ÷ $80, and the breakeven point in units is 2,000.

DO IT! 18-5 (a)

CM per unit = Unit selling price – Unit variable costs $12 = $30 – $18 CM ratio = CM per unit/Unit selling price 40% = $12/$30 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio = $220,000 ÷ 40% = $550,000

(b)

Margin of safety

Actual sales – Break-even sales Actual sales $800,000 – $550,000 = $800,000 =

= (c)

31.25%

Sales – Variable costs – Fixed costs = Net income $30Q – $18Q = $220,000 + $140,000 $12Q = $360,000 Q = 30,000 units 30,000 units X $30 = $900,000 required sales

SOLUTIONS TO EXERCISES EXERCISE 18-1 (a) The determination as to whether a cost is variable, fixed, or mixed can be made by comparing the cost in total or on a per-unit basis at two different levels of production. Variable Costs Fixed Costs Mixed Costs

Vary in total but remain constant on a per-unit basis. Remain constant in total but vary on a per-unit basis. Contain both a fixed element and a variable element. Vary both in total and on a per-unit basis.

(b) Using these criteria as a guideline, the classification is as follows: Direct materials Direct labor Utilities EXERCISE 18-2 (a)

Variable Variable Mixed

Rent Maintenance Supervisory salaries

Fixed Mixed Fixed

EXERCISE 18-2 (Continued) (b)

The relevant range is 3,000 – 8,000 units of output since a straight-line relationship exists for both direct materials and rent within this range.

(c)

Variable cost per unit Within the relevant range (3,000 – 8,000 units)

= Cost Units = $15,000* 5,000*

$3 per unit

*Any costs and units within the relevant range could have been used to calculate the same unit cost of $3. (d)

Fixed cost within the relevant range (3,000 – 8,000 units)

$8,000

EXERCISE 18-3 (a) Maintenance Costs: $2,800 $5,500 – $2,700 = = $7 variable cost per machine hour 400 700 – 300

Total costs Less: Variable costs 700 X $7 300 X $7 Total fixed costs

700 Machine Hours $5,500

300 Machine Hours $2,700

4,900 $ 600

2,100 $ 600

Thus, maintenance costs are $600 per month plus $7 per machine hour.

EXERCISE 18-3 (Continued) $6,000

(b)

$5,000

Total Cost Line

$5,500

$4,000

COSTS

$3,000

Variable Cost Element

$2,000

$1,000 $ 600 Fixed Cost Element 0 100 200 300 400 500 600 700 Machine Hours

EXERCISE 18-4 1. Wood used in the production of furniture. 2. Fuel used in delivery trucks. 3. Straight-line depreciation on factory building. 4. Screws used in the production of furniture. 5. Sales staff salaries. 6. Sales commissions. 7. Property taxes. 8. Insurance on buildings. 9. Hourly wages of furniture craftsmen. 10. Salaries of factory supervisors. 11. Utilities expense. 12. Telephone bill.

Variable. Variable. Fixed. Variable. Fixed. Variable. Fixed. Fixed. Variable. Fixed. Mixed. Mixed.

EXERCISE 18-5 (a) Maintenance Costs: $4,620 – $2,640 = $1,980 = $.44 variable cost per machine hour 8,000 – 3,500 4,500 Activity Level High $4,620

Total cost Less: Variable costs 8,000 X $.44 3,500 X $.44 Total fixed costs

Low $2,640

3,520 1,540 $1,100

$1,100

Thus, maintenance costs are $1,100 per month plus $.44 per machine hour. (b)

$5,000 $4,620 Total Cost Line

COSTS

$4,000

$3,000

Variable Cost Element

$2,000

$1,100 $1,000 Fixed Cost Element 0

2,000

4,000

6,000

Machine Hours

8,000

EXERCISE 18-6 (a)

(b)

Cost Direct materials Direct labor Utilities Property taxes Indirect labor Supervisory salaries Maintenance Depreciation

Fixed

Variable X X

Mixed

X X X X X X

Fixed costs

= $1,000 + $1,900 + $2,400 + $300 + $200 = $5,800

Variable costs to produce 3,000 units = $7,500 + $18,000 + $4,500 = $30,000 Variable cost per unit

= $30,000/3,000 units = $10 per unit

Variable cost portion of mixed cost

= Total cost – Fixed portion

Utilities: Variable cost to produce 3,000 units = $2,100 – $300 = $1,800 Variable cost per unit

= $1,800/3,000 units = $.60 per unit

Maintenance: Variable cost to produce 3,000 units = $1,100 – $200 = $900 Variable cost per unit

= $900/3,000 units = $.30 per unit

Cost to produce 5,000 units = (Variable costs per + Fixed cost unit X 5,000 units) = (($10 + $.60 + $.30) X 5,000) + $5,800 = $54,500 + $5,800 = $60,300

EXERCISE 18-7 MEMO To:

Marty Moser

From:

Student

Re:

Assumptions underlying CVP analysis

CVP analysis is a useful tool in analyzing the effects of changes in costs and volume on a company’s profits. However, there are some assumptions which underlie CVP analysis. When these assumptions are not valid, the results of CVP analysis may be inaccurate. The five assumptions are: 1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. 2. Costs can be classified accurately as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold. 5. When more than one type of product is sold, the sales mix will remain constant. If you want further explanation of any of these assumptions, please contact me. EXERCISE 18-8 (a) Contribution margin per lawn

$60 – ($12 + $10 + $2)

Contribution margin per lawn

$36

Contribution margin ratio

$36 ÷ $60 = 60%

Fixed costs = $1,400 + $200 + $2,000 = $3,600 Break-even point in lawns = $3,600 ÷ $36 = 100 (b) Break-even point in dollars = 100 lawns X $60 per lawn = $6,000 per month OR Fixed costs ÷ Contribution margin ratio = $3,600 ÷ .60 = $6,000 per month

EXERCISE 18-9 1.

Contribution margin per room

$60 – ($14 + $28)

Contribution margin per room

$18

Contribution margin ratio

$18 ÷ $60 = 30%

Fixed costs = $5,900 + $1,100 + $1,000 + $100 = $8,100 Break-even point in rooms = $8,100 ÷ $18 = 450 2.

Break-even point in dollars

= 450 rooms X $60 per room = $27,000 per month

OR Fixed costs ÷ Contribution margin ratio = $8,100 ÷ .30 = $27,000 per month EXERCISE 18-10 (a) Contribution margin in dollars:

Contribution margin per unit: Contribution margin ratio: (b) Break-even sales in dollars: Break-even sales in units:

Sales = 560 X $120 = $67,200 Variable costs = $67,200 X .60 = 40,320 Contribution margin $26,880

$120 – $72 ($120 X 60%) = $48. $48 ÷ $120 = 40%. $21,024 = $52,560. 40% $21,024 = 438. $48

EXERCISE 18-11 (a) 1. Contribution margin ratio is: $27,000 = 75% $36,000 Break-even point in dollars = $18,000 = $24,000 75% $36,000 2. Round-trip fare = = $24 1,500 fares Break-even point in fares = $24,000 = 1,000 fares $24 (b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $18,000. EXERCISE 18-12 (a) Unit contribution margin =

Fixed costs Break-even sales in units $112,000 ($350,000 ÷ $5)

= $1.60 Variable cost per unit

= Unit selling price – Unit contribution margin = $5.00 – $1.60 = $3.40

OR 70,000 X $5.00 = 70,000X + $112,000 where X = Variable cost per unit Variable cost per unit = $3.40 Contribution margin ratio = $1.60 ÷ $5.00 = 32%

EXERCISE 18-12 (Continued) (b) Fixed costs ÷ Contribution margin ratio = Break-even sales in dollars Fixed costs ÷ .32 = $420,000 = $134,400 ($420,000 X.32) Since fixed costs were $112,000 in 2016, the increase in 2017 is $22,400 ($134,400 – $112,000). EXERCISE 18-13 (a) and (b)

BILLINGS COMPANY CVP Income Statement For the Month Ended September 30, 2017

Sales (600 video game consoles) .................. Variable costs ................................................. Contribution margin ....................................... Fixed costs ...................................................... Net income ...................................................... (c)

(d)

Total $240,000 168,000 72,000 54,000 $ 18,000

Per Unit $400 280 $120

Sales = Variable costs + Fixed costs $400X = $280X + $54,000 $120X = 54,000 X = 450 units BILLINGS COMPANY CVP Income Statement For the Month Ended September 30, 2017

Sales (450 video game consoles)................... Variable costs.................................................. Contribution margin........................................ Fixed costs ...................................................... Net income.......................................................

Total $180,000 126,000 54,000 54,000 $ –0–

Per Unit $400 280 $120

EXERCISE 18-14 (a) Units sold in 2016 =

$570,000 + $210,000

(b) Units needed in 2017 =

$150 – $90

= 13,000 units

$570,000 + $262,000 * $150 – $90

= 13,867 units

(rounded) *$210,000 + $52,000 = $262,000

(c)

$570,000 + $262,000 = 13,000 units, where X = new selling price X – $90 $832,000 = 13,000X – $1,170,000 $2,002,000 = 13,000X X = $154

EXERCISE 18-15 1.

Unit sales price = $400,000 ÷ 5,000 units = $80 Increase selling price to $88, or ($80 X 110%). Net income = $440,000 – $240,000 – $90,000 = $110,000.

Reduce variable costs to 55% of sales. Net income = $400,000 – $220,000 – $90,000 = $90,000.

Alternative 1, increasing selling price, will produce the higher net income.

EXERCISE 18-16 (a)

$3,200

Sales Line

2,800

DOLLARS (000)

2,400

Break-even Point

Total Cost Line

2,000 1,600 1,200 800 Fixed Cost Line 400 100 200 300 400 500 600 700 800 Number of Units (in thousands)

(b) 1.

Break-even sales in units: $4X = $2.50X + $600,000 $1.50X = $600,000 X = 400,000 units

Break-even sales in dollars: X = .625X + $600,000 .375X = $600,000 X = $1,600,000 or $600,000 ÷ 37.5%

Margin of safety in dollars: $2,000,000 – $1,600,000 = $400,000 Margin of safety ratio: $400,000 ÷ $2,000,000 = 20%

EXERCISE 18-17 (a) Contribution ratio = Contribution margin ÷ Sales ($40 – $24) ÷ $40 = 40% (b) Break-even in dollars: $19,500 ÷ 40% = $48,750 (c) Margin of safety = (2,500 X $40) – $48,750 = $51,250 $51,250 ÷ $100,000 = 51.25% (d) Current contribution margin $40 – $24 = $16 Total contribution margin is $16 X 2,500 = $40,000 30% increase in contribution margin is $40,000 X 30% = $12,000 Total increase in sales required: $12,000 ÷ 40% = $30,000

SOLUTIONS TO PROBLEMS PROBLEM 18-1A (a) Variable costs (per haircut) Barbers’ commission Barber supplies Utilities Total variable cost per haircut

$4.50 .30 .20 $5.00

(b) $10.00X = $5.00X + $7,000 $ 5.00X = $7,000 X = 1,400 haircuts (c)

Fixed costs (per month) Barbers’ salaries Manager’s extra salary Advertising Rent Utilities Magazines Total fixed

1,400 haircuts X $10 = $14,000

DOLLARS (000)

$5,000 500 200 1,100 175 25 $7,000

Sales Line Break-even Point

Total Cost Line

12 9 Fixed Cost Line

6 3

300

600

900

1,200 1,500 1,800

Number of Haircuts

(d) Net income = $16,000 – [($5.00 X 1,600) + $7,000] = $1,000

PROBLEM 18-2A (a)

JORGE COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2017 Sales .............................................................. Variable expenses Cost of goods sold................................ Selling expenses ................................... Administrative expenses ...................... Total variable expenses ................ Contribution margin ..................................... Fixed expenses Cost of goods sold................................ Selling expenses ................................... Administrative expenses ...................... Total fixed expenses ..................... Net income ....................................................

$1,800,000 $1,170,000* 70,000 20,000 1,260,000 540,000 280,000 65,000 60,000 405,000 $ 135,000

*Direct materials $430,000 + direct labor $360,000 + variable manufacturing overhead $380,000. (b) Variable costs = 70% of sales ($1,260,000 ÷ $1,800,000) or $.35 per bottle ($.50 X 70%). Total fixed costs = $405,000. 1.

$.50X = $.35X + $405,000 $.15X = $405,000 X = 2,700,000 units

2,700,000 X $.50 = $1,350,000

= ($1,800,000 – $1,350,000) ÷ $1,800,000 = 25%

(d) Required sales X=

$405,000 + $180,000 = $1,950,000 .30

PROBLEM 18-3A

(a) Sales were $2,500,000, variable expenses were $1,750,000 (70% of sales), and fixed expenses were $850,000. Therefore, the break-even point in dollars is: $850,000 = $2,833,333 (rounded) .30 (b) 1. The effect of this alternative is to increase the selling price per unit to $6 ($5 X 120%). Total sales become $3,000,000 (500,000 X $6). Thus, the contribution margin ratio changes to 42% [($3,000,000 – $1,750,000) ÷ $3,000,000]. The new break-even point is: $850,000 = $2,023,810 (rounded) .42 2.

The effects of this alternative are to change total fixed costs to $760,000 ($850,000 – $90,000) and to change the contribution margin to 25% [($2,500,000 – $1,750,000 – $125,000) ÷ $2,500,000]. The new break-even point is: $760,000 = $3,040,000 .25

Alternative 1 is the recommended course of action because it has a lower break-even point.

PROBLEM 18-4A

(a) Current break-even point: $40X = $24X + $270,000 (where X = pairs of shoes) $16X = $270,000 X = 16,875 pairs of shoes New break-even point:

$38X = $24X + ($270,000 + $24,000) $14X = $294,000 X = 21,000 pairs of shoes

(b) Current margin of safety ratio =

(20,000 X $40) – (16,875 X $40) (20,000 X $40)

= 16% (rounded)

New margin of safety ratio

(24,000 X $38) – (21,000 X $38) (24,000 X $38)

= 13% (rounded) (c)

BARGAIN SHOE STORE CVP Income Statement

Sales (20,000 X $40) Variable expenses (20,000 X $24) Contribution margin Fixed expenses Net income

Current $800,000 480,000 320,000 270,000 $ 50,000

New $912,000 576,000 336,000 294,000 $ 42,000

(24,000 X $38) (24,000 X $24)

The proposed changes will raise the break-even point 4,125 units. This is a significant increase. Margin of safety is 3% lower and net income is $8,000 lower. The recommendation is to not accept the proposed changes.

PROBLEM 18-5A

(a) (1) Current Year $1,600,000

Sales Variable costs Direct materials Direct labor Manufacturing overhead ($380,000 X .70) Selling expenses ($250,000 X .40) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin

490,000 290,000 266,000 100,000 54,000 1,200,000 $ 400,000

Sales

Current Year $1,600,000 X 1.1

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

490,000 290,000 266,000 100,000 54,000 1,200,000 $ 400,000

X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1

Projected Year $1,760,000 539,000 319,000 292,600 110,000 59,400 1,320,000 $ 440,000

(2) Fixed Costs Current Year Manufacturing overhead ($380,000 X .30) $114,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $480,000

Projected year $114,000 150,000 216,000 $480,000

PROBLEM 18-5A (Continued) (b) Unit selling price = $1,600,000 ÷ 100,000 = $16 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $16 – $12 = $4 Contribution margin ratio = $4 ÷ $16 = .25 Break-even point in units = Fixed costs ÷ Unit contribution margin 120,000 units = $480,000 ÷ $4 Break-even point in dollars = Fixed costs $1,920,000 = $480,000

÷ Contribution margin ratio ÷ .25

(c) Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $2,720,000

($480,000

$200,000)

.25

(d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 29.4%

($2,720,000

–

$1,920,000)

$2,720,000

PROBLEM 18-6A

(a) 1.

Let variable selling and administrative expenses = VSA Sales – Variable cost of goods sold – VSA = Contribution Margin $1,200,000 – ($400,000 + $500,000 + $50,000 + VSA) = $180,000 VSA = $70,000

Let fixed manufacturing overhead = FMO Sales – Variable cost of goods sold – FMO = Gross profit $1,200,000 – ($400,000 + $500,000 + $50,000 + FMO) = $180,000 FMO = $70,000

Let fixed selling and administrative expenses = FSA Contribution margin ratio = $180,000 ÷ $1,200,000 = 15% Contribution margin at break-even = $1,300,000 X 15% = $195,000 At break-even, Contribution margin = Fixed costs (FSA + FMO) $195,000 = FSA + $70,000 FSA = $125,000

(b) Incremental sales = $1,200,000 X 25% = $300,000 Incremental contribution margin = $300,000 X 15% = $45,000 The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $45,000. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.

CD18

CURRENT DESIGNS

(a) $250 + $100 + $170 + $420 + $400 = $1,340 total variable costs (b) Contribution margin per unit = $2,000 – $1,340 = $660 (c) $359,700* ÷ $660 = 545 units *$119,700 + $240,000 (d) ($359,700 + $270,600) ÷ $660 = 955 units (e) Actual (expected) sales = $2,000 X 1,000 = $2,000,000 Break-even sales = $2,000 X 545 = $1,090,000 Margin of safety in dollars = $2,000,000 – $1,090,000 = $910,000 Margin of safety ratio = $910,000 ÷ $2,000,000 = 45.5%

BYP 18-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) (1)

Capital-Intensive

(2)

Fixed manufacturing costs $2,524,000 Incremental selling expenses 502,000 Total fixed costs $3,026,000 Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin Total fixed costs (1)

Labor-Intensive

Fixed manufacturing costs $1,550,000 Incremental selling expenses 502,000 Total fixed costs $2,052,000

$32.00 $5.00 6.00 3.00 2.00

Selling price Variable costs Direct materials Direct labor Variable overhead 16.00 Selling expenses $16.00 Contribution margin

$3,026,000

Total fixed costs (1)

$32.00 $5.50 8.00 4.50 2.00

20.00 $12.00 $2,052,000

Contribution margin per unit (2)

$16.00

Contribution margin per unit (2)

$12.00

Break-even in units (1) ÷ (2)

189,125

Break-even in units (1) ÷ (2)

171,000

(b)

Creative Ideas Company would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal. $16X + $3,026,000 = $20X + $2,052,000 $4X = $974,000 X = 243,500 units

(c)

Creative Ideas should employ the capital-intensive manufacturing method if annual sales are expected to exceed 243,500 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 243,500 units. The labor-intensive method is more profitable for sales up to 243,500 units because the fixed costs are lower. The capital-intensive method is more profitable for sales above 243,500 units because its contribution margin is higher.

BYP 18-2

MANAGERIAL ANALYSIS

(a) The variable costs per unit are: Cost of goods sold ($600,000 ÷ 240,000) ..................... $2.50 Selling expenses ($117,600 ÷ 240,000) ........................................... 49 Administrative expenses ($60,000 ÷ 240,000) ............. .................. 25 Total........................................................................ $3.24 Fixed costs are: Cost of goods sold ($800,000 X .25) ............................ Selling expenses ($280,000 X .58)................................ Administrative expenses ($150,000 X .60)...................

$200,000 162,400 90,000 $452,400

The break-even points are: X = ($3.24 ÷ $5.00) X + $452,400 X = .65X + $452,400 .35X = $452,400 X = $1,292,571 (rounded) $5.00X = $3.24X + $452,400 $1.76X = $452,400 X = 257,045 units (rounded) (b) Variable unit cost of goods sold = $2.75 ($600,000 ÷ 240,000 = $2.50; $2.50 + $.25) Sales volume = 300,000 units (240,000 X 125%) Total sales = 300,000 X $5.25 = $1,575,000 Net income computation: Sales ....................................................... Variable expenses Cost of goods sold (300,000 X $2.75) ......................... Selling expenses (300,000 X $.49)........................... Administrative expenses (300,000 X $.25)........................... Total variable expenses.......... Contribution margin...............................

$1,575,000 $825,000 147,000 75,000 1,047,000 528,000

BYP 18-2 (Continued) Fixed expenses Cost of goods sold ........................ Selling expenses............................ Administrative expenses............... Total fixed expenses .............. Net income.............................................

$200,000 162,400 90,000 452,400 $ 75,600

X = ($1,047,000 ÷ $1,575,000)X + $452,400 X = .66X + $452,400 .34X = $452,400 X = $1,330,588 (rounded) Profits and the break-even point would both increase. (c) Sales [384,000 (1) X ($5.00 – $.25)] ............... Variable expenses Cost of goods sold (384,000 X $2.50)................................. Selling expenses (384,000 X $.59)......... Administrative expenses (384,000 X $.25) .................................. Total variable expenses ................. Contribution margin ...................................... Fixed expenses Cost of goods sold................................. Selling expenses ($162,400 + $40,000) ........................... Administrative expenses ....................... Total fixed expenses ...................... Net income .....................................................

$1,824,000 $960,000 226,560 96,000 1,282,560 541,440 $200,000 202,400 90,000 492,400 $ 49,040

(1) Sales volume = 240,000 X 160% = 384,000 X = ($1,282,560 ÷ $1,824,000)X + $492,400 X = .70X + $492,400 .30X = $492,400 X = $1,641,333 Profits and the break-even point would both increase. (d) Peri’s plan should be accepted. It produces a higher net income and a lower break-even point than Paul’s plan.

BYP 18-3

REAL-WORLD FOCUS

(a) Sweeteners and packaging are a variable cost to Coca-Cola because their use is directly proportional to the amount of product produced. If the unit cost of a variable cost item increases, the contribution margin will decline. This will lead to a decline in net income unless the company can increase its selling price, increase the number of units it sells, or reduce other costs. (b) This description makes the marketing expenditures sound like they are a variable cost, since it suggests that they vary with the amount of units sold. However, unlike variable costs, the relationship of marketing costs is not directly proportional to sales, since other factors also influence units sold. Thus, it is not a pure variable cost. However, it is also not a fixed cost, in that there usually is a relationship between marketing expenditures and sales. For CVP purposes, it might best be handled as a mixed cost, having both a fixed and variable component. (c) The first measure, gallon shipments of concentrates and syrups, is the activity index, since it best reflects the company’s production and sales activity at the wholesale level, its primary line of business. The second measure, unit cases of finished product, indicates the amount of activity by Coke’s primary customers, the bottlers. Coke also keeps track of this since it provides information about what is happening at the retail level.

BYP 18-4

REAL-WORLD FOCUS

(a) Barnes and Noble has 1,362 stores with a total of 18.8 million square feet. That is a huge investment in fixed costs that have very little value in an e-book environment. (b) Barnes and Noble’s big advantage (which enabled it to put lots of small independent book sellers out of business), was that each of its superstores had 150,000 books in stock. However, that is no longer as impressive when you consider that booksellers’ websites now give you access to millions of e-book titles which can be downloaded directly to e-readers. (c) The authors say that the arrival of Apple’s iPad has huge implications for e-books. ITunes has more than 125 million customers. They represent a very wide potential audience for e-books. (d) Barnes and Noble earns about $12.50 on a $25 hardcover book. The same book, as an e-book, would sell for $12.99 and Barnes and Noble would earn $3.90. Obviously they can’t afford this decline unless they can dramatically reduce their fixed costs. (e) Barnes and Noble was one of the first companies to have an e-reader, called the Rocket e-book. However, it abandoned its e-reader in 2003 because sales of e-books had been very low. Four years later Amazon introduced its Kindle e-reader, which has been hugely popular. A second mistake was that Barnes and Noble was very slow to upgrade its website to encourage the sale of e-books. Again, Amazon was more than happy to fill the void.

BYP 18-5

COMMUNICATION ACTIVITY

To:

My Roommate

From:

Your Roommate

Subject:

Cost-Volume-Profit Questions

In response to your request for help, I provide you the following: (a) The mathematical formula for break-even sales is: Break-even Sales = Variable Costs + Fixed Costs Break-even sales in dollars is found by expressing variable costs as a percentage of unit selling price. For example, if the percentage is 70%, the break-even formula becomes X = .70X + Fixed Costs. The answer will be in sales dollars. Break-even sales in units is found by using unit selling price and unit variable costs in the formula. For example, if the selling price is $300 and variable costs are $210, the break-even formula becomes $300X = $210X + Fixed Costs. The answer will be in sales units. (b) The formulas for unit contribution margin and contribution margin ratio differ as shown below: Unit Selling Price – Unit Variable Costs = Unit Contribution Margin Unit Contribution Margin ÷ Unit Selling Price = Contribution Margin Ratio You can see that Unit CM is used in computing the CM ratio. (c) When contribution margin is used to determine break-even sales, total fixed costs are divided by either the contribution margin ratio or unit contribution margin. Using the CM ratio results in determining the break-even point in dollars. Using unit CM results in determining the break-even point in units.

BYP 18-5 (Continued) The formula for determining break-even sales in dollars is: Fixed Costs ÷ Contribution Margin Ratio = Break-even Sales in Dollars The formula for determining break-even sales in units is: Fixed Costs ÷ Unit Contribution Margin = Break-even Sales in Units I hope this memo answers your questions.

BYP 18-6

ETHICS CASE

(a) The stakeholders in this situation are: ⯈ Scott Bestor, accountant of Westfield Company. ⯈ The dislocated personnel of Westfield. ⯈ The senior management who made the decision. (b) Scott is hiding an error and is knowingly deceiving the company’s management with inaccurate data. (c) Scott’s alternatives are: ⯈ Keep quiet. ⯈ Confess his mistake to management. The students’ recommendations should recognize the practical aspects of the situation but they should be idealistic and ethical. If the students can’t be totally ethical when really nothing is at stake, how can they expect to be ethical under real-world pressures?

BYP 18-7

ALL ABOUT YOU

(a)

The variable gasoline cost of going one mile in the hybrid car would be $0.09 ($3.60/40). The variable gasoline cost of going one mile in the traditional car would be $0.12 ($3.60/30).

(b)

The savings per mile of driving the hybrid vehicle would be $0.03 ($0.12 – $0.09).

(c)

In order to break even on your investment, you would need to drive 150,000 miles. This is determined by dividing the additional fixed cost of $4,500 by the cost savings per mile of $0.03.

(d)

There are many other factors that you would want to consider in your analysis. For example, do the vehicles differ in their expected repair bills, insurance costs, licensing fees, or ultimate resale value. Also, some states and some employers offer rebates for the purchase of hybrid vehicles. In addition, your decision might be influenced by non-financial factors, such as a desire to reduce emissions.

CHAPTER 19 Cost-Volume-Profit Analysis: Additional Issues ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

A Problems

Apply basic CVP concepts.

1, 2, 3, 4, 5, 6

1, 2, 3, 4, 5

1A, 2A, 6A

Explain the term sales mix and its effects on break-even sales.

7, 8, 9

7, 8, 9, 10

6, 7, 8, 9, 10

Determine sales mix when a company has limited resources.

10, 11

11, 12

11, 12, 13

Indicate how operating leverage affects profitability.

12, 13, 14, 15, 16

13, 14, 15

14, 15, 16

5A, 6A

*5.

Explain the difference between absorption costing and variable costing.

17, 18, 19, 20, 21, 22

16, 17, 18, 19

17, 18, 19

7A, 8A

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compute break-even point under alternative courses of action.

Moderate

20–30

Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.

Moderate

20–30

Determine break-even sales under alternative sales strategies and evaluate results.

Moderate

20–30

Determine sales mix with limited resources.

Simple

10–15

Compute degree of operating leverage and evaluate impact of operating leverage on financial results.

Moderate

20–30

Determine contribution margin, break-even point, target sales, and degree of operating leverage.

Moderate

20–30

*7A

Prepare income statements under absorption costing and variable costing for a company with beginning inventory, and reconcile differences.

Moderate

20–30

*8A

Prepare absorption and variable costing income statements and reconcile differences between absorption and variable costing income statements when sales level and production level change. Discuss relative usefulness of absorption costing versus variable costing.

Moderate

20–30

ANSWERS TO QUESTIONS 1.

CVP or cost-volume-profit analysis is the study of the effects of changes in costs and volume on a company’s profit.

Managers use CVP analysis to make decisions involving break-even point, sales required to reach a target net income, margin of safety, the most profitable sales mix, allocation of limited resources, and operating leverage.

Both types of income statements report the same amount of net income. But the format used to reach net income differs. A traditional income statement’s format consists of: Sales revenue – cost of goods sold = gross profit; Gross profit – selling and administrative expenses = net income. A CVP income statement’s format consists of: Sales revenue – variable expenses = contribution margin; Contribution margin – fixed expenses = net income.

The CVP income statement isolates variable costs from fixed costs while the traditional income statement does not. The CVP format indicates contribution margin in total and frequently on a per unit basis as well. This format facilitates calculation of break-even point and target net income. It also highlights how changes in sales volume or cost structure affect net income.

WHEAT COMPANY CVP Income Statement Sales ........................................................................................................ Variable costs ($500,000 X .75) + ($200,000 X .75) ................................. Contribution margin ..................................................................................

$900,000 525,000 $375,000

If the selling price is reduced but variable and fixed costs remain unchanged, the break-even point will increase.

Sales mix is the relative percentage of each product sold when a company sells more than one product. Sales mix changes the calculation of the break-even point because the fixed costs must be divided by the weighted-average unit contribution margin.

The 150,000-mile tire has a higher unit contribution margin, that is, each tire sold covers a larger amount of fixed costs. Therefore, if the sales mix shifts away from the 150,000-mile tire to the 50,000-mile tire, the company will have to sell more total tires in order to break-even.

If a company has many products, the break-even point is calculated using sales information for divisions or product lines, rather than individual products. The weighted-average contribution margin ratio is computed by multiplying the sales mix percentage of each product line by the contribution margin ratio of each product line, and then summing the results. Total break-even sales in dollars is then calculated by dividing the company’s total fixed costs by the weightedaverage contribution margin ratio. Finally, to determine the amount of sales generated by each product line at the break-even point, multiply the total break-even sales by the sales mix percentage of each product line.

Questions Chapter 19 (Continued) 10. Contribution margin per unit of limited resource is determined by dividing the unit contribution margin of the product by the number of units of the limited resource required to produce the product. 11. The theory of constraints is a specific approach used to identify and manage constraints to achieve the company’s goals. According to this theory, a company must continually identify its constraints and find ways to reduce or eliminate them, where appropriate. Examples of constraints would be production bottlenecks or poorly trained workers. 12. Cost structure refers to the relative proportion of fixed costs versus variable costs that a company incurs. Companies that rely heavily on fixed costs will have higher break-even points. 13. Operating leverage refers to the extent to which a company’s net income reacts to a given change in sales. A company can increase its operating leverage by increasing its reliance on fixed costs. 14. Typically manual labor is considered a variable cost. Depreciation on factory equipment is a fixed cost. Therefore, if a company replaces manual labor with automated factory equipment it will increase its operating leverage, and increase its break-even point. 15. The degree of operating leverage is a measure of a company’s relative operating leverage. It is calculated by dividing the contribution margin by net income at a particular level of sales. 16. Pine’s degree of operating leverage of 8 versus Fir’s measure of 4 tells us that Pine will experience twice (8 ÷ 4) the increase (or decrease) in net income for a given increase (decrease) in sales as Fir. *17. Under absorption costing, both variable and fixed manufacturing costs are considered to be product costs. Under variable costing, only variable manufacturing costs are product costs and fixed manufacturing costs are expensed when incurred. *18. (a)

The rationale for variable costing centers on the purpose of fixed manufacturing costs, which is to have productive facilities available for use. Since these costs are incurred whether a company operates at zero or 100% capacity, it is argued that they should be expensed when they are incurred. Variable costing is useful in product costing internally by management and it is useful in controlling manufacturing costs. (b) Variable costing cannot be used for financial reporting purposes because it does not follow generally accepted accounting principles.

*19.

One way to compute the difference is as follows: Ending inventory 8,500

X Fixed manufacturing overhead cost per unit X $5

= $42,500

Absorption costing will report a $42,500 higher net income than variable costing because a portion of the fixed manufacturing overhead costs are deferred in inventory.

Questions Chapter 19 (Continued) *20. If production equals sales in any given period, the net incomes under both methods will be equal. In this case, there is no increase in the ending inventory. So fixed manufacturing overhead costs in the current period are not deferred to future periods through the ending inventory. *21. If production is greater than sales, absorption costing net income will be greater than variable costing net income. Absorption costing net income is higher because some of the fixed manufacturing overhead costs will be deferred in the inventory account until the products are sold. *22. In the long run, neither method will produce a higher net income amount. Over a long period of time, sales can never exceed production, nor production exceed sales by significant amounts. For this reason, over the lifetime of a corporation, variable costing and absorption costing will tend to yield the same net income amounts.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 19-1 1.

(a) (b)

$70 = ($250 – $180) 28% = ($70 ÷ $250)

$300 = ($500 – $200) 40% = ($200 ÷ $500)

(e) (f)

$1,100 = ($330 ÷ 30%) $770 = ($1,100 – $330)

BRIEF EXERCISE 19-2 HAMBY INC. Income Statement For the Quarter Ended March 31, 2017 Sales........................................................................ Variable expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total variable expenses.......................... Contribution margin............................................... Fixed expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total fixed expenses ............................... Net income..............................................................

$2,000,000 $760,000 95,000 79,000 934,000 1,066,000 600,000 60,000 66,000 726,000 $ 340,000

BRIEF EXERCISE 19-3 Contribution margin ratio = [($250,000 – $150,000) ÷ $250,000] = 40% Required sales in dollars = $120,000 ÷ 40% = $300,000

BRIEF EXERCISE 19-4 (a) $400Q = $250Q + $210,000 + $0 $150Q = $210,000 Q = 1,400 units (b) Unit contribution margin $150, or ($400 – $250) X = $210,000 ÷ $150 X = 1,400 units BRIEF EXERCISE 19-5 X = .70X + $210,000 + $60,000 .30X = $270,000 X = $900,000

BRIEF EXERCISE 19-6 Margin of safety = $1,200,000 – $960,000 = $240,000 Margin of safety ratio = $240,000 ÷ $1,200,000 = 20% BRIEF EXERCISE 19-7 Model A12 B22 C124

Sales Mix Percentage 60% 15% 25%

Unit Contribution Margin $15 ($50 – $35) $30 ($100 – $70) $100 ($400 – $300)

Weighted-Average Unit Contribution Margin $ 9.00 4.50 25.00 $38.50

BRIEF EXERCISE 19-8 Total break-even = ($269,500 ÷ $38.50*) = 7,000 units *Computed in BE 6-7 Sales Units Units of A12 = .60 X 7,000 = 4,200 Units of B22 = .15 X 7,000 = 1,050 Units of C124 = .25 X 7,000 = 1,750 7,000 BRIEF EXERCISE 19-9 (a)

(b)

Weighted-average contribution = margin ratio

(.30 X .20) + (.50 X .30) + ( .20 X .45) = .30

Total break-even point = in dollars

($450,000 ÷ .30) = $1,500,000

Birthday $1,500,000 X .30 = $ 450,000 Standard tapered $1,500,000 X .50 = 750,000 Large scented $1,500,000 X .20 = 300,000 $1,500,000 BRIEF EXERCISE 19-10 (a)

Sales Mix Bedroom Division $500,000 ÷ $1,250,000 = .40 Dining Room Division $750,000 ÷ $1,250,000 = .60

(b)

Weight-average contribution = $575,000 = .46 margin ratio $1,250,000 OR Contribution Margin Ratio Bedroom Division($275,000 ÷ $500,000) = .55 Dining Room Division($300,000 ÷ $750,000) = .40 Weighted-average contribution margin ratio = (.55 X .40) + (.40 X .60) = .46

BRIEF EXERCISE 19-11

Unit contribution margin (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]

Product A $10 2 $ 5

Product B $12 3 $ 4

Product 1 $ 42 .15 $280

Product 2 $ 32 .10 $320

BRIEF EXERCISE 19-12

Unit contribution margin (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]

Product 2 has a higher contribution margin per limited resource, even though it has a unit lower contribution margin. Given that machine hours are limited to 2,000 per month, Sage Corporation should produce Product 2. BRIEF EXERCISE 19-13 Degree of operating leverage (old) =

$200,000 ÷ $40,000 = 5

Degree of operating leverage (new) =

$240,000 ÷ $40,000 = 6

If Sam’s sales change, the resulting change in net income will be 1.2 times (6 ÷ 5) higher with the new machine than under the old system.

BRIEF EXERCISE 19-14 Break-even point in dollars: Diggs Co. $75,000 ÷ ($120,000 ÷ $200,000) = $125,000

Doggs Co. $105,000 ÷ ($150,000 ÷ $200,000) = $140,000

Doggs Company’s cost structure relies much more heavily on fixed costs than that of Diggs Co. As result, Doggs has a higher contribution margin ratio of .75 ($150,000 ÷ $200,000) versus .60 ($120,000 ÷ $200,000), for Diggs Co. Doggs also has much higher fixed costs to cover. Its break-even point is therefore higher than that of Diggs Co. BRIEF EXERCISE 19-15 Degree of operating leverage = Contribution margin ÷ Net income Montana Corp. 1.6 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 1.6 = $80,000 APK Co. 5.4 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 5.4 = $270,000 *BRIEF EXERCISE 19-16 Variable Costing Direct materials Direct labor Variable manufacturing overhead Total product costs

$14,400 25,600 29,400 $69,400

*BRIEF EXERCISE 19-17 Absorption Costing Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total product costs

$14,400 25,600 29,400 12,000 $81,400

*BRIEF EXERCISE 19-18 (a) Absorption Costing Direct materials................................................................ Direct labor....................................................................... Variable manufacturing overhead .................................. Fixed manufacturing overhead ($128,000 ÷ 8,000) ........ Total manufacturing cost per unit .................................. (b) Variable Costing Direct materials............................................... Direct labor...................................................... Variable manufacturing overhead ................. Total manufacturing cost per unit .................

$20 14 15 16 $65

$20 14 15 $49

*BRIEF EXERCISE 19-19 MEMO To:

Chief financial officer

From:

Student

Re:

Absorption and variable costing

Under absorption costing, fixed manufacturing overhead is a product cost, while under variable costing, fixed manufacturing overhead is a period cost (expensed as incurred). Since units produced (50,000) exceeded units sold (46,000) last month, income under absorption costing will be higher than under variable costing. Some fixed overhead (4,000 units X $4 = $16,000) will be assigned to ending inventory and therefore not expensed under absorption costing, whereas all fixed overhead is expensed under variable costing. Therefore, absorption costing net income will be higher than variable costing net income by $16,000.

SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 19-1 (a)

Break-even point in units is 7,500 units ($150,000 ÷ $20). Break-even point in sales dollars is $375,000 ($150,000 ÷ .40*). The margin of safety in dollars is $75,000 ($450,000 – $375,000). *$20 ÷ $50.

(b)

Break-even point in units is 8,333 units (rounded) ($150,000 ÷ $18*). Break-even point in sales dollars is $400,000 ($150,000 ÷ .375**). The margin of safety in dollars is $118,400 ($518,400*** – $400,000). *$50 – (.04 X $50) – 30 = $18. **$18 ÷ $48 = .375 ***9,000 + (.20 X 9,000) = 10,800 units, 10,800 units X $48 = $518,400 The increase in the break-even point from $375,000 to $400,000 indicates that management should not implement the proposed change while the increase in the margin of safety from $75,000 to $118,400 indicates that management should implement the proposed change. Since the expected 20% increase in sales volume will result in a contribution margin of $194,400 (10,800 X $18) which is only $14,400 more than the current amount, management should be cautious before reducing unit prices.

DO IT! 19-2 (a)

The sales mix percentages as a function of units sold is: Basic 750 ÷ 1,500 = 50%

Basic Plus 450 ÷ 1,500 = 30%

Premium 300 ÷ 1,500 = 20%

(b) The weighted-average unit contribution margin is: [.50 X ($250 – $195)] + [.3 X ($400 – $285)] + [.20 X ($800 – $415)] = $139.

(c)

The break-even point in units is: $180,700 ÷ $139 = 1,300 units.

DO IT! 19-2 (Continued) (d)

The break-even units to produce for each product are: Basic: 1,300 units X 50% = 650 units Basic Plus 1,300 units X 30% = 390 units Premium: 1,300 units X 20% = 260 units 1,300 units

DO IT! 19-3 (a)

The Best binoculars have the highest unit contribution margin. Thus, ignoring any manufacturing constraints, it would appear that the company should shift toward production of more Best units.

(b) The contribution margin per unit of limited resource is calculated as:

Unit contribution margin Limited resource consumed per unit

(c)

Good $40 .5 = $80

Better Best $150 $420 1.5 = $100 6 = $70

The Better binoculars have the highest contribution margin per unit of limited resource, even though they do not have the highest unit contribution margin. Given the resource constraint, any additional capacity should be used to make Better binoculars.

DO IT! 19-4 (a)

Old New

Contribution Margin $1,400,000 $2,300,000



Net Income

 

$400,000 $400,000

= =

Degree of operating Leverage 3.5 5.8

The degree of operating leverage measures the company’s sensitivity to changes in sales. By switching to a cost structure dominated by fixed costs, the company would significantly increase its operating leverage. As a result, with a percentage change in sales, its percentage change in net income would be 1.66 times as much (5.8 + 3.5) under the new structure as it would under the old.

SOLUTIONS TO EXERCISES EXERCISE 19-1 (a)

Contribution margin per room = Contribution margin per room = Contribution margin ratio =

$60 – ($8 + $34) $18 $18 ÷ $60 = 30%

Fixed costs = $10,600 + $2,400 + $1,500 + $800 = $15,300 Break-even point in rooms = $15,300 ÷ $18 = 850 2.

Break-even point in dollars

= =

850 rooms X $60 per room $51,000 per month

OR Fixed costs ÷ Contribution margin ratio = $15,300 ÷ .30 = $51,000 per month (b)

Margin of safety in dollars: Planned activity = 50 rooms per day X 30 days = 1,500 rooms per month Expected rental revenue = 1,500 rooms X $60 = $90,000 Margin of safety in dollars = $90,000 – $51,000 = $39,000

Margin of safety ratio:

$39,000 = 43% $90,000 (rounded)

EXERCISE 19-2 (a)

Contribution margin in dollars: Sales = 4,000 X $30 =

$120,000 Variable costs = $120,000 X .75 = 90,000 Contribution margin $ 30,000

Unit contribution margin: Contribution margin ratio:

$30 – $22.50 ($30 X 75%) = $7.50. $7.50 ÷ $30 = 25%.

EXERCISE 19-2 (Continued) (b)

Break-even sales in dollars:

$16,800 25%

Break-even sales in units:

$16,800

= $67,200. = 2,240.

$7.50 (c)

Margin of safety in dollars:

$120,000 – $67,200 = $52,800.

Margin of safety ratio:

$52,800 ÷ $120,000 = 44%.

EXERCISE 19-3 Current selling price = $325,000 ÷ 5,000 units Current selling price = $65 1.

Increase selling price to $71.50 ($65 X 110%). Net income = $357,500* – $210,000 – $75,000 = $72,500. *($71.50 X 5,000)

Reduce variable costs to 58% of sales. Net income = $325,000 – $188,500** – $75,000 = $61,500. **($325,000 X .58)

Reduce fixed costs to $60,000 ($75,000 – $15,000). Net income = $325,000 – $210,000 – $60,000 = $55,000.

Alternative 1, increasing unit sales price, will produce the highest net income.

EXERCISE 19-4 (a) 1. Contribution margin ratio is:

$30,000

= 62.5%

$48,000 Break-even point in dollars = 2. Round-trip ticket price =

$20,250 = $32,400 62.5% $48,000

= $120

400 flights Break-even point in flights =

$32,400

= 270 flights

$120 (b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $20,250. (c) Fare revenue ($108* X 500**) Variable costs ($18,000 X 1.25) Contribution margin Fixed costs Net income

$54,000 22,500 31,500 20,250 $11,250

Yes, the fare decrease should be implemented because net income increases to $11,250. *$120 – (.10 X $120) **400 + 100 EXERCISE 19-5 (a)

CAREY COMPANY CVP Income Statement For the Year Ended December 31, 2017

Sales (60,000 X $26) ...................................... Variable costs (60,000 X $15) ....................... Contribution margin (60,000 X $11) ............. Fixed costs .................................................... Net income.....................................................

Total $1,560,000 900,000 660,000 500,000 $ 160,000

Per Unit $26 15 $11

EXERCISE 19-5 (Continued) (b)

CAREY COMPANY CVP Income Statement For the Year Ended December 31, 2017

Sales [(60,000 X 105%) X $24.50*] ................ Variable costs (63,000 X $12.00**) ................ Contribution margin (63,000 X $12.50)......... Fixed costs ($500,000 + $100,000)................ Net income .....................................................

Total $1,543,500 756,000 787,500 600,000 $ 187,500

Per Unit $24.50 12.00 $12.50

*$26.00 – ($3 X 50%) = $24.50. **$15.00 – ($15 X 20%) = $12.00. EXERCISE 19-6

Lawnmowers Weed-trimmers Chainsaws

Sales Mix Percentage 20% 50% 30%

Unit contribution Margin $30 $20 $40

Weighted-Average Contribution Margin $ 6 10 12 $28

Total break-even sales in units = $4,200,000 ÷ $28 = 150,000 units

Lawnmowers Weed-trimmers Chainsaws Total units

Total Sales Mix Break-even Sales Percentage in Units 20% X 150,000 = 50% X 150,000 = 30% X 150,000 =

Sales Units Needed Per Product 30,000 units 75,000 units 45,000 units 150,000 units

EXERCISE 19-7 (a)

Oil changes Brake repair

Sales Mix Percentage 70% 30%

Contribution Margin Ratio 20% 40%

Weighted-Average Contribution Margin Ratio .14 .12 .26

Total break-even sales in dollars = $15,600,000 ÷ .26 = $60,000,000

Oil changes Brake repair Total sales

Sales Mix Percentage 70% X 30% X

Total Break-even Sales in Dollars $60,000,000 $60,000,000

= =

Sales Dollars Needed Per Product $42,000,000 18,000,000 $60,000,000

(b) Sales to achieve target net income = ($78,000 + $52,000) ÷ .26 = $500,000

Oil changes Brake repair Total sales

Sales Mix Percentage 70% X 30% X

Total Sales Needed $500,000 = $500,000 =

Sales Dollars Needed Per Product Per Store $350,000 150,000 $500,000

EXERCISE 19-8 (a)

Mail pouches and small boxes Non-standard boxes

Sales Mix Percentage

Contribution Margin Ratio

Weighted-Average Contribution Margin Ratio

80%

20%

.16

20%

70%

.14 .30

Total break-even sales in dollars = $12,000,000 ÷ .30 = $40,000,000

EXERCISE 19-8 (Continued) Total Breakeven Sales in Dollars

Sales Mix Percentage Mail pouches and small boxes Non-standard boxes Total sales

Sales Dollars Needed Per Product

80%

$40,000,000

$32,000,000

20%

$40,000,000

8,000,000 $40,000,000

(b)

Mail pouches and small boxes Non-standard boxes

Sales Mix Percentage

Contribution Margin Ratio

Weighted-Average Contribution Margin Ratio

40%

20%

.08

60%

70%

.42 .50

Total break-even sales in dollars = $12,000,000 ÷ .50 = $24,000,000 Total Breakeven Sales in Dollars

Sales Mix Percentage Mail pouches and small boxes Non-standardized boxes Total sales

Sales Dollars Per Product

40%

$24,000,000

$ 9,600,000

60%

$24,000,000

14,400,000 $24,000,000

EXERCISE 19-9 (a) Weighted-average unit contribution margin = ($40 X .35) + ($20 X .55) + ($60 X .10) = $31 Break-even point in units = $620,000 ÷ $31 = 20,000 (b) Shoes (20,000 X .35) = 7,000 pairs of shoes Gloves (20,000 X .55) = 11,000 pairs of gloves Range-finders (20,000 X .10) = 2,000 range-finders

EXERCISE 19-9 (Continued) (c) Shoes: 7,000 X $40 = $280,000 Gloves: 11,000 X $20 = 220,000 Range-finders: 2,000 X $60 = 120,000 Total contribution margin 620,000 Fixed costs 620,000 Net income $ 0 EXERCISE 19-10 (a) Sales mix percentage iPad division: $600,000 ÷ ($600,000 + $400,000) = .60 iPod division: $400,000 ÷ ($600,000 + $400,000) = .40 Contribution margin ratio: iPad division: $180,000 ÷ $600,000 = .30 iPod division: $140,000 ÷ $400,000 = .35 (b)

Weighted-average contribution = $320,000 = .32 margin ratio $1,000,000

Weighted-average contribution margin ratio = (.60 X .30) + (.40 X .35) = .32 (c) Break-even point in dollars = $120,000 ÷ .32 = $375,000 (d) Sales dollars needed at break-even point for each division iPad division: $375,000 X .60 = $225,000 iPod division: $375,000 X .40 = $150,000 EXERCISE 19-11 (a) A Unit contribution margin (a) Machine hours required (b) Contribution margin per unit of limited resource (a) ÷ (b)

6 2 $3.00

Product B $ $

2 1 2

C $

3 2 $1.50

(b) Product A should be manufactured because it results in the highest contribution margin per machine hour.

EXERCISE 19-11 (Continued) (c) 1. Machine hours (a) (3,000 ÷ 3) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]

Product A B 1,000 1,000 $ 3 $3,000

C 1,000

$ 2 $ 1.50 $2,000 $1,500

The total contribution margin = ($3,000 + $2,000 + $1,500) = $6,500. 2. Machine hours (a) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]

Product A 3,000 $ 3 $9,000

EXERCISE 19-12 (a) Product D: $30 ÷ $10 = 3.0 hours per unit Product E: $80 ÷ $10 = 8.0 hours per unit Product F: $35 ÷ $10 = 3.5 hours per unit (b) Selling price Variable costs Contribution margin Direct labor hours per unit Contribution margin per direct labor hour

D $200 125 75 ÷ 3.0

Product E $ 300 160 140 ÷ 8.0

F $250 180 70 ÷ 3.5

$ 25

$17.50

$ 20

Total direct labor hours available Contribution margin per direct labor hour Total contribution margin

Product D 2,000 X $25 $50,000

EXERCISE 19-13 (a)

Product Basic Deluxe $40 $ 52 22 24 $18 $ 28 .5 .8

Selling price per unit Variable costs per unit Unit contribution margin (a) Machine hours required (b) Contribution margin per machine hour (a) ÷ (b)

$36

$35

(b) The Basic product should be manufactured because it results in the higher contribution margin per machine hour. (c) 1. Machine hours allocated X Contribution margin per machine hour Contribution margin 2. Machine hours allocated X Contribution margin per machine hour Contribution margin

Basic 500

Deluxe 500

Total 1,000

$36 $18,000

$35 $17,500

$35,500

Basic 1,000

Deluxe –0–

Total 1,000

$36 $36,000

$35 –0–

$36,000

EXERCISE 19-14 (a) Armstrong Contador

Contribution Margin $260,000 $450,000

÷ ÷ ÷

Net Income $100,000 $100,000

Degree of Operating = Leverage = 2.60 = 4.50

Interpretation: Contador has a higher degree of operating leverage. Its earnings would increase (decrease) by a greater amount than Armstrong if each experienced an equal increase (decrease) in sales.

EXERCISE 19-14 (Continued) (b) Sales Variable costs Contribution margin Fixed costs Net income

Armstrong Company $550,000* 264,000** 286,000 160,000 $126,000

Contador Company $550,000 55,000*** 495,000 350,000 $145,000

*$500,000 X 1.1 **$240,000 X 1.1 ***$ 50,000 X 1.1 (c) Each company experienced a $50,000 increase in sales. However, because of Contador’s higher operating leverage, it experienced a $45,000 ($145,000 – $100,000) increase in net income while Armstrong experienced only a $26,000 ($126,000 – $100,000) increase. This is what we would have expected, since Contador’s degree of operating leverage exceeds that of Armstrong. EXERCISE 19-15 (a)

Manual system Computerized system

Contribution Margin $300,000

÷ ÷

Net Income $200,000

= =

Degree of Operating Leverage 1.50

$900,000

$200,000

4.50

(b) The computerized system would produce profits that are 3.0 times (4.50 ÷ 1.50) as much as the manual system. With a $150,000 increase in sales, net income would increase $30,000 ($230,000 – $200,000) under the manual system and $90,000 ($290,000 – $200,000) under the computerized system.

EXERCISE 19-15 (Continued) Manual System $1,650,000 1,320,000* 330,000 100,000 $ 230,000

Sales Variable costs Contribution margin Fixed costs Net income

Computerized System $1,650,000 660,000** 990,000 700,000 $ 290,000

*($1,200,000 ÷ $1,500,000) X $1,650,000 **($600,000 ÷ $1,500,000) X $1,650,000 (c) Manual system

(Actual Sales

–

Break-even Sales)

Actual Sales

Margin of Safety Ratio

($1,500,000

–

$500,000*)

$1,500,000

.67

($1,500,000

–

$1,166,667**)

$1,500,000

.22

Computerized system

*$100,000 ÷ ($300,000 ÷ $1,500,000) **$700,000 ÷ ($900,000 ÷ $1,500,000) The manual system could weather the greater decline in sales before reaching the break-even point. Under the manual system sales could drop 67% before suffering a loss, while sales under the computerized system could only decline by 22% before suffering a loss. EXERCISE 19-16 (a)

Contribution Margin ÷ Traditional Yams $ 80,000 ÷ Auto-Yams $240,000 ÷

Net Income $50,000 $50,000

= = =

Degree of Operating Leverage 1.60 4.80

Auto-Yams, which relies more heavily on fixed costs, has the higher degree of operating leverage, 4.8 versus 1.60. That means for every dollar of increase (decrease) in sales, Auto-Yams will generate 3 (4.80 ÷ 1.60) times more (less) in contribution margin and net income.

EXERCISE 19-16 (Continued) (b) % Change in Sales X

Degree of Operating Leverage

% Change in = Net Income

15% decrease: Traditional Yams Auto-Yams

(15%) (15%)

X X

1.60 4.80

= =

(24.0%) (72.0%)

10% increase: Traditional Yams Auto-Yams

10% 10%

X X

1.60 4.80

= =

16.0% 48.0%

(c) There are several possible answers that could be given. For example, if the candied Yams business is fairly stable, Auto-Yams might be the choice, because they will generate the higher contribution margin and net income. If, however, sales swing widely from year to year, Traditional Yams might be chosen because they will provide the more stable contribution margin and net income. Finally, if the investment banker is a risk taker, she might choose Auto-Yams in spite of year to year sales swings. EXERCISE 19-17 (a) Unit Cost Direct materials Direct labor Variable manufacturing overhead Manufacturing cost per unit

$ 7.50 3.45 5.80 $16.75

EXERCISE 19-17 (Continued) (b) SIREN COMPANY Income Statement For the Year Ended December 31, 2017 Variable Costing Sales (80,000 lures X $25) Variable cost of goods sold (80,000 lures X $16.75) Variable selling and administrative expenses (80,000 lures X $3.90) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net Income (loss)

$2,000,000 $1,340,000 312,000

1,652,000 348,000

225,000 210,100 $

435,100 (87,100)

(c) Unit Cost Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($225,000 ÷ 90,000) Manufacturing cost per unit

$ 7.50 3.45 5.80 2.50 $19.25

(d) SIREN COMPANY Income Statement For the Year Ended December 31, 2017 Absorption Costing Sales (80,000 lures X $25) Cost of goods sold (80,000 lures X $19.25) Gross profit Variable selling and administrative expenses (80,000 lures X $3.90) Fixed selling and administrative expenses Net Income

$2,000,000 1,540,000 460,000 $312,000 210,100

522,100 $ (62,100)

*EXERCISE 19-18 (a) Direct materials used Direct labor incurred Variable manufacturing overhead Variable manufacturing costs

$ 79,000 30,000 21,500 $130,500

Variable manufacturing cost per unit = $130,500 ÷ 9,000 = $14.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $14.50 = $11,600 (b) Absorption costing would show a higher net income because a portion of the fixed costs are deferred to future periods. The following computation indicates that finished goods inventory will be $4,000 higher under absorption costing which will cause its net income to be $4,000 higher. Direct materials used Direct labor incurred Variable manufacturing overhead Fixed manufacturing overhead Total manufacturing costs

$ 79,000 30,000 21,500 45,000 $175,500

Total manufacturing costs per unit = $175,500 ÷ 9,000 = $19.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $19.50 = $15,600 Inventory (absorption costing) Inventory (variable costing)

$15,600 11,600 $ 4,000

*EXERCISE 19-19 (a) Utility Expense Kilowatt Hourly Variable X = hours Charge Utilities

Months in a year

500

$0.50

Months in a year

Monthly Fee

Fixed Utilities

$1,500

= $18,000

$3,000

*EXERCISE 19-19 (Continued) Variable Costing Labor: Crate builders Material: Wood Variable Overhead: Utilities Nails Total manufacturing costs

$43,000 54,000 3,000 350 $100,350

(b) Absorption Costing Labor: Crate builders Material: Wood Variable overhead: Utilities Nails Fixed overhead: Utilities Rent Total manufacturing costs

$ 43,000 54,000 3,000 350 18,000 21,400 $139,750

(c) The entire difference in costs between the two methods is due to the fact that fixed overhead is included as part of manufacturing costs only under the absorption costing method. This difference amounts to $39,400 ($18,000 + $21,400).

SOLUTIONS TO PROBLEMS PROBLEM 19-1A (a) Sales were $2,000,000 and variable expenses were $1,200,000, which means contribution margin was $800,000 and CM ratio was .40. Fixed expenses were $1,035,000. Therefore, the break-even point in dollars is: $1,035,000 = $2,587,500 .40 (b) 1. The effect of this alternative is to increase the selling price per unit to $31.25 ($25 X 125%). Total sales become $2,500,000 (80,000 X $31.25). Thus, contribution margin ratio changes to 52% [($2,500,000 – $1,200,000) ÷ $2,500,000]. The new break-even point is: $1,035,000 = $1,990,385 (rounded) .52 2.

The effects of this alternative are: (1) fixed costs decrease by $160,000, (2) variable costs increase by $100,000 ($2,000,000 X 5%), (3) total fixed costs become $875,000 ($1,035,000 – $160,000), and the contribution margin ratio becomes .35 [($2,000,000 – $1,200,000 – $100,000) ÷ $2,000,000]. The new break-even point is: $875,000

= $2,500,000

.35 3.

The effects of this alternative are: (1) variable and fixed cost of goods sold become $784,000 each, (2) total variable costs become $934,000 ($784,000 + $92,000 + $58,000), (3) total fixed costs are $1,301,000 ($784,000 + $425,000 + $92,000) and the contribution margin ratio becomes .533 [($2,000,000 – $934,000) ÷ $2,000,000]. The new break-even point is: $1,301,000 = $2,440,901 (rounded) .533

Alternative 1 is the recommended course of action using break-even analysis because it has the lowest break-even point.

PROBLEM 19-2A

(a) (1) Current Year $1,500,000

Sales Variable costs Direct materials Direct labor Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .40) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

Sales

Current Year $1,500,000 X 1.1

Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin

511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000

X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1

Projected Year $1,650,000 562,100 319,000 269,500 110,000 59,400 1,320,000 $ 330,000

(2) Fixed Costs Current Year Manufacturing overhead ($350,000 X .30) $105,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $471,000

Projected year $105,000 150,000 216,000 $471,000

PROBLEM 19-2A (Continued) (b) Unit selling price = $1,500,000 ÷ 100,000 = $15 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $15 – $12 = $3 Contribution margin ratio = $3 ÷ $15 = .20 Break-even point in units 157,000 units

= Fixed costs = $471,000

÷ ÷

Unit contribution margin $3.00

Break-even point in dollars $2,355,000

= Fixed costs = $471,000

÷ ÷

Contribution margin ratio .20

+ Target net income)

÷ Contribution margin ratio

$3,355,000

($471,000

(d) Margin of safety ratio 29.8%

$200,000)

.20

= (Expected sales

– Break-even sales)

÷ Expected sales

–

($3,355,000

$2,355,000)

(e) (1) Sales Variable costs Direct materials Direct labor ($290,000 – $104,000) Manufacturing overhead ($350,000 X .30) Selling expenses ($250,000 X .90) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin

Current Year $1,500,000 511,000 186,000 105,000 225,000 54,000 1,081,000 $ 419,000

$3,355,000

PROBLEM 19-2A (Continued) Fixed cost Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .10) Administrative expenses ($270,000 X .80) Total fixed costs

$245,000 25,000 216,000 $486,000

(2) Contribution margin ratio = $419,000 ÷ $1,500,000 = .28 (rounded) (3) Break-even point in dollars = $486,000 ÷ .28 = $1,735,714 (rounded) The break-even point in dollars declined from $2,355,000 to $1,735,714. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission-based approach to compensate its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) which would increase the break-even point.

PROBLEM 19-3A (a)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage 15% 50% 10% 25%

Total sales required to achieve target net income =

Appetizers Main entrees Desserts Beverages

X X X X X

Contribution Margin Ratio = 50% = 25% = 50% = 80% =

Weighted-Average Contribution Margin Ratio .075 .125 .050 .200 .450

( $1,053,000 + $117,000 ) ÷ .45 = $2,600,000

Sales Mix Percentage X 15% X 50% X 10% X 25% X

Total Sales Needed $2,600,000 $2,600,000 $2,600,000 $2,600,000

= = = = =

Sales from Each Product $ 390,000 1,300,000 260,000 650,000 $2,600,000

(b)

Appetizers Main entrees Desserts Beverages

Sales Mix Contribution Percentage X Margin Ratio = 25% X 50% = 25% X 10% = 10% X 50% = 40% X 80% =

Total sales required to achieve target net income = *$1,053,000 + $585,000

Weighted-Average Contribution Margin Ratio .125 .025 .050 .320 .520

( $1,638,000* + $117,000) ÷ .52 = $ 3,375,000

PROBLEM 19-3A (Continued) Thus, sales would have to increase by $775,000 ($3,375,000 – $2,600,000) to achieve the target net income. This increase in sales is driven by the increase in fixed costs. The sales of each product line would be:

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage X 25% X 25% X 10% X 40% X

Total Sales Needed $3,375,000 $3,375,000 $3,375,000 $3,375,000

= = = = =

Sales from Each Product $ 843,750 843,750 337,500 1,350,000 $3,375,000

(c)

Appetizers Main entrees Desserts Beverages

Sales Mix Percentage X 15% X 50% X 10% X 25% X

Contribution Margin Ratio 50% 10% 50% 80%

= = = = =

Weighted-Average Contribution Margin Ratio .075 .050 .050 .200 .375

The weighted-average contribution margin ratio computed in part (a) was 45%. With the contribution margin ratio on entrees falling to 10%, that average will now be 37.5% as shown previously. Applying this to the new fixed costs of $1,638,000 and target net income of $117,000 we get: Total sales required to achieve target net income

Appetizers Main entrees Desserts Beverages

($1,638,000 + $117,000) ÷ .375 = $ 4,680,000

Sales Mix Percentage 15% 50% 10% 25%

X X X X X

Total Sales Needed $4,680,000 $4,680,000 $4,680,000 $4,680,000

= = = = =

Sales from Each Product $ 702,000 2,340,000 468,000 1,170,000 $4,680,000

Relative to parts (a) and (b), the total required sales for (c) would increase. It appears that the least risky approach would be for Paul to switch to the new sales mix, but not to incur the additional fixed costs of expanding operations. If the switch in sales mix appears to be successful, then it may be appropriate for him to incur the additional fixed costs necessary for expansion of operations.

PROBLEM 19-4A

(a) Selling price Less: Variable costs Unit contribution margin

Economy $30 16 $14

Product Standard $50 20 $30

Deluxe $100 46 $ 54

Ignoring the machine time constraint, the Deluxe product should be produced because it has the highest unit contribution margin. (b) Unit contribution margin (a) Machine hours required (b) Contribution margin per limited resource (a)/(b)

Economy $14 .5

Product Standard $ 30 .8

Deluxe $ 54 1.6

$28

$37.50

$33.75

(c) If additional machine hours become available, the additional time should be used to produce the Standard product since it has the highest contribution margin per machine hour.

PROBLEM 19-5A (a) To determine the break-even point in dollars we must first calculate the contribution margin ratio for each company.

Blanc Company Noir Company

Contribution ÷ Margin $220,000 ÷ $320,000 ÷

Sales $500,000 $500,000

Blanc Company Noir Company

Fixed Costs $170,000 $270,000

Contribution Margin Ratio .44 .64

Blanc Company Noir Company

÷ ÷ ÷

(Actual Sales – Break-even Sales) ($500,000 – $386,364) ($500,000 – $421,875)

Contribution Margin = Ratio = .44 = .64 = = =

÷ Actual Sales ÷ $500,000 ÷ $500,000

Break-even Point in Dollars $386,364 $421,875 = = =

Margin of Safety Ratio .227 .156

(b)

Blanc Company Noir Company

Contribution Margin $220,000 $320,000

÷ ÷ ÷

Net Income $50,000 $50,000

Degree of Operating = Leverage = 4.4 = 6.4

Because Noir Company relies more heavily on fixed costs, it has a higher degree of operating leverage. This means that its net income will be more sensitive to changes in sales. For a given change in sales, the change in net income will be 1.45 (6.4 ÷ 4.4) times higher for Noir Company than for Blanc Company. (c) Sales Variable costs Contribution margin Fixed costs Net income *$500,000 X 1.2 **$280,000 X 1.2 ***$180,000 X 1.2

Blanc Company $600,000* 336,000** 264,000 170,000 $ 94,000

Noir Company $600,000 216,000*** 384,000 270,000 $114,000

PROBLEM 19-5A (Continued) (d) Sales Variable costs Contribution margin Fixed costs Net income (Loss)

Blanc Company $400,000* 224,000** 176,000 170,000 $ 6,000

Noir Company $400,000 144,000*** 256,000 270,000 ($ 14,000)

*$500,000 X .80 **$280,000 X .80 ***$180,000 X .80 (e) In part (b) the degree of operating leverage of Noir Company was higher than that of Blanc Company, telling us that the net income of Noir Company was more sensitive to changes in sales than that of Blanc Company. In part (c) we see that a 20% increase in sales increased the net income of Noir Company by $64,000 ($114,000 – $50,000), while the net income of Blanc Company increased by only $44,000 ($94,000 – $50,000). However, in part (d) we see that a 20% decrease in sales resulted in a $64,000 ($50,000 + $14,000) decline in net income for Noir Company, while Blanc Company’s net income only declined by $44,000 ($50,000 – $6,000). The increased risk caused by higher operating leverage is also seen in part (a). Noir Company has a higher break-even point, and a lower margin of safety ratio than Blanc Company. Thus, while operating leverage can be very beneficial for a company that expects its sales to increase, it can also significantly increase a company’s risk.

PROBLEM 19-6A

(a) Reformat the income statement to CVP format. All amount are in $000s. Sales ......................................................... Variable costs ($31,500 + $13,500).......... Contribution margin ................................ Less: Fixed costs ($8,610 + $10,260) ..... Operating income ....................................

$75,000 45,000 30,000 18,870 $11,130

Contribution margin ratio = $30,000 ÷ $75,000 = 40% Break-even point = $18,870 ÷ 40% = $47,175 (b) If a hired workforce replaces sales agents, commissions will be reduced to 8% of sales, or $6,000; but fixed costs will increase by $7,500. Sales ......................................................... Variable costs ($31,500 + $6,000)............ Contribution margin ................................ Less: Fixed costs ($18,870* + $7,500) ... Operating income ....................................

$75,000 37,500 37,500 26,370 $11,130

*($8,610 + $10,260) Contribution margin ratio = $37,500 ÷ $75,000 = 50% Break-even point = $26,370 ÷ 50% = $52,740 (c) Operating leverage = contribution margin ÷ operating income (1) Current situation: from part (a) $30,000 ÷ $11,130 = 2.70 (2) Proposed situation: from part (b) $37,500 ÷ $11,130 = 3.37

PROBLEM 19-6A (Continued) The calculations indicate that at a sales level of $75 million, a percentage change in sales and contribution margin will result in 2.70 times that percentage change in operating income if Bonita continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.37 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Bonita employing their own agents gives them more operating leverage. This will result in greater benefits (increases in operating income) if revenues increase, but greater risks (decreases in operating income) if revenues decline. (d) The sales level at which operating incomes will be identical is called the point of indifference. This would be when the cost of the network of agents (18% of sales) is exactly equal to the cost of paying employees 8% commission along with additional fixed costs of $7.5 million. None of the other costs is relevant, because they will not change between alternatives. Let the sales volume = S 18% X S = (8% X S) + $7,500,000 .18S = .08S + $7,500,000 .10S = $7,500,000 S = $75,000,000

*PROBLEM 19-7A

(a)

JACKSON COMPANY Income Statement For the Year Ended December 31, 2016 Variable Costing Sales (3,500 tons X $2,000) ......................... Variable cost of goods sold Inventory, January 1 ............................ Variable cost of goods manufactured [4,000 tons X ($2,000 X .15)] ............ Variable cost of goods available for sale .............................................. Inventory, December 31 [500 tons X ($2,000 X .15)] .............. Variable cost of goods sold ................ Variable selling expenses [3,500 tons X ($2,000 X .10)] ............ Contribution margin .................................... Fixed manufacturing overhead................... Fixed administrative expenses ................... Net income ...................................................

$7,000,000 $

–0–

1,200,000 1,200,000 150,000 1,050,000 700,000 2,800,000 500,000

1,750,000 5,250,000 3,300,000 $1,950,000

*PROBLEM 19-7A (Continued) JACKSON COMPANY Income Statement For the Year Ended December 31, 2017 Variable Costing Sales (4,000 tons X $2,000) ........................... Variable cost of goods sold Inventory, January 1 .............................. Variable cost of goods manufactured [3,500 tons X ($2,000 X .15)] .............. Variable cost of goods available for sale ................................................ Inventory, December 31 ......................... Variable cost of goods sold................... Variable selling expenses [4,000 tons X ($2,000 X .10)] .............. Contribution margin ...................................... Fixed manufacturing overhead ..................... Fixed administrative expenses ..................... Net income ..................................................... (b)

$8,000,000 $ 150,000 1,050,000 1,200,000 –0– 1,200,000 800,000 2,800,000 500,000

2,000,000 6,000,000 3,300,000 $2,700,000

JACKSON COMPANY Income Statement For the Year Ended December 31, 2016 Absorption Costing Sales (3,500 tons X $2,000) ...................... Cost of goods sold Inventory, January 1 ......................... Cost of goods manufactured............ Cost of goods available for sale....... Inventory, December 31 .................... Cost of goods sold............................ Gross profit ............................................... Variable selling expenses [3,500 tons X ($2,000 X .10)] ................. Fixed administrative expenses ................ Net income ................................................

$7,000,000 $ –0– 4,000,000 (1) 4,000,000 500,000 (2) 3,500,000 3,500,000 700,000 500,000

(1) 4,000 X [($2,000 X .15) + ($2,800,000 ÷ 4,000)] (2) 500 X [($2,000 X .15) + ($2,800,000 ÷ 4,000)]

1,200,000 $2,300,000

*PROBLEM 19-7A (Continued) JACKSON COMPANY Income Statement For the Year Ended December 31, 2017 Absorption Costing Sales (4,000 tons X $2,000) .................. $8,000,000 Cost of goods sold Inventory, January 1 ..................... $ 500,000 Cost of goods manufactured......... 3,850,000 (1) Cost of goods available for sale ... 4,350,000 Inventory, December 31................ –0– Cost of goods sold........................ 4,350,000 Gross profit ........................................... 3,650,000 Variable selling expenses [4,000 tons X ($2,000 X .10)] ............. 800,000 Fixed administrative expenses ............ 500,000 1,300,000 Net income ............................................ $2,350,000 (1) 3,500 X [($2,000 X .15) + ($2,800,000 ÷ 3,500)] (c) The variable costing and the absorption costing net income can be reconciled as follows: 2016

2017

Variable costing net income $1,950,000 Fixed manufacturing overhead expensed with variable costing $2,800,000 Less: Fixed manufacturing overhead expensed with absorption costing (2,450,000)(1) Difference 350,000 Absorption costing net income $2,300,000



In 2016, with absorption costing $2,450,000  $2, 800, 000 X

(1)



$2,700,000 $2,800,000 (3,150,000)(2) (350,000) $2,350,000

  of the 4, 000 units produced  3, 500 units sold

fixed manufacturing overhead is expensed as part of cost of goods sold, and $350,000 500 units in inventory   $2, 800, 000 X   is included in the ending inventory. 4, 000 units produced   (2)

In 2017, with absorption costing $3,150,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2017 of $2,800,000 plus $350,000 of fixed manufacturing overhead from 2016 that was included in the beginning inventory for 2017.

*PROBLEM 19-7A (Continued) (d) Income parallels sales under variable costing as seen in the increase in net income in 2017 when 500 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2016 when production exceeded sales by 500 tons.

*PROBLEM 19-8A (a)

DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2017 Absorption Costing

Sales (60,000 units X $30) Cost of goods sold (60,000 units X $21) Gross profit Variable selling and administrative expenses (60,000 units x $2) Fixed selling and administrative expenses Net income

60,000 Produced $1,800,000 1,260,000 540,000

90,000 Produced $1,800,000 (60,000 X $18)

1,080,000 720,000

120,000

50,000 $ 370,000

50,000 $ 550,000

(b) DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2017 Variable Costing

Sales (60,000 units X $30) Variable cost of goods sold (60,000 units X $12) Variable selling and administrative expenses (60,000 units X $2) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net income

60,000 Produced $1,800,000

90,000 Produced $1,800,000

720,000

120,000 960,000 540,000

50,000 $ 370,000

*PROBLEM 19-8A (Continued) (c) If the company produces 90,000 units, but only sells 60,000 units, then 30,000 units will remain in ending inventory. Under absorption costing these 30,000 units will each include $6 of fixed manufacturing overhead—a total of $180,000. However, under variable costing, fixed manufacturing overhead is expensed when incurred. This accounts for the $180,000 difference ($550,000 – $370,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing overhead included in ending inventory (30,000 units X $6) Net income under variable costing

$550,000 180,000 $370,000

(d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. (1) The use of variable costing is consistent with cost-volume-profit and incremental analysis. (2) Net income computed under variable costing is unaffected by changes in production levels. Note that, under variable costing the company’s net income is $370,000 no matter what the level of production is. (3) Net income computed under variable costing is closely tied to changes in sales levels (not production levels), and therefore provides a more realistic assessment of the company’s success or failure during a period. (4) The presentation of fixed and variable cost components on the face of the variable costing income statement makes it easier to identify these costs and understand their effect on the business. Under absorption costing, the allocation of fixed costs to inventory makes it difficult to evaluate the impact of fixed costs on the company’s results.

CD 19

CURRENT DESIGNS

(a)

Rotomolded Kayaks (($950 – $570) X .80) (b)

Composite Kayaks = (($2,000 – $1,340) X .20)

Break-even Sales = $820,000 ÷ $436 = 1,881 units Break-even Sales Distribution:

(c)

Weighted Average Unit Contribution Margin $436

Rotomolded Kayaks = 1,881 X 80% = 1,505 units Composite Kayaks = 1,881 X 20% = 376 units

Target Net Income in Units:

Rotomolded Kayaks + ($380 X .70)

Composite Kayaks ($660 X .30)

Weighted-Average CM/Unit $464

Required Sales in Units = ($820,000 + $2,000,000) ÷ $464 = 6,078 units Required Sales Distribution:

(d)

Rotomolded Kayaks = 6,078 X 70% = 4,255 units Composite Kayaks = 6,078 X 30% = 1,823 units

CVP Income Statement

Sales Variable Costs Contribution Margin Fixed Costs Net Income *($570 ÷ $950) X $2,000,000

Rotomolded $2,000,000 1,200,000* 800,000 660,000 $ 140,000

Composite $1,000,000 670,000** 330,000 160,000 $ 170,000

**($1,340 ÷ $2,000) X $1,000,000

CD 19 (Continued) (e)

Degree of Operating Leverage Rotomolded Kayaks = $800,000 ÷ $140,000 = 5.71 Composite Kayaks = $330,000 ÷ $170,000 = 1.94 At a sales mix of 2/3 to 1/3, the degree of operating leverage is nearly three times as high for the rotomolded kayaks as it is for the composite kayaks. This means that the company’s net income will respond more quickly to a change in the sales of rotomolded kayaks than to composite kayaks. For example, an increase in sales of the rotomolded kayaks will increase the company’s net income at a faster rate than an increase in the sales of the composite kayaks. This result will differ depending on what sales mix assumption is made.

BYP 19-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) Sales (10,000 seats X $500) Variable costs (10,000 seats X $200) Contribution margin Fixed costs Net income (b)

$5,000,000 2,000,000 3,000,000 2,000,000 $1,000,000

Contribution margin ratio = $3,000,000 ÷ $5,000,000 = .60 Break-even point in dollars = $2,000,000 ÷ .60 = $3,333,333 Margin of safety ratio = ($5,000,000 – $3,333,333) ÷ $5,000,000 = .333 Degree of operating leverage = $3,000,000 ÷ $1,000,000 = 3.0

(c)

Sales (10,000 seats X $500) Variable costs (10,000 seats X $ 100) Contribution margin Fixed costs Net income (d)

$5,000,000 1,000,000 4,000,000 3,000,000 $1,000,000

Contribution margin ratio = $4,000,000 ÷ $5,000,000 = .80 Break-even point in dollars = $3,000,000 ÷ .80 = $3,750,000 Margin of safety ratio = ($5,000,000 – $3,750,000) ÷ $5,000,000 = .25 Degree of operating leverage = $4,000,000 ÷ $1,000,000 = 4.00

(e)

By automating its manufacturing process the company will replace some of its variable costs with fixed costs. This shift toward more fixed costs will increase its break-even point from $3,333,333 to $3,750,000 and reduce its margin of safety from 33.3% to 25%. This means that under the old system sales could fall by 33.3% percent before the company would operate at a loss, whereas under the automated system they could only fall by 25%. Both of these findings suggest that the company would be riskier with the automated system. However, the company’s degree of operating leverage would increase from 3.0 to 4.00. This means that with a change in sales, the change in net income would be 1.33 (4 ÷ 3) times higher under the automated system. This would be good if the company expects sales to increase, but would be bad if the company’s sales fall.

BYP 19-2

(a)

MANAGERIAL ANALYSIS

The contribution margin ratios under each approach are: Current approach Automated approach

$500,000/$2,000,000 $1,000,000/$2,000,000

= .25 = .50

This means that for every dollar of sales, net income goes up by 25 cents under the current approach, but by $.50 under the automated approach. (b)

The break-even points in sales dollars under each approach are: Current approach Automated approach

$380,000/.25 $800,000/.50

= =

$1,520,000 $1,600,000

This shows that, under the automated approach, the company’s sales would have to be 5.26% higher just to break-even. (c)

At the current level of sales, the margin of safety ratio under each approach is: Current approach Automated approach

($2,000,000 – $1,520,000)/$2,000,000 ($2,000,000 – $1,600,000)/$2,000,000

= .24 = .20

The company has a low margin of safety under either approach. Under the current approach sales could drop 24% before the company would be operating at a loss. Under the automated approach the company’s sales could drop by 20% before it would be operating at a loss. (d)

The degree of operating leverage under each approach at the current level of sales is: Current approach Automated approach

$500,000/$120,000 $1,000,000/$200,000

= =

4.17 5.00

This means that for a 10% drop in sales net income would drop by 41.7 percent for the current approach, but 50% for the automated approach. Recall, however, that at the current level of sales the company makes considerably more money using the automated approach.

BYP 19-2 (Continued) (e)

In order to solve for the sales level where net income would be equal under either approach, set the two CVP equations equal to each other and solve for sales: Sales – ((1 – .75) X Sales) – $380,000 = Sales – ((1 – .5) X Sales) – $800,000 (.25 X Sales) – $380,000 = (.5 X Sales) – $800,000 (.25 X Sales) = $420,000 Sales = $1,680,000

When sales are equal to $1,680,000 the company would make the same amount of income under either approach. Current approach Automated approach

(f)

$1,680,000 – [(1 – .25) X $1,680,000] – $380,000 = $40,000 $1,680,000 – [(1 – .5) X $1,680,000] – $800,000 = $40,000

Based upon this numeric analysis it would appear that the decision to purchase the automated system would be a good decision. The current level of sales far exceeds the break-even point, and, unless sales were to fall all the way to $1,680,000, the company would be better off under the automated system. However, there are many difficult issues that should also be considered. Not-the-least of these is the decision to lay-off 15 employees, many of whom have likely been with the company for a long time. Also, the company should carefully evaluate whether the automated system will be able to attain the same level of quality as the skilled employees. Perhaps the automated system would be more appropriate for some of the painting work, while skilled labor would be more appropriate for other painting work.

BYP 19-3

REAL-WORLD FOCUS

(a)

Sales Variable costs Contribution margin

Consumer Products $1,031.8 610.0 $ 421.8

Pet Products $ 837.3 350.0 $ 487.3

Soup and Infant-Feeding Products $ 302.0 100.0 $ 202.0

Contribution margin ÷ Sales Contribution margin ratio

$ 421.8 1,031.8 40.9%

$ 487.3 837.3 58.2%

$ 202.0 302.0 66.9%

Division sales ÷ Total sales Sales mix percentage

$1,031.8 2,171.1 47.5%

$ 837.3 2,171.1 38.6%

$ 302.0 2,171.1 13.9%

($ in millions)

(b)

Consumer products Pet products Soup and infant-feeding products Break-even point in dollars

Consumer products Pet products Soup and infantfeeding products Total sales *Sales are rounded

Weighted-Average Sales Mix Contribution Contribution Percentage X Margin Ratio = Margin Ratio 47.5% 40.9% .194 38.6% 58.2% .225 13.9%

66.9%

.093 .512

$860,300,000 ÷ .512 = $1,680,273,438 Sales Mix Percentage X Total Sales = 47.5% X $1,680,273,438 = 38.6% X $1,680,273,438 = 13.9%

X $1,680,273,438 =

Sales from Each Product* $ 798,129,883 648,585,547 233,558,008 $1,680,273,438

BYP 19-4

REAL-WORLD FOCUS

(a) The four primary product lines are FedEx Express (provides express transportation); FedEx Ground (small package ground delivery); FedEx Freight (regional, less-than-truckload freight service); and FedEx Services (Sales, information technology, communications). The key factors affecting operating results are overall customer demand, the volumes of shipments transported through networks; the mix of services purchased by customers; the prices obtained for services; ability to manage cost structure for capital expenditures and operating expenses; ability to match operating costs to shifting volumes; and the timing and amount of fluctuations in fuel prices and our ability to recover incremental fuel costs through our fuel surcharges. (b) FEDEX GROUND Income Statement For the Year Ended May 31, 2013 Variable Costing (In Millions) Revenues...................................................... Variable costs: Salaries and employee benefits............. Purchased transportation ...................... Fuel .......................................................... Maintenance and repairs ........................ Intercompany charges............................ Contribution margin ............................... Fixed costs: Rentals..................................................... Depreciation and amortization............... Other ........................................................ Net income ...................................................

$10,578 $1,586 4,191 17 190 1,148 331 434 893

7,132 3,446

1,658 $1,788

Contribution Margin $3,446

÷ ÷

Revenues $10,578

= =

Contribution Margin Ratio 32.6%

Fixed Costs $1,658

÷ ÷

Contribution Margin Ratio .326

= =

Break-even Point in Dollars $5,085.9 million

BYP 19-4 (Continued) (c) (i) 2013 FedEx Express FedEx Ground FedEx Freight FedEx Services Total

(ii) FedEx Express FedEx Ground FedEx Freight

$27,171 ÷ $44,730 = 60.7% 10,578 ÷ $44,730 = 23.6% 5,401 ÷ $44,730 = 12.1% 1,580 ÷ $44,730 = 3.5% $44,730

2013 2.0% 16.9% 3.9%

2011 $24,581 ÷ $39,661 = 62.0% 8,485 ÷ $39,661 = 21.4% 4,911 ÷ $39,661 = 12.4% 1,327 ÷ $39,661 = 4.2% $39,661

2011 5.0% 15.6% (3.6)%

(iii) In part (ii) we see that the FedEx Express’s operating margin declined, but the other two increased. We also see in part (ii) that FedEx Express had the lowest operating margin in 2013 (2.0%) while FedEx Ground had the highest (16.9%). In part (i) we see that the company shifted its sales mix percentage down in FedEx Express (62.0% to 60.7%) and FedEx Services but increased its sales mix percentage for FedEx Ground (21.4% to 23.6%) and FedEx Freight (12.4% to 12.1%). Thus, during this period two of the company’s divisions became more profitable, and the company successfully shifted its sales mix so that more of its revenue came from its more profitable divisions.

BYP 19-5

REAL-WORLD FOCUS

(a) Smart Balance relies very heavily on outsourcing. It keeps it employees and investments in fixed assets to a minimum. As a consequence it has very low fixed costs. (b) The company keeps new-product development and marketing in house. (c) The potential advantage of having very low fixed costs is that the company has a lower break-even point. It can be profitable at relatively low volumes of sales and therefore it has less potential for financial failure. (d) The potential disadvantage of this approach is that its low fixed costs means that the company has low operating leverage. If the company’s sales increase significantly, it would not enjoy the same increase in profitability as a company that was producing its own goods.

BYP 19-6

COMMUNICATION ACTIVITY

MEMO To:

Bjorn Borg—CEO

From:

Student

Re:

Best use of limited resources

I share your concern, that, since we are operating at full capacity, we need to ensure that our product mix maximizes our profitability. The decision of how to best utilize our limited productive resources is one of the most important decisions we face. We currently make two different anchors, a traditional fishing anchor, and a high-end yacht anchor. The unit contribution margin of the yacht anchor is three times that of the fishing anchor, thus one might logically assume that we should shift our production toward producing the yacht anchor. However, this assumption ignores an element that is critical to the decision. In order to make a proper decision, we would need to know the contribution margin per unit of limited resource that each product produces. While the yacht anchor has a very high contribution margin, it also may consume considerably more productive resources. I propose that a study be done to determine exactly how much of the limited productive resource is consumed by one unit of each of the two anchor types. In addition, at the same time that this study is being undertaken, I propose that the marketing department undertake a study of the demand for each anchor type. This is important so that we don’t produce anchors that we can’t sell. Finally, a shift in our product mix would maximize our profitability at our current level of productive capacity. However, we should also consider a more long-term solution to our production constraints. Since we have been operating at, or near full capacity for two years, it would seem appropriate to undertake a study of whether an acquisition of additional plant equipment would be appropriate.

*BYP 19-7

ETHICS CASE

(a) The division’s net income increased by $225,000 ($525,000 – $300,000). This represents a 75% increase over the previous year ($225,000 ÷ $300,000). Thus Brett’s bonus would be 75 X $5,000 = $375,000. (b) In 2016 the number of units produced and sold were equal. When this occurs variable costing and absorption costing provide the same results. Thus, in 2016, net income under variable costing would have been $300,000. In 2017, units produced exceeded units sold by 5,000 units. However, net income under variable costing is not impacted by the number of units produced. Since the number of units sold did not change from 2016 to 2017, and the selling price, variable cost per unit, and total fixed costs didn’t change, the division’s net income in 2017 would equal its 2016 income of $300,000. (c) In part (b) it was determined that the division’s net income would have been $300,000 in 2017 under variable costing. Since this is the same as 2016 net income, Brett would not receive a bonus. (d) If Brett intentionally overproduced inventory in order to increase his bonus, then his actions were unethical. Overproduction of inventory increases the company’s costs related to inventory, such as storage, handling, waste and theft. Based on the information provided we can’t actually determine Brett’s motives. He may have believed that just-in-time inventory was causing the company to lose sales due to “stock-outs.” If that was the case, there would be options available to the company other than totally giving up on just-in-time practices. In order to eliminate any potential conflicts of interest between Brett and the company, and to ensure that his actions are in the best interest of the company, the company could begin preparing variable costing income statements to supplement its absorption costing statements for the purpose of calculating bonuses. This would eliminate any incentive Brett might have to over-produce, as well as providing useful information for other internal management decision making.

BYP 19-8

(a)

ALL ABOUT YOU

Using a common equation for CVP analysis, Sales = Variable Costs + Fixed Costs + Net Income, and substituting the information provided, and knowing that at break-even, net income = $0, ($26 X 300) = Variable Costs + ($4,000 + $1,460) + $0 $7,800 = Variable Costs + $5,460 + $0 $2,340 = Variable Costs (in total) or $7.80 (variable costs/member/month) = $2,340 ÷ 300

(b)

To find the sales required to reach a target net income, contribution margin must be calculated. Contribution Margin = Sales – Variable Costs Contribution Margin = $7,800 – $2,340 Contribution Margin = $5,460 Unit Contribution Margin = $5,460/300 memberships = $18.20 Contribution Margin Ratio = $5,460/$7,800 = 70% To compute the sales required to reach a target net income of $3,640. Required Sales in Units = (Fixed Costs + /Unit Contribution Target Net Income) Margin Required Sales in Units = ($5,460 + $3,640)/$18.20 Required Sales in Units = 500 memberships Required Sales in Dollars = 500 memberships X $26 = $13,000 Using the contribution margin ratio, Required Sales in Dollars = (Fixed Costs + Target Net Income)

/Contribution Margin Ratio

Required Sales in Dollars = ($5,460 + $3,640)/70% Required Sales in Dollars = $13,000 (c)

Answers will vary. Suggested examples include franchise fees, employee wages, utilities, supplies, and maintenance.

(d)

Answers will vary.

BYP 19-9 CONSIDERING CORPORATE SOCIAL RESPONSIBILITY

Discussion Guide: If reduction of greenhouse gas emissions is a goal, then one step toward attainment of that goal is to assign a cost to greenhousegas emissions. One approach that is currently being used is the buying and selling of carbon-emission rights. As companies buy and sell emission rights, the price of polluting becomes a tangible factor in the formulations that will be used to make future energy-source decisions. This approach has been effective in addressing similar issues, such as the reduction of sulfur emissions. However, as suggested in the “No” response, many believe that, to be effective and fair, an enforceable international agreement on such an approach would be necessary. In the United States, companies currently participate on a voluntary basis; in some other countries, participation is required. Another factor to consider in these decisions is the timing of conversion to new technology. A gradual conversion to new technologies as existing power plants reach the end of their productive lives would be far less costly than a rapid conversion to new technologies that required scrapping existing plants before they are fully depreciated. Decisions about which plants to replace and when to replace them will require careful cost-benefit analyses.

CHAPTER 20 Incremental Analysis ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

A Problems

Describe management’s decision-making process and incremental analysis.

1, 2, 3, 4

1, 2

1, 18

Analyze the relevant costs in accepting an order at a special price.

2, 3, 4, 18

Analyze the relevant costs in a make-or-buy decision.

6, 7

5, 6, 7, 8, 18

Analyze the relevant costs in determining whether to sell or process materials further.

8, 9, 10

5, 6

9, 10, 11, 12, 18

Analyze the relevant costs to be considered in repairing, retaining or replacing equipment.

13, 14, 18

Analyze the relevant costs in deciding whether to eliminate an unprofitable segment.

15, 16, 17, 18

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Use incremental analysis for special order and identify nonfinancial factors in the decision.

Simple

20–30

Use incremental analysis related to make or buy, consider opportunity cost, and identify nonfinancial factors.

Moderate

30–40

Determine if product should be sold or processed further.

Moderate

30–40

Compute gain or loss, and determine if equipment should be replaced.

Moderate

30–40

Prepare incremental analysis concerning elimination of divisions.

Moderate

30–40

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises Learning Objective

Knowledge Comprehension

Application

Analysis

Kimmel, Accounting, 6/e, Solutions Manual (For Instructor Use Only)

Describe management’s decisionmaking process and incremental analysis.

Q20-1 Q20-2 Q20-3

Q20-4 BE20-1 E20-1 BE20-2 E20-18

DI20-1

Analyze the relevant costs in accepting an order at a special price.

Q20-5 E20-18

BE20-3

DI20-2 E20-2 E20-3 E20-4

Analyze the relevant costs in a make-or-buy decision.

Q20-6 Q20-7 E20-18

BE20-4

DI20-3 E20-5

Analyze the relevant costs in determining whether to sell or process materials further.

E20-18

BE20-5 BE20-6 DI20-4

E20-9 E20-10 E20-11 P20-3A

Analyze the relevant costs to be considered in repairing, retaining or replacing equipment.

Q20-11 E20-18

BE20-7 DI20-5

E20-14 P20-4A

Analyze the relevant costs in deciding whether to eliminate an unprofitable segment.

Q20-12 E20-18

BE20-8 DI20-6

E20-15 E20-16 E20-17

BYP20-1 BYP20-4 BYP20-5

BYP20-2

Broadening Your Perspective

Q20-8 Q20-9 Q20-10

Synthesi

P20-5A

BYP20-8

20-3

ANSWERS TO QUESTIONS 1.

The following steps are frequently involved in management’s decision-making process: (1) Identify the problem and assign responsibility. (2) Determine and evaluate possible courses of action. (3) Make a decision. (4) Review results of the decision.

My roommate is incorrect. Accounting contributes to the decision-making process at Steps 2 and 4. Prior to the decision, accounting provides relevant revenue and cost data for each course of action. Following the decision, internal reports are prepared to show the actual impact of the decision.

Disagree. Incremental analysis involves the identification of financial data that change under alternative courses of action.

In incremental analysis, the important point to consider is whether costs will differ (change) between the two alternatives. As a result, sometimes (1) variable costs do not change under the alternative courses of action and (2) fixed costs do change.

The relevant data in deciding whether to accept an order at a special price are the incremental revenues to be obtained compared to the incremental costs of filling the special order.

The manufacturing costs that are relevant in the make-or-buy decision are those that will change if the parts are purchased.

Opportunity cost may be defined as the potential benefit that may be obtained by following an alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the facilities used to make the part can be used to generate additional income.

The decision rule in a decision to sell a product or to process it further is: Process further as long as the incremental revenue from the additional processing exceeds the incremental processing costs.

Joint products are products that are produced from a single raw material and a common production process. An accounting issue related to joint products is how to allocate the joint costs incurred during the production process that creates the joint products.

10.

Joint costs are irrelevant to a sell-or-process-further decision because they are sunk costs and will not change whether the decision is to sell the existing product or process it further. Therefore, joint costs are ignored in this decision.

11.

A sunk cost is a cost that cannot be changed by any present or future decision. Sunk costs, such as the book value of an old piece of equipment, therefore, are not relevant in a decision to retain or replace equipment.

12.

Net income will be lower if an unprofitable product line is eliminated when the product line is producing a positive contribution margin and its fixed costs cannot be avoided or reduced.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 20-1 The correct order is: 1. 2. 3. 4.

Identify the problem and assign responsibility. Determine and evaluate possible courses of action. Make a decision. Review results of the decision.

BRIEF EXERCISE 20-2

Revenues Costs Net income

Alternative A $160,000 100,000 $ 60,000

Alternative B $180,000 125,000 $ 55,000

Net Income Increase (Decrease) $ 20,000 (25,000) ($ 5,000)

Alternative A is better than Alternative B.

BRIEF EXERCISE 20-3

Revenues Costs—Variable manufacturing Shipping Net income

Reject Order $0 0 0 $0

The special order should be accepted. *3,000 X $25 **3,000 X $20 ***3,000 X $ 3

Accept Order $75,000* 60,000** 9,000*** $ 6,000

Net Income Increase (Decrease) $ 75,000 (60,000) (9,000) $ 6,000

BRIEF EXERCISE 20-4

Variable manufacturing costs Fixed manufacturing costs Purchase price Total annual cost

Make $50,000 30,000 –0– $80,000

Buy $ –0– 30,000 60,000 $90,000

Net Income Increase (Decrease) $ 50,000 0 (60,000) $(10,000)

The decision should be to make the part. BRIEF EXERCISE 20-5

Sales price per unit Cost per unit Variable Fixed Total Net income per unit

Sell $62.00

Process Further $70.00

Net Income Increase (Decrease) $8.00

36.00 10.00 46.00 $16.00

42.00 10.00 52.00 $18.00

(6.00) 0 (6.00) $2.00

The bookcases should be processed further because the incremental revenues exceed incremental costs by $2.00 per unit.

BRIEF EXERCISE 20-6 The allocated joint costs are irrelevant to the sell or process further decisions. If AB1 is processed further, the company will earn incremental revenue of $50,000 ($150,000 – $100,000) and only incur incremental costs of $45,000. Therefore, the company should process AB1 further and sell AB2. If XY1 is processed further, the company will earn incremental revenue of $35,000 ($130,000 – $95,000) but will incur incremental costs of $50,000. Therefore, the company should sell XY1 rather than process it further.

BRIEF EXERCISE 20-7

Variable manufacturing costs for 5 years New machine cost Sell old machine Total

Retain Equipment

Replace Equipment

Net 5-Year Income Increase (Decrease)

$3,000,000

$2,500,000 400,000 (30,000) $2,870,000

$ 500,000 (400,000) 30,000 $ 130,000

$3,000,000

The old factory machine should be replaced. BRIEF EXERCISE 20-8

Sales Variable costs Contribution margin Fixed costs Net income

Continue $200,000 180,000 20,000 30,000 $ (10,000)

Eliminate $ –0– –0– –0– 20,000 $(20,000)

Net Income Increase (Decrease) $(200,000) 180,000 (20,000) 10,000 $ (10,000)

The Big Bart product line should be continued because $20,000 of contribution margin will not be realized if the line is eliminated. This amount is greater than the $10,000 savings of fixed costs. SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 20-1

Revenues Maintenance expense Operating expenses Equipment upgrade Opportunity cost DO IT! 20-2

Alternative 1 $65,000 5,000 26,000 17,000 4,000

Alternative 2 $60,000 5,000 22,000 0 0

Net Income Increase (Decrease) $(5,000) 0 4,000 0 4,000 $3,000

Sunk (s)

Revenues Costs Net income

Reject $ –0– $ –0– $ –0–

Accept $180,000 144,000* $ 36,000

Net Income Increase (Decrease) $180,000 (144,000) $ 36,000

*(6,000 X $20) + (6,000 X $4) Given the results of the above analysis, Maize Company should accept the special order.

DO IT! 20-3 (a)

Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price Total cost

Net Income Increase (Decrease) $ 30,000 42,000

Make $ 30,000 42,000

Buy $ –0– –0–

45,000

–0–

45,000

60,000 –0– $177,000

45,000 162,000* $207,000

15,000 (162,000) $ (30,000)

*60,000  $2.70 Given the results of the above analysis, Wilma Company will incur $30,000 of additional costs if it buys the switches. (b) Total cost Opportunity cost Total cost

Make $177,000 34,000 $211,000

Buy $207,000 –0– $207,000

Net Income Increase (Decrease) $(30,000) 34,000 $ 4,000

Yes, the answer is different: The analysis shows that net income will be increased by $4,000 if Wilma Company purchases the switches.

DO IT! 20-4

Sales per unit Cost per unit Variable Fixed Total Net income per unit

Sell $75

Process Further $100

Net Income Increase (Decrease) $25

$40 10 $50

$ 59 13 $ 72

($19) (3) ($22)

$25

$ 28

$ 3

The tables should be processed further and Mesa Verde should finish the tables because the incremental revenues exceed incremental costs by $3 per unit.

DO IT! 20-5

Operating expenses Repair costs Rental revenue New machine cost Sale of old machine Total cost

Retain Equipment $120,000 40,000

$160,000

Replace Equipment

$ (60,000) 170,000 (25,000) $ 85,000

Net Income Increase (Decrease) $120,000 40,000 60,000 (170,000) 25,000 75,000

DO IT! 20-6

Sales Variable costs Contribution margin Fixed costs Net income

Continue $500,000 370,000 130,000 150,000 $ (20,000)

Eliminate $ 0 0 0 38,000 $(38,000)

Net Income Increase (Decrease) $(500,000) 370,000 (130,000) 112,000 $ (18,000)

The analysis indicates that Gator should not eliminate the gloves and mittens line because net income would decrease $18,000.

SOLUTIONS TO EXERCISES EXERCISE 20-1 1. 2. 3. 4. 5. 6. 7. 8. 9.

False. The first step in management’s decision-making process is “identify the problem and assign responsibility”. False. The final step in management’s decision-making process is to review the results of the decision. True. False. In making business decisions, management ordinarily considers both financial and nonfinancial information. True. True. False. Costs that are the same under all alternative courses of action do not affect the decision. False. When using incremental analysis, either costs or revenues or both will change under alternative courses of action. False. Sometimes variable costs will not change under alternative courses of action, but fixed costs will.

EXERCISE 20-2 (a)

Revenues ($4.80) Materials ($0.50) Labor ($1.50) Variable overhead ($1.00) Fixed overhead Sales commissions Net income

Reject Order $ –0– –0– –0– –0– –0– –0– $ –0–

Accept Order $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000

Net Income Increase (Decrease) $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000

(b)

As shown in the incremental analysis, Gruden should accept the special order because incremental revenue exceeds incremental expenses by $3,000.

(c)

It is assumed that sales of the golf discs in other markets would not be affected by this special order. If other sales were affected, Gruden would have to consider the lost sales in making the decision. Second, if Gruden is operating at full capacity, it is likely that the special order would be rejected.

EXERCISE 20-3 (a)

Revenues (15,000 X $7.60) Cost of goods sold Operating expenses Net income

Reject Order $0 0 0 $0

Accept Order $114,000 78,000 (1) 31,800 (2) $ 4,200

Net Income Increase (Decrease) $114,000 (78,000) (31,800) $ 4,200

(1) Variable cost of goods sold = $2,600,000 X 70% = $1,820,000. Variable cost of goods sold per unit = $1,820,000 ÷ 350,000 = $5.20 Variable cost of goods sold for the special order = $5.20 X 15,000 = $78,000.

(2) Variable operating expenses = $840,000 X 80% = $672,000 $672,000 ÷ 350,000 = $1.92 per unit 15,000 X $1.92 = $28,800 $28,800 + $3,000 = $31,800 (b) As shown in the incremental analysis, Moonbean Company should accept the special order because incremental revenues exceed incremental expenses by $4,200. EXERCISE 20-4

Revenues Variable costs: Direct materials Direct labor Variable overhead Total variable costs Net income

Reject Order $0

Accept Order $1,187,500 (1)

Net Income Increase (Decrease) $1,187,500

0 0 0 0 $0

500,000 187,500 250,000 937,500 $ 250,000

(500,000) (187,500) (250,000) (937,500) $ 250,000

(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000] Klean Fiber should accept the Army’s offer since it would increase net income by $250,000.

EXERCISE 20-5 (a)

Direct materials (30,000 X $4.00) Direct labor (30,000 X $5.00) Variable overhead costs ($150,000 X 70%) Fixed manufacturing costs Purchase price (30,000 X $12.95) Total annual cost

Make $120,000 150,000

0 0

Net Income Increase (Decrease) $ 120,000 150,000

105,000 45,000 0 $420,000

0 45,000 388,500 $433,500

105,000 0 (388,500) $ (13,500)

Buy

(b) No, Pottery Ranch should not purchase the finials. As indicated by the incremental analysis, it would cost the company $13,500 more to purchase the finials. (c) Yes, by purchasing the finials, a total cost saving of $6,500 will result as shown below.

Total annual cost (above) Opportunity cost Total cost

Make $420,000 20,000 $440,000

Buy $433,500 0 $433,500

Net Income Increase (Decrease) $(13,500) 20,000 $ 6,500

EXERCISE 20-6 (a) 1.

Direct materials Direct labor Variable overhead Fixed overhead Purchase price Total annual cost

Make Buy $1,000,000 $ –0– 800,000 –0– 120,000 –0– 600,000 195,000 0 2,300,000 $2,520,000 $2,495,000

Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 405,000 (2,300,000) $ 25,000

Yes. The offer should be accepted as net income will increase by $25,000.

EXERCISE 20-6 (Continued) 2.

Direct materials Direct labor Variable overhead Fixed overhead Opportunity cost Purchase price Totals

Make $1,000,000 800,000 120,000 600,000 375,000 0 $2,895,000

Buy $

0 0 0 600,000 0 2,300,000 $2,900,000

Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 0 375,000 (2,300,000) $ (5,000)

No. The offer should not be accepted as net income would be $5,000 less. (b) Qualitative factors include the possibility of laying off those employees that produced the robot and the resulting poor morale of the remaining employees, maintaining quality standards, and controlling the purchase price in the future.

EXERCISE 20-7 (a) Direct materials Direct labor Variable overhead Purchase price Total unit cost

Make Sails $100 80 25 0 $205

Buy Sails $ 0 0 0 250 $250

Net Income Increase (Decrease) $ 100 80 25 (250) $ (45)

Riggs should be making the sails, because they could save $45 per unit or $54,000. The president was including the fixed overhead cost in the calculation. Variable overhead = Total overhead ($90) – Fixed overhead ($78,000 ÷ 1,200) = $25. This amount has been allocated, so Riggs will incur the cost whether or not they make the sails. This is an example of an irrelevant cost, because it does not differ between the two alternatives.

EXERCISE 20-7 (Continued) (b)

The best decision would be to rent out the space as shown below. The differential savings would be $77,000 – $54,000 = $23,000.

(Based on 1,200 units) Manufacturing cost Purchase price Opportunity cost Total annual cost (c)

Per Unit $205 $250

Make Sails $246,000 0 77,000 $323,000

Buy Sails $ 0 300,000 0 $300,000

Net Income Increase (Decrease) $ 246,000 (300,000) 77,000 $ 23,000

Qualitative factors to consider would be (1) whether Riggs will be able to exercise control over the future price of the product (2) whether Riggs will be able to exercise control over the quality of the product and (3) the potential for interruptions in the supply of the product.

EXERCISE 20-8 (a) Direct materials Direct labor Material handling Variable overhead Purchase price Total unit cost

Make IMC2 $ 65.00 45.00 6.50 72.00* 0 $188.50

Buy IMC2 $ 0 0 0 0 200.00 $200.00

Net Income Increase (Decrease) $ 65.00 45.00 6.50 72.00 (200.00) $ (11.50)

*Variable overhead = 60% X ($126.50 – 6.50) The unit should not be purchased from the outside vendor, as the per unit cost would be $11.50 greater than if they made it.

EXERCISE 20-8 (Continued) (b)

In order for Innova to make an accurate decision, they would have to know the opportunity cost of manufacturing the other product. As determined in (a), purchasing the product from outside would cost $11,500 more (1,000 X $11.50). Innova would have to increase their contribution margin by more than $11,500 through the manufacture of the other product, before it would be economical for them to purchase the IMC2 from the outside vendor.

(c)

Qualitative factors to consider would be (1) quality of the component (2) on-time delivery, and (3) reliability of the vendor.

EXERCISE 20-9

Sales per unit Costs per unit Direct materials Direct labor Total Net income per unit

Sell (Basic Kit) $30

Process Further (Stage 2 Kit) $36

Net Income Increase (Decrease) $6

$16 0 $16

$ 8 (1) 9 (2) $17

$8 (9) $(1)

$14

$19

(1) The cost of materials decreases because Anna can make two Stage 2 Kits from the materials for a basic kit. (2) The total time to make the two kits is one hour at $18 per hour or $9 per unit.

EXERCISE 20-9 (Continued) Anna should carry the Stage 2 Kits. The incremental revenue, $6, exceeds the incremental processing costs, $1. Thus, net income will increase by processing the kits further. EXERCISE 20-10 (a)

Sales ($60,000 + $15,000 + $55,000) Joint costs Net income

$ 130,000 (100,000) $ 30,000

(b) Sales ($190,000 + $35,000 + $215,000) Joint costs Additional costs ($100,000 + $30,000 + $150,000) Net income

$ 440,000 (100,000) (280,000) $ 60,000

Incremental revenue Incremental costs Incremental profit (loss) (1)

Product 10 $ 130,000 (100,000) $ 30,000

Product 12 Product 14 $ 20,000 $ 160,000 (30,000) (150,000) $(10,000) $ 10,000

Sales value after further processing – Sales value @ split-off point

Products 10 and 14 should be processed further and product 12 should be sold at the split-off point. (d) Sales ($190,000 + $15,000 + $215,000) Joint costs Additional costs ($100,000 + $150,000) Net income

$ 420,000 (100,000) (250,000) $ 70,000

Net income is $10,000 ($70,000 – $60,000) higher in (d) than in (b) because product 12 is not processed further, thereby increasing overall profit $10,000.

EXERCISE 20-11 To determine whether each of the three joint products should be sold as is, or processed further, we must determine the incremental profit or loss that would be earned by each. The allocated joint costs are irrelevant to the decision since these costs will not change whether or not the products are sold as is or processed further.

Incremental revenue Incremental cost Incremental profit (loss)

Spock $ 90,000* (110,000) $ (20,000)

Uhura $100,000** (85,000) $ 15,000

Sulu $345,000*** (250,000) $ 95,000

From this analysis we see that Uhura and Sulu should be processed further because the incremental revenue exceeds the incremental costs, but Spock should be sold as is. *$300,000 – $210,000

**$400,000 – $300,000

***$800,000 – $455,000

EXERCISE 20-12 (a)

The costs that are relevant in this decision are the incremental revenues and the incremental costs associated with processing the material past the split-off point. Any costs incurred up to the split-off point are sunk costs, and therefore, irrelevant to this decision.

(b)

Revenue after further processing: Product D—$60,000 (4,000 units X $15.00 per unit) Product E—$97,200 (6,000 units X $16.20 per unit) Product F—$45,200 (2,000 units X $22.60 per unit) Revenue at split-off: Product D—$40,000 (4,000 units X $10.00 per unit) Product E—$69,600 (6,000 units X $11.60 per unit) Product F—$38,800 (2,000 units X $19.40 per unit) Incremental revenue Incremental cost Increase (decrease) in profit

D $20,000 (14,000) $ 6,000

E $27,600 (20,000) $ 7,600

F $ 6,400 (9,000) $(2,600)

Products D and E should be processed further. (c)

The decision would remain the same. It does not matter how the joint costs are allocated because joint costs are irrelevant to this decision.

EXERCISE 20-13 (a)

Cost Accumulated depreciation Book value Sales proceeds Loss on sale

$100,000 (25,000*) 75,000 50,000 $ 25,000

*One year’s depreciation: ($100,000 – $0) ÷ 4 years (b)

Annual operating costs New scanner cost Old scanner salvage Total

Retain Scanner $315,000* $315,000

Replace Scanner $240,000** 110,000 (50,000) $300,000

Net Income Increase (Decrease) $ 75,000 (110,000) 50,000 $ 15,000

*(3 years X $105,000) **[3 years X ($105,000 – $25,000)] Yes. Twilight Hospital should replace the old scanner because it will result in a savings of $15,000 over the next three years. (c)

As shown in (a) above, replacing the old scanner will result in reporting a loss of $25,000. Reluctance to report losses of this nature is the usual reason for not recognizing that a poor decision was made in the past. The remaining book value of the old scanner ($75,000) is a sunk cost. It will be deducted in the future, if the scanner is retained, or written off now if it is replaced. However, if it is replaced now, that cost will be partially offset by the salvage value that Dyno is willing to pay ($50,000).

EXERCISE 20-14

Operating costs New machine cost Salvage value (old) Total

Retain Machine $125,000 (1) 0 0 $125,000

Replace Machine $100,000 (2) 25,000 (6,000) $119,000

Net Income Increase (Decrease) $ 25,000 (25,000) 6,000 $ 6,000

(1) $25,000 X 5. (2) $20,000 X 5. The current machine should be replaced. The incremental analysis shows that net income for the five-year period will be $6,000 higher by replacing the current machine. EXERCISE 20-15

Sales Variable costs Cost of goods sold Operating expenses Total variable Contribution margin Fixed costs Cost of goods sold Operating expenses Total fixed Net income (loss)

Continue $100,000

Eliminate $ 0

Net Income Increase (Decrease) $(100,000)

61,000 30,000 91,000 9,000

0 0 0 0

61,000 30,000 91,000 (9,000)

15,000 20,000 35,000 $(26,000)

15,000 20,000 35,000 $(35,000)

0 0 0 $ (9,000)

Veronica is incorrect. The incremental analysis shows that net income will be $9,000 less if the Percy Division is eliminated. This amount equals the contribution margin that would be lost through discontinuing the division. (Note: None of the fixed costs can be avoided.)

EXERCISE 20-16 (a)

$30,000 + $70,000 – $40,000 = $60,000

(b)

Tingler $300,000 150,000 150,000 142,500* $ 7,500

Sales Variable expenses Contribution margin Fixed expenses Net income

Shocker $500,000 200,000 300,000 267,500** $ 32,500

Total $800,000 350,000 450,000 410,000 $ 40,000

*$30,000 + [($300,000 ÷ $800,000) X $300,000] **$80,000 + [($500,000 ÷ $800,000) X $300,000] (c)

As shown in the analysis above, Cawley should not eliminate the Stunner product line. Elimination of the line would cause net income to drop from $60,000 to $40,000. The reason for this decrease in net income is that elimination of the product line would result in the loss of $55,000 of contribution margin while saving only $35,000 of fixed expenses.

EXERCISE 20-17 Calculation of contribution margin per unit: Selling price per unit Less: variable costs/unit Contribution margin/unit

C $95 50 $45

D $75 40 $35

E $115 45 $ 70

Fixed costs = $24 X (9,000 + 20,000) = $696,000 Company profit with Products C and D: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income

C 9,000

D 20,000

Total

$855,000 450,000 $405,000

$1,500,000 800,000 $ 700,000

$2,355,000 $1,250,000 1,105,000 696,000 $ 409,000

EXERCISE 20-17 (Continued) Company profit with Products C and E: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income

C 9,900*

E 10,000

Total

$940,500 495,000 $445,500

$1,150,000 450,000 $ 700,000

$2,090,500 945,000 1,145,500 696,000 $ 449,500

*Product C sales increase by 10%, (9,000 X 110%) Yes they should introduce Product E since net profit would increase by $40,500 ($449,500 – $409,000). EXERCISE 20-18 1. Irrelevant. Unavoidable costs will be incurred regardless of the decision made. 2. Relevant. 3. Irrelevant. This is a sunk cost and all sunk costs are irrelevant. 4. Irrelevant. These are sunk costs. 5. Relevant. 6. Relevant. 7. Relevant. 8. Relevant. 9. Irrelevant. If there is no change in the direct materials charge regardless of the decision made, the cost is irrelevant. 10. Relevant.

SOLUTIONS TO PROBLEMS PROBLEM 20-1A

Reject Order $0 0

Accept Order $280,000 220,000 (1)

Net Income Increase (Decrease) $ 280,000 (220,000)

0 $0

22,500 (2) $ 37,500

(22,500) $ 37,500

(a)

Revenues (10,000 X $28) Cost of goods sold Selling and administrative expenses Net income

(1) Variable costs = $3,600,000 – $960,000 = $2,640,000; $2,640,000 ÷ 120,000 units = $22.00 per unit; 10,000 X $22.00 = $220,000. (2) Variable costs = $405,000 – $225,000 = $180,000; $180,000 ÷ 120,000 units = $1.50 per unit; 10,000 X ($1.50 + $0.75) = $22,500. (b) Yes, the special order should be accepted because net income will increase by $37,500. (c) Unit selling price = $22.00 (variable manufacturing costs) + $2.25 variable selling and administrative expenses + $5.00 net income = $29.25. (d) Nonfinancial factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customer’s schedule for delivery without increasing costs.

PROBLEM 20-2A

(a)

Make CISCO Direct materials (8,000 X $4.80) Direct labor (8,000 X $4.30) Indirect labor (8,000 X $.43) Utilities (8,000 X $.40) Depreciation Property taxes Insurance Purchase price Freight and inspection (8,000 X $.35) Receiving costs Total annual cost

$38,400

Buy CISCO $

Net Income Increase (Decrease)

$38,400

34,400

3,440 3,200 3,000 700 1,500 0

0 0 900 200 600 80,000

3,440 3,200 2,100 500 900 (80,000)

0 0 $84,640

2,800 1,300 $85,800

(2,800) (1,300) $ (1,160)

(b)

The company should continue to make CISCO because net income would be $1,160 less if CISCO were purchased from the supplier.

(c)

The decision would be different. Because of the opportunity cost of $3,000, net income will be $1,840 higher if CISCO is purchased as shown below: Net Income Increase (Decrease) Make CISCO Buy CISCO Total annual cost $84,640 $85,800 $(1,160) 3,000 0 3,000 Opportunity cost $87,640 $85,800 $ 1,840 Total cost

(d)

Nonfinancial factors include: (1) the adverse effect on employees if CISCO is purchased, (2) how long the supplier will be able to satisfy the Shatner Manufacturing Company’s quality control standards at the quoted price per unit, and (3) whether the supplier will deliver the units when they are needed by Shatner.

PROBLEM 20-3A

(a) (1)

Table Cleaner Not Processed Further Sales: FloorShine (600,000 ÷ 30) X $20 Table Cleaner (300,000 ÷ 25) X $17 Total revenue Costs: CDG Additional costs of FloorShine Total costs Gross profit

(2)

$400,000 204,000 $604,000 210,000 240,000 450,000 $154,000

Table Cleaner Processed Further Sales: FloorShine Table Stain Remover (300,000 ÷ 25) X $14 Table Polish (300,000 ÷ 25) X $14 Total revenue Costs: CDG Additional costs of FloorShine TCP Total costs Gross profit

$400,000 168,000 168,000 $736,000 210,000 240,000 100,000 550,000 $186,000

(3) If the table cleaner is processed further overall company profits will be $32,000 higher. Therefore, management made the wrong decision by choosing to not process table cleaner further.

PROBLEM 20-3A (Continued) (b) Incremental revenue Incremental costs Totals

Don’t Process Table Cleaner Further $204,000 0 $204,000

Process Table Cleaner Further $336,000 100,000 $236,000

Net Income Increase (Decrease) $132,000 (100,000) $ 32,000

When trying to decide if the table cleaner should be processed further into TSR and TP, only the relevant data need be considered. All of the costs that occurred prior to the creation of the table cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.

PROBLEM 20-4A (a)

Cost Accumulated depreciation Book value Sales proceeds Loss on sale

$120,000 (24,000*) 96,000 (25,000) $ 71,000

*$120,000 ÷ 5 years = $24,000 (b) (1) Revenues ($240,000 X 4 yrs.) Less costs: Variable costs ($35,000 X 4) Fixed costs ($23,000 X 4) Selling & administrative Depreciation Net income

Retain Old Elevator $960,000 $140,000 92,000 116,000* 96,000

444,000 $516,000

*($29,000 X 4) (2) Revenues Less costs: Variable costs ($10,000 X 4) Fixed costs ($8,500 X 4) Selling and administrative Depreciation Operating income Less: Loss on old elevator Net income

Replace Old Elevator $960,000 $ 40,000 34,000 116,000 160,000

350,000 610,000 71,000 $539,000

Retain Old Elevator $140,000 92,000 .

$232,000

Replace Old Elevator $ 40,000 34,000 160,000 (25,000) $209,000

Net Income Increase (Decrease) $ 100,000 58,000 (160,000) 25,000 $ 23,000

PROBLEM 20-4A (Continued) (d)

MEMO

TO: Ron Richter FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Elevator When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $71,000 loss that would be experienced if we replace the old elevator with the newer model is related to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old elevator to the cash proceeds that would be received. The book value of $96,000 would be deducted as depreciation expense over the next four years if the elevator were retained. If the elevator is replaced with the newer model, the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $96,000 book value will be expensed under either alternative, making it irrelevant.

PROBLEM 20-5A

(a) Sales Variable costs Cost of goods sold Selling and administrative Total variable expenses Contribution margin

Division I $250,000

Division II $200,000

140,000 30,000 170,000 $ 80,000

172,800 36,000 208,800 $ (8,800)

(b) (1)

Net Income Increase (Decrease)

Division I

Continue

Eliminate

Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$ 80,000

$(80,000)

60,000 45,000 105,000 $(25,000)

30,000 22,500 52,500 $(52,500)

30,000 22,500 52,500 $(27,500)

(2) Division II

Continue

Eliminate

Net Income Increase (Decrease)

Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations

$ (8,800)

$ 8,800

19,200 24,000 43,200 $(52,000)

9,600 12,000 21,600 $(21,600)

9,600 15,000 21,600 $30,400

Division II should be eliminated as its negative contribution margin is $8,800. Income from operations would increase $30,400 if Division II is eliminated. Division I should be continued because it is producing positive contribution margin of $80,000. Income from operations will decrease $27,500 by discontinuing this division.

PROBLEM 20-5A (Continued) (c)

BRISLIN COMPANY CVP Income Statement For the Quarter Ended March 31, 2017 Divisions Sales Variable costs Cost of goods sold Selling and administrative Total variable costs Contribution margin Fixed costs Cost of goods sold (1) Selling and administrative (2) Total fixed costs Income (loss) from operations

I $250,000

III $500,000

IV $450,000

Total $1,200,000

140,000

240,000

187,500

567,500

30,000

90,000

170,000 80,000

270,000 230,000

217,500 232,500

657,500 542,500

63,200

65,700

192,100

49,000

34,000

24,000

107,000

112,200

97,200

89,700

299,100

$(32,200) $132,800

$142,800

$ 243,400

(1) Division’s fixed cost of goods sold plus 1/3 of Division II’s unavoidable fixed cost of goods sold [$192,000 X (100% – 90%) X 50% = $9,600]. Each division’s share is $3,200. (2) Division’s fixed selling and administrative expense plus 1/3 of Division II’s unavoidable fixed selling and administrative expenses [$60,000 X (100% – 60%) X 50% = $12,000]. Each division’s share is $4,000. (d) Income from operations with Division II of $213,000 (given) plus incremental income of $30,400 from eliminating Division II = $243,400 income from operations without Division II.

CD20

CURRENT DESIGNS

Situation #1 (a) Current Designs should accept the special order based on the following calculations:

Revenues Costs Net Income

Reject Order $0 0 $0

Accept Order $25,000* (19,000)** $ 6,000

Net Income Increase (Decrease) $25,000 (19,000) $ 6,000

*(100 X $250) **(($80 + $60 + $20) X 100) + ($1,000 + $2,000) (b) Assuming that Current Designs is currently operating with excess capacity, it should accept the order based on the calculations shown in part (a). If Current Designs is currently operating at full capacity, it would have to weigh its options. If it displaced production of regular kayaks in order to fill this order, it would have to consider the opportunity costs associated with this decision. The opportunity cost, when operating at full capacity, would be the lost contribution margin from regular sales given up in order to fulfill the special order. Alternatively, rather than reject the special order, it might consider temporarily expanding the plant’s capacity by adding an additional production shift to handle the special order. If this option were considered, it would have to identify all additional incremental costs (for example, overtime pay) that would be incurred.

CD20 (Continued) Situation #2 (a) Current designs should not replace the Rotomold oven based on the following calculations:

Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total

Retain Oven $110,500* 0 0 $110,500

Replace Oven $ 97,500** 250,000 (10,000) $337,500

Net Income Increase (Decrease) $ 13,000 (250,000) 10,000 ($ 227,000)

*(17,000 therms/year X $0.65/therm X 10 years) **(15,000 therms/year X $0.65/therm X 10 years)

(b) Even with the cost of natural gas increasing at a faster than expected rate, Current Designs still should not replace the Rotomold oven as the rate increase does not cover the cost of the new oven based on the following calculations:

Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total

Retain Oven $144,500* 0 0 $144,500

*(17,000 therms/year X $0.85/therm X 10 years) **(15,000 therms/year X $0.85/therm X 10 years)

Replace Oven $127,500** 250,000 (10,000) $367,500

Net Income Increase (Decrease) $ 17,000 (250,000) 10,000 ($ 223,000)

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

CD20 (Continued) Situation #3 (a) Current Designs should make the seats based on the following calculations:

Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price ($50 X 3,000) Total annual cost

Make $ 60,000 45,000 36,000 20,000 0 $161,000

0 0 0

Net Income Increase (Decrease) $ 60,000 45,000 36,000

15,000 150,000 $165,000

5,000 (150,000) ($ 4,000)

Buy $

(b) When the opportunity cost of $20,000 is considered, Current Designs should buy the seats based on the following calculations:

Total annual cost Opportunity cost Total cost

Make $161,000 20,000 $181,000

Buy $165,000 0 $165,000

Net Income Increase (Decrease) ($ 4,000) 20,000 $16,000

BYP 20-1

DECISION-MAKING ACROSS THE ORGANIZATION

Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Purchase price Total costs and expenses Net income (1) (2) (3) (4) (5)

Retain Purchase Old Machine New Machine $6,000,000 (1) $6,600,000 (2)

Net Income Increase (Decrease) $ 600,000

4,500,000 (3) 900,000 500,000 — 5,900,000 $ 100,000

(120,000) (90,000) (65,000) (150,000) (425,000) $ 175,000

4,620,000 (4) 990,000 565,000 150,000 (5) 6,325,000 $ 275,000

12,000 X $100 X 5 years = $6,000,000. $6,000,000 X 110% = $6,600,000. $6,000,000 X (100% – 25%) = $4,500,000. $6,600,000 X (100% – 30%) = $4,620,000. $140,000 + $4,000 + $6,000 = $150,000.

The new machine should be purchased. The incremental analysis shows that net income will increase from $100,000 to $275,000 over the five years with the new machine.

BYP 20-2

MANAGERIAL ANALYSIS

(a)

$ 14.50

Buy— TransTech $ 14.50

$ 14.50

2.00 0.80 0.60 3.00 0.50 0 — 6.90 $ 7.60 $38,000

0 0 0 0 0 10.00 0.20* 10.20 $ 4.30 $21,500

0 0 0 0 0 5.00 0.20 5.20 $ 9.30 $46,500

Make Sales Revenue Variable Manufacturing Cost: Circuit Board Plastic Case Alarms (4 @ $.15 each) Labor Overhead Purchase Cost Fixed Manufacturing Cost: Total Manufacturing Cost Profit per Unit Total Profit

Buy— Omega

*The $1,000 cost that will continue to be incurred, even if the product is not manufactured, divided by the 5,000 units. The company will make the most profit if the clocks are purchased from Omega Company. The company will make $8,500 less if the clocks are manufactured by MiniTek. The company will make $25,000 less if the clocks are purchased from Trans-Tech. (b) There are several important nonfinancial factors described in the case. Other factors might be identified as well. The factors described are: The company is having serious difficulty manufacturing the clocks. Therefore, it would probably be willing to have someone else manufacture the clocks, even if it cost more to do so. The most promising company appears to be Omega; however, there is a serious question about Omega’s ability to remain in business. However, the company could purchase just this one order from Omega, and then continue to search for another manufacturer, or stop manufacturing the clocks. Trans-Tech’s stringent requirements for preferred customer status, in the form of large sales requirements, appear to limit the possibilities for MiniTek to use it as a supplier. However, if MiniTek does desire to continue to offer the clocks because of their popularity, then perhaps Trans-Tech could be used in the future.

BYP 20-2 (Continued) (c) Many answers are possible, depending upon each student’s assessment of the seriousness of the issues mentioned in (b). One answer would be: The company should use Omega to manufacture the Kmart order. After that, the company should not offer the clocks any longer. Especially since the clocks are no longer very profitable, it does not seem like a good idea to keep spending money to modify the process.

BYP 20-3

REAL-WORLD FOCUS

(a) Before building the special-order new ceiling fans, company management must consider the effect of the new lines on current production capacity, existing and available channels of distribution, the effect on manufacturing efficiency, the effect on sales of current lines of product, and the supply of materials and labor. (b) Incremental analysis would provide a financial comparison of income with the special-order ceiling fans to income without the special orders.

BYP 20-4

REAL-WORLD FOCUS

(a) The types of outsourcing services that the company provides assistance on are: Information technology outsourcing, finance and accounting, human resource outsourcing, business process outsourcing, procurement, and call centers. (b) Insourcing means to take work that is currently being performed by an outside service provider back in-house. For example, collections of accounts receivable might currently be performed by a collection agency, and you might decide to establish a collection group within your company. (c) Some of the benefits of insourcing include:  Greater control over resources  Greater ability to control intellectual property  Increased visibility of accountability within the organization

BYP 20-5

COMMUNICATION ACTIVITY

To:

Preston Thiese—Plant Manager

From:

Hank Jewel—Production Manager

I have spent considerable time thinking about the dilemma created by the new PDD1130 machine. Clearly, it is far superior to our existing machine. There is no question that it would save us tremendous amounts of money. I hope I am not overstepping my bounds here, but I just reviewed a chapter in my managerial accounting text on incremental analysis which has made me think we need to reconsider this decision. The key to incremental analysis is identifying relevant costs. Relevant costs are those costs that vary depending on the course of action taken. In our situation, a relevant cost would be the savings that we would experience were we to purchase the new machine. The book value of the existing machine is not a relevant cost since it would not be changed by purchasing or not purchasing the new machine. Costs incurred in the past that do not change are referred to as sunk costs. Sunk costs are irrelevant to incremental analysis. I would really like to lay out an analysis of our options to decide the proper course of action. I am concerned that by using the old machine for a couple of years the profitability of the plant could be impacted negatively.

BYP 20-6

ETHICS CASE

(a) Many factors need to be considered when determining whether to close a division. The loss of jobs can have a devastating impact on a community and on the morale of remaining employees. From a financial perspective, closing a division that is reporting losses will not necessarily increase the reported net income of the company. The reason: if fixed costs that have been allocated to a division that is closed are reallocated to the remaining divisions, the company’s net income might actually decrease. This sounds like it would most likely be the case at Peters. (b) It is not unusual to reevaluate fixed cost allocations periodically. However, the allocation should be based on the underlying economics of the situation rather than the motives of individuals. (c) Blake should explain to the board of directors that the change in income is due to a reallocation and that closing the plumbing division is not advisable. In this case, being honest is not only the ethical thing to do, but it will also maximize the company’s net income.

BYP 20-7

ALL ABOUT YOU

(a) Chronic homelessness is defined as being on the streets for a year or more. (b) Homelessness costs cities money because the chronic homeless have frequent jail time, shelter costs, emergency room visits and hospital stays. Some costs per city per homeless person are: New York $40,000; Dallas $50,000; San Diego $150,000. (c) The first step is to try to identify the size of the problem by doing street counts. From this count, benchmarks can be set, enabling a reward system for meeting goals. Next is to identify what the homeless people want. What do they think they need to help them address their problem? They typically want adequate housing with some privacy. (d) It has been estimated that in New York this approach costs about $22,000 per year. New York has documented an 88% success rate (defined as not returning to the streets for five years). (e) In terms of incremental analysis, two alternatives are to either continue with the current situation, with the costs presented in part (b) or to implement the approach outlined in part (d). From a purely financial perspective the approach in (d) appears to have significant merit. Also (d) does not even take into account the intangible benefits of improving the quality of life for this segment of the population.

BYP 20-8

CONSIDERING YOUR COSTS AND BENEFITS

Discussion guide: This is a very difficult decision. All of the evidence suggests that your short-term and long-term prospects will be far greater with some form of post–high-school degree. Because of this, we feel strongly that you should make every effort to continue your education. Many of the discussions provided in this text present ideas on how to get control of your individual financial situation. We would encourage you to use these tools to identify ways to reduce your financial burden in order to continue your education. We also want to repeat that even taking only one course a semester is better than dropping out. Your instructors and advisors frequently provide advice to students who are faced with the decision about whether to continue with their education. If you are in this situation, we would encourage you to seek their advice since the implications of this decision can be long-lasting.

CHAPTER 21 Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE A Problems

Brief Exercises

Do It!

Exercises

1, 2, 3, 4, 5, 6, 7, 8, 9, 10

Prepare budgets for sales, production, and direct materials.

11, 12, 13

2, 3, 4,

2, 3, 4, 5, 6, 7, 8, 10

1A, 2A, 3A

Prepare budgets for direct labor, manufacturing overhead, and selling and administrative expenses, and a budgeted income statement.

14, 15, 16, 17, 18

5, 6, 7, 8

9, 10, 11, 12, 13

1A, 2A, 6A

Prepare a cash budget and a budgeted balance sheet.

19, 20

14, 15, 16, 17, 18, 19

4A, 6A

Apply budgeting principles to nonmanufacturing companies.

21, 22

19, 20, 21

Learning Objectives

Questions

State the essentials of effective budgeting and the components of the master budget.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare budgeted income statement and supporting budgets.

Simple

30–40

Prepare sales, production, direct materials, direct labor, and income statement budgets.

Simple

40–50

Prepare sales and production budgets and compute cost per unit under two plans.

Moderate

30–40

Prepare cash budget for two months.

Moderate

30–40

Prepare purchases and income statement budgets for a merchandiser.

Simple

30–40

Prepare budgeted cost of goods sold, income statement, retained earnings and balance sheet.

Complex

40–50

ANSWERS TO QUESTIONS 1.

(a) A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. (b) A budget aids management in planning because it represents the primary method of communicating agreed-upon objectives throughout the organization. Once adopted, a budget becomes an important basis for evaluating performance.

The primary benefits of budgeting are: (1) It requires all levels of management to plan ahead and to formalize goals on a recurring basis. (2) It provides definite objectives for evaluating performance at each level of responsibility. (3) It creates an early warning system for potential problems, so that management can make changes before things get out of hand. (4) It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. (5) It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. (6) It motivates personnel throughout the organization to meet planned objectives.

The essentials of effective budgeting are: (1) a sound organizational structure, (2) research and analysis, and (3) acceptance by all levels of management.

(a) Disagree. Accounting information makes major contributions to the budgeting process. Accounting provides the starting point of budgeting by providing historical data on revenues, costs, and expenses. An accountant becomes the translator of the budget and communicates the budget to all areas of responsibility. Accountants also prepare periodic budget reports that compare actual results with planned objectives and provide a basis for evaluating performance. (b) The budget itself, and the administration of the budget, are the responsibility of management.

The budget period should be long enough to provide an attainable goal under normal business conditions. The budget period should minimize the impact of seasonal and cyclical business fluctuations, but it should not be so long that reliable estimates are impossible. The most common budget period is one year.

Disagree. Long-range planning usually encompasses a period of at least five years. It involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies. In addition, long-range planning reports contain considerably less detail than budget reports.

Participative budgeting involves the use of a “bottom-to-top” approach, which requires input from lower level management during the budgeting process so as to involve employees from various levels and areas within the company. The potential benefits of this approach are lower-level managers have more detailed knowledge of the specifics of their job, and thus should be able to provide better budgetary estimates. In addition, by involving lower-level managers in the process, it is more likely that they will perceive the budget as being fair and reasonable. One disadvantage of participative budgeting is that it takes more time, and thus costs more. Another disadvantage of participative budgeting is that it may enable managers to game the system through such practices as budgetary slack.

Questions Chapter 21 (Continued) 8.

Budgetary slack is the amount by which a manager intentionally underestimates budgeted revenues or overestimates budgeted expenses in order to make it easier to achieve budgetary goals. Managers may have an incentive to create budgetary slack in order to increase the likelihood of receiving a bonus, or decrease the likelihood of losing their job.

A master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. The master budget is developed within the framework of a sales forecast.

10.

The sales budget is the starting point in preparing the master budget. An inaccurate sales budget may adversely affect net income. An overly optimistic sales budget may result in excessive inventories and a very conservative sales budget may lead to inventory shortages.

11.

The statement is false. The production budget only shows the units that must be produced to meet anticipated sales and ending inventory requirements.

12.

The required units of production are 155,000 (160,000 + 15,000 = 175,000 – 20,000 = 155,000).

13.

The desired ending direct materials units are 21,000 (64,000 + 9,000 = 73,000 – 52,000 = 21,000).

14.

Total budgeted direct labor costs are $960,000 (80,000 X .75 X $16 = $960,000).

15.

(a) Manufacturing overhead rate based on direct labor cost is 48% [$198,000 + $162,000 = $360,000; $360,000 ÷ (150,000 X 1/3 X $15/hr.) = 48%]. (b) Manufacturing overhead rate per direct labor hour is $7.20 ($360,000 ÷ 50,000).

16.

The first quarter budgeted selling and administrative expenses are $74,000 [(12% X $200,000) + $50,000]. The second quarter total is $78,800 [(12% X $240,000) + $50,000].

17.

The budgeted cost per unit of product is $46 ($10 + $20 + $16). Gross profit per unit is $19 ($65 – $46). Total budgeted gross profit is $475,000 (25,000 X $19).

18.

The supporting schedules are the budgets for sales, direct materials, direct labor, and manufacturing overhead.

19.

The three sections of a cash budget are: (1) cash receipts, (2) cash disbursements, and (3) financing. The cash budget also shows the beginning and ending cash balances.

20.

Cash collections are: January—$600,000 X 40% = $240,000. February— $600,000 X 50% = $300,000. March—$600,000 X 10% = $60,000.

21.

The formula is: Budgeted cost of goods sold plus desired ending merchandise inventory minus beginning merchandise inventory equals required merchandise purchases.

22.

In a service company, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services provided. The latter is based on expected billable time of the professional staff.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 21-1 Sales Budget

Production Budget

Direct Materials Budget

Direct Labor Budget

Operating Budgets

Manufacturing Overhead Budget

Selling and Administrative Expense Budget

Budgeted Income Statement

Capital Expenditure Budget

Cash Budget

Financial Budgets Budgeted Balance Sheet

BRIEF EXERCISE 21-2 PAIGE COMPANY Sales Budget For the Year Ending December 31, 2017 Quarter Expected unit sales Unit selling price Total sales

Year

10,000

14,000

15,000

18,000

57,000

X $70 $700,000

X $70 $980,000

X $70 $1,050,000

X $70 $1,260,000

X $70 $3,990,000

BRIEF EXERCISE 21-3 PAIGE COMPANY Production Budget For the Six Months Ending June 30, 2017 Quarter Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required production units a

14,000 X .25

10,000 X .25

15,000 X .25

Six Months

10,000 3,500a 13,500 2,500b 11,000

14,000 3,750c 17,750 3,500 14,250

25,250

BRIEF EXERCISE 21-4 PERINE COMPANY Direct Materials Budget For the Month Ending January 31, 2017 Units to be produced....................................................... Direct materials per unit ................................................. Total pounds required for production............................ Add: Desired ending inventory (25% X 5,000 X 2) ...... Total materials required .................................................. Less: Beginning materials inventory (4,000 X 2 X 25%).................................................. Direct materials purchases............................................. Cost per pound................................................................ Total cost of direct materials purchases .......................

4,000 X 2 8,000 2,500 10,500 2,000 8,500 X $6 $51,000

BRIEF EXERCISE 21-5 GUNDY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2017 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost

1 5,000 X 1.6 8,000 X $15 $120,000

2 7,000 X 1.6 11,200 X $15 $168,000

Six Months

$288,000

BRIEF EXERCISE 21-6 ROCHE INC. Manufacturing Overhead Budget For the Year Ending December 31, 2017 Quarter 1 Variable costs Fixed costs Total manufacturing overhead

$20,000 40,000 $60,000

$25,000 $30,000 40,000 40,000 $65,000 $70,000

Year

$35,000 40,000 $75,000

$110,000 160,000 $270,000

BRIEF EXERCISE 21-7 ELBERT COMPANY Selling and Administrative Expense Budget For the Year Ending December 31, 2017

Variable expenses Fixed expenses Total selling and administrative expenses

1 $24,000 40,000

Quarter 2 3 4 Year $28,000 $32,000 $36,000 $120,000 40,000 40,000 40,000 160,000

$64,000

$68,000 $72,000 $76,000 $280,000

BRIEF EXERCISE 21-8 NORTH COMPANY Budgeted Income Statement For the Year Ending December 31, 2017 Sales.................................................................................. Cost of goods sold (50,000 X $25) .................................. Gross profit....................................................................... Selling and administrative expenses .............................. Income from operations................................................... Interest expense ............................................................... Income before income taxes ........................................... Income tax expense ......................................................... Net income........................................................................

$2,250,000 1,250,000 1,000,000 300,000 700,000 10,000 690,000 200,000 $ 490,000

BRIEF EXERCISE 21-9 Collections from Customers January February March $165,000 $ 55,000 195,000 $ 65,000 225,000 $165,000 $250,000 $290,000

Credit Sales January, $220,000 February, $260,000 March, $300,000

BRIEF EXERCISE 21-10 Budgeted cost of goods sold ($400,000 X 65%)........................ Add: Desired ending inventory ($480,000 X 65% X 20%) ....... Total inventory required ............................................................. Less: Beginning inventory ($400,000 X 65% X 20%)................ Required merchandise purchases for April ..............................

$260,000 62,400 322,400 52,000 $270,400

SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 21 -1 1. 2. 3. 4. 5. 6.

Operating budgets Master budget Participative budgeting Financial budgets Sales forecast Long-range plans

DO IT! 21 -2 PARGO COMPANY Sales Budget For the Year Ending December 31, 2017 Quarter 1 Expected unit sales Unit selling price Total sales

Year

200,000 250,000 250,000 300,000 1,000,000 X $40 X $40 X $40 X $45 — $8,000,000 $10,000,000 $10,000,000 $13,500,000 $41,500,000

DO IT! 21 -2 (Continued) PARGO COMPANY Production Budget For the Year Ending December 31, 2017 Quarter

Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units

200,000

250,000

300,000

62,500 262,500

62,500 312,500

75,000 325,000

60,000* 360,000

50,000** 212,500

62,500 250,000

62,500 262,500

75,000 285,000

Year

1,010,000

*Estimated first-quarter 2018 sales volume 200,000 + (200,000 X 20%) = 240,000: 240,000 X 25%. **25% of estimated first-quarter 2017 sales units (200,000 X 25%).

PARGO COMPANY Direct Materials Budget For the Year Ending December 31, 2017 Quarter 1

Year

Units to be produced 212,500 250,000 262,500 285,000 X 2 X 2 X 2 Direct materials per unit X 2 Total pounds needed for 500,000 525,000 570,000 production 425,000 Add: Desired ending direct materials 52,500 57,000 *45,000 50,000 (pounds) 552,500 582,000 615,000 Total materials required 475,000 Less: Beginning direct 50,000 52,500 57,000 materials (pounds) **42,500 Direct materials 502,500 529,500 558,000 purchases 432,500 X $12 X $12 X $12 Cost per pound X $12 Total cost of direct materials purchases $5,190,000 $6,030,000 $6,354,000 $6,696,000 $24,270,000 *Estimated first-quarter 2018 production requirements 450,000 X 10% = 45,000 **10% of estimated first-quarter pounds needed for production.

DO IT! 21 -3 (a)

Total unit cost: Cost Element Direct materials .............................. Direct labor ..................................... Manufacturing overhead ................ Total unit cost ........................

(b)

Quantity 2 pounds 0.3 hours 0.3 hours

Unit Cost $12.00 $15.00 $20.00

Total $24.00 4.50 6.00 $34.50

PARGO COMPANY Budgeted Income Statement For the Year Ending December 31, 2017 Sales (1,000,000) units from sales budget, page 9-10....... Cost of goods sold (1,000,000 X $34.50/unit) .................. Gross profit ....................................................................... Selling and administrative expenses............................... Net income.........................................................................

$41,500,000 34,500,000 7,000,000 6,000,000 $ 1,000,000

DO IT! 21 -4 BATISTA COMPANY Cash Budget April Beginning cash balance.............................................................. Add: Cash receipts for April ...................................................... Total available cash..................................................................... Less: Cash disbursements in April ........................................... Excess of available cash over cash disbursements ................. Add: Financing ($25,000 – $15,000) .......................................... Ending cash balance...................................................................

$ 25,000 245,000 270,000 255,000 15,000 10,000 $ 25,000

To maintain the desired minimum cash balance of $25,000, Batista Company must borrow $10,000.

DO IT! 21 -5 Zeller COMPANY Merchandise Purchases Budget For the Six Months Ending June 30, 2017 Quarter Budgeted cost of goods sold (Sales  .50) Add: Desired ending merchandise inventory (10% of next quarter’s cost of goods sold) Total Less: Beginning merchandise inventory (10% this quarter’s cost of goods sold) Required merchandise purchases

$20,000

$24,000

2,400 22,400

2,900 26,900

2,000 $20,400

2,400 $24,500

Six Months

$44,900

SOLUTIONS TO EXERCISES EXERCISE 21-1 MEMO To

Jim Dixon

From: Student Re:

Budgeting

I am glad Trusler Company is considering preparing a formal budget. There are many benefits derived from budgeting, as I will discuss later in this memo. A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. The master budget generally consists of operating budgets such as the sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, selling and administrative expense budget, and budgeted income statement; and financial budgets such as the capital expenditure budget, cash budget, and budgeted balance sheet. The primary benefits of budgeting are: 1. It requires all levels of management to plan ahead and to formalize goals on a recurring basis. 2. It provides definite objectives for evaluating performance at each level of responsibility. 3. It creates an early warning system for potential problems, so that management can make changes before things get out of hand. 4. It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. 5. It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. 6. It motivates personnel throughout the organization to meet planned objectives. In order to maximize these benefits, it is essential that budgeting take place within a sound organizational structure, so authority and responsibility for all phases of operations are clearly defined. Also, the budget should be based on research and analysis that results in realistic goals. Finally, the effectiveness of a budget program is directly related to its acceptance by all levels of management. If you want further explanation of any of these topics, please contact me.

EXERCISE 21-4 TURNEY COMPANY Production Budget For the Year Ending December 31, 2017 Product HD-240 Quarter Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units (1) (2)

40% of next quarter’s sales. 40% X (5,000 X 125%).

5,000

7,000

8,000

10,000

2,800 7,800

3,200 10,200

4,000 12,000

2,500 (2) 12,500

2,000 5,800

2,800 7,400

3,200 8,800

4,000 8,500

Year

30,500

EXERCISE 21-5 DEWITT INDUSTRIES Direct Materials Purchases Budget For the Quarter Ending March 31, 2017

Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds)* Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials purchases

January 10,000 X 2 20,000

February 8,000 X 2 16,000

March 5,000 X 2 10,000

3,200 23,200

2,000 18,000

1,600 11,600

4,000 19,200 X $3

3,200 14,800 X $3

2,000 9,600 X $3

$57,600

$44,400

$28,800

*20% of next month’s production needs. EXERCISE 21-6 (a)

HARDIN COMPANY Production Budget For the Six Months Ending June 30, 2017 Quarter Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units (1)

25% X 6,000. 25% X 7,000. (3) 25% X 5,000. (2)

Six Months

1 5,000

2 6,000

1,500(1) 6,500 1,250(3) 5,250

1,750 (2) 7,750 1,500 6,250 11,500

EXERCISE 21-6 (Continued) (b)

HARDIN COMPANY Direct Materials Budget For the Six Months Ending June 30, 2017 Quarter Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds) Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials Purchases (1) 40% X 18,750. (2) 7,200 X (3 X 40%). (3) 40% X 15,750.

1 5,250 X 3 15,750

2 6,250 X 3 18,750

7,500 (1) 23,250

8,640(2) 27,390

6,300 (3) 7,500 16,950 19,890 X $4 X $4 $67,800

$79,560

EXERCISE 21-7 Finished goods: Sales ........................................................................ Plus: Ending inventory........................................... Total required .............................................................. Less: beginning inventory .................................... Production required .................................................... Direct materials per unit ............................................. Units of direct material required for production ....... Plus: ending inventory................................................ Total required .............................................................. Less: beginning inventory .................................... Purchases of direct material required ....................... Cost per unit ................................................................ Total cost of materials ................................................ The May raw material purchases would be $20,580. (a)

Six Months

2,390 + 2,310 – 2,200 = 2,500; 2,500 X 2 X .50 = 2,500 (b) 2,675 + 2,200 – 2,230 = 2,645; 2,645 X 2 X .50 = 2,645

2,675 2,200 4,875 2,230 2,645 X

2 5,290 2,500(a) 7,790 2,645(b) 5,145 X $4 $20,580

$147,360

EXERCISE 21-8 (a)

FUQUA COMPANY Production Budget For the Two Months Ending February 28, 2017 January Expected unit sales ................................................ 10,000 Add: desired ending finished goods inventory ...................................................... 2,400* Total required units ................................................ 12,400 Less: beginning finished goods inventory .......... 2,000** Required production units ..................................... 10,400

February 12,000 2,600*** 14,600 2,400 12,200

*20% X next month’s expected sales or 12,000 X 20% **20% X 10,000 ***20% X 13,000 (b)

FUQUA COMPANY Direct Materials Budget For the Month Ending January 31, 2017

Units to be produced ............................................................ Direct material pounds per unit ........................................... Total pounds needed for production................................... Add: desired pounds in ending materials inventory ......... Total materials required ....................................................... Less: beginning direct materials (pounds) ......................... Direct materials purchases .................................................. Cost per pound ..................................................................... Total cost of direct materials purchases............................. *(12,200 X 4) X 40%

**(10,400 X 4) X 40%

January 10,400 X4 41,600 19,520* 61,120 16,640** 44,480 X $2 $88,960

EXERCISE 21-9 RODRIQUEZ, INC. Direct Labor Budget For the Year Ending December 31, 2017 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost

1 20,000 X

1.5

2 25,000 X

1.5

3 35,000 X

1.5

4 30,000 X

Year

1.5

30,000

37,500

52,500

45,000

X $16 $480,000

X $16 $600,000

X $18 $945,000

X $18 $810,000

$2,835,000

EXERCISE 21-10 LOWELL COMPANY Production Budget For the Quarter Ending March 31, 2017 Sales in units Plus: desired ending inventory Total needs Less: beginning inventory Required production units (1)

Jan 12,000 19,200(1) 31,200 17,600 13,600

(14,000 X 100%) + (13,000 X 40%) (13,000 X 100%) + (11,000 X 40%) (3) (11,000 X 100%) + (11,000 X 40%) (2)

Feb 14,000 17,400(2) 31,400 19,200 12,200

Mar 13,000 15,400(3) 28,400 17,400 11,000

Total 39,000 15,400 54,400 17,600 36,800

EXERCISE 21-10 (Continued) LOWELL COMPANY Direct Labor Budget For the Quarter Ending March 31, 2017 Production in units Direct labor hours per unit Total hours needed Rate per hour Total direct labor

Jan 13,600 X 2.00 27,200 X $8.00 $217,600

Feb Mar 12,200 11,000 X 2.00 X 1.50 24,400 16,500 X $8.00 X $8.00 $195,200 $132,000

Total

$544,800

EXERCISE 21-11 ATLANTA COMPANY Manufacturing Overhead Budget For the Year Ending December 31, 2017 Quarter Variable costs Indirect materials ($.80/hour) Indirect labor ($1.20/hour) Maintenance ($.50/hour) Total variable Fixed costs Supervisory salaries Depreciation Maintenance Total fixed Total manufacturing overhead Direct labor hours Manufacturing overhead rate per direct labor hour ($443,000 ÷ 78,000)

*(10,000 X 1.5)

Year

$12,000 18,000 7,500 37,500

$ 14,400 21,600 9,000 45,000

$ 16,800 25,200 10,500 52,500

$ 19,200 28,800 12,000 60,000

$ 62,400 93,600 39,000 195,000

35,000 15,000 12,000 62,000 $99,500

35,000 15,000 12,000 62,000 $107,000

35,000 15,000 12,000 62,000 $114,500

35,000 15,000 12,000 62,000 $122,000

140,000 60,000 48,000 248,000 $443,000

15,000*

18,000

21,000

24,000

78,000 $5.68

EXERCISE 21-12 KIRKLAND COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2017 Quarter

Six Months

Budgeted sales in units

1 20,000

2 22,000

Variable expenses (1) Sales commissions Delivery expense Advertising Total variable

$20,000* 8,000 12,000 40,000

$22,000 8,800 13,200 44,000

$ 42,000 16,800 25,200 84,000

12,000 8,000 4,200 1,500 800 500 27,000

24,000 16,000 8,400 3,000 1,600 1,000 54,000

$67,000

$71,000

$138,000

Fixed expenses Sales salaries Office salaries Depreciation Insurance Utilities Repairs expense Total fixed Total selling and administrative expenses

(1) Variable costs per dollar of sales are: Sales commissions (5%), Delivery expense (2%), and Advertising (3%). *(20,000 X $20 X 5%)

EXERCISE 21-13 (a) FULTZ COMPANY Computation of Cost of Goods Sold For the Year Ending December 31, 2017 Cost of one unit of finished goods: Direct materials (1 X $5) ............................................................... Direct labor (3 X $15) .................................................................... Manufacturing overhead (3 X $5) ................................................ Total ......................................................................................

$ 5 45 15 $65

30,000 units X $65 = $1,950,000. (b) FULTZ COMPANY Budgeted Income Statement For the Year Ending December 31, 2017 Sales (30,000 X $85)............................................................ Cost of goods sold (see part (a)) ....................................... Gross profit ......................................................................... Selling and administrative expenses ................................ Income from operations ..................................................... Interest expense ................................................................. Income before income taxes .............................................. Income tax expense ($400,000 X 30%) .............................. Net income ..........................................................................

$2,550,000 1,950,000 600,000 170,000 430,000 30,000 400,000 120,000 $ 280,000

EXERCISE 21-14 DANNER COMPANY Cash Budget For the Two Months Ending February 28, 2017

Beginning cash balance ......................................... Add: Receipts Collections from customers ...................... Sale of marketable securities .................... Total receipts .............................................. Total available cash ................................................ Less: Disbursements Direct materials........................................... Direct labor ................................................. Manufacturing overhead ............................ Selling and administrative expenses ........ Total disbursements................................... Excess (deficiency) of available cash over cash disbursements .................................................... Financing Add: Borrowings.................................................... Less: Repayments .................................................. Ending cash balance ..............................................

January $ 45,000

February $ 27,500

85,000 12,000 97,000 142,000

150,000 0 150,000 177,500

50,000 30,000 19,500 15,000 114,500

75,000 45,000 23,500 20,000 163,500

27,500

14,000

0 0 $ 27,500

6,000 0 $ 20,000

EXERCISE 21-15 DEITZ CORPORATION Cash Budget For the Quarter Ended March 31, 2017 Beginning cash balance ........................................................... Add: Receipts Collections from customers......................................... Sale of equipment ......................................................... Total receipts .......................................................... Total available cash .................................................................. Less: Disbursements Direct materials............................................................. Direct labor.................................................................... Manufacturing overhead .............................................. Selling and administrative expenses .......................... Purchase of securities.................................................. Total disbursements .............................................. Excess of available cash over disbursements........................ Financing Add: Borrowings ..................................................................... Less: Repayments.................................................................... Ending cash balance ................................................................

$ 30,000 185,000 3,000 188,000 218,000 43,000 70,000 35,000 45,000 14,000 207,000 11,000 14,000 –0– $ 25,000

EXERCISE 21-16 (a)

TRENSHAW COMPANY Cash Budget For the Month Ended July 31, 2017 Beginning cash balance ............................ Add: Cash collections .............................. Total cash available ................................... Less: Cash disbursements Merchandise purchases ......... Operating expenses................ Equipment purchase .............. Total cash disbursements ......................... Excess of available cash over disbursements ................................ Add: Borrowings....................................... Ending cash balance .................................

$45,000 90,000 $135,000 $56,200 40,800 20,000 117,000 18,000 7,000 $ 25,000

Cash disbursements of $117,000 plus the desired ending cash balance of $25,000 exceeds the $135,000 total cash available by $7,000. Therefore, Trenshaw Company will have to borrow $7,000. (b) An advantage of cash budgeting is that it allows cash shortfalls to be predicted. If the timing of future cash shortfalls is known, arrangements to borrow funds can be made well in advance, which often means that interest rates may be more favorable than if the funds are needed on short notice.

EXERCISE 21-17 (a)

NEITO COMPANY Expected Collections from Customers

March cash sales (30% X $250,000) ..................................... Collection of March credit sales [(70% X $250,000) X 10%].................................................. Collection of February credit sales [(70% X $220,000) X 50%].................................................. Collection of January credit sales [(70% X $200,000) X 36%].................................................. Total collections........................................................ (b)

March $ 75,000 17,500 77,000 50,400 $219,900

NEITO COMPANY Expected Payments for Direct Materials

March cash purchases (50% X $38,000) .............................. Payment of March credit purchases [(50% X $38,000) X 40%].................................................... Payment of February credit purchases [(50% X $36,000) X 60%].................................................... Total payments..........................................................

March $19,000 7,600 10,800 $37,400

EXERCISE 21-18 (a)

(1) GREEN LANDSCAPING INC. Schedule of Expected Collections From Clients For the Quarter Ending March 31, 2017 January November ($80,000)...... December ($90,000) ...... January ($100,000) ....... February ($120,000) ...... March ($140,000)........... Total collections .....

February

$ 8,000 27,000 60,000

$95,000

$111,000

March

Quarter $

9,000 30,000 72,000

$ 10,000 36,000 84,000 $130,000

8,000 36,000 100,000 108,000 84,000 $336,000

(2) GREEN LANDSCAPING INC. Schedule of Expected Payments for Landscaping Supplies For the Quarter Ending March 31, 2017 January December ($14,000) ...... January ($12,000) ......... February ($15,000)........ March ($18,000)............. Total payments .......

$ 5,600 7,200

$12,800

February $ 4,800 9,000 $13,800

March

Quarter

$ 6,000 10,800 $16,800

$ 5,600 12,000 15,000 10,800 $43,400

(b) (1) Accounts receivable at March 31, 2017: ($120,000 X 10%) + ($140,000 X 40%) = $68,000 (2) Accounts payable at March 31, 2017: ($18,000 X 40%) = $7,200

EXERCISE 21-19 PLETCHER DENTAL CLINIC Cash Budget For the Two Quarters Ending June 30, 2017

Beginning cash balance ....................................... Add: Receipts Collections from patients ...................... Sale of equipment .................................. Investment interest ................................ Total receipts .................................... Total cash available .............................................. Less: Disbursements Professional salaries ............................. Overhead costs ...................................... Selling and administrative costs........... Equipment purchase.............................. Payment of income taxes ...................... Total disbursements ........................ Excess (deficiency) of cash available over cash disbursements ................................. Financing Add: Borrowings................................................. Less: Repayments ............................................... Ending cash balance ............................................ *$50,000 – $2,000 **$70,000 – $2,000

1st Quarter $ 30,000

2nd Quarter $ 25,000

235,000 12,000 0 247,000 277,000

380,000 0 7,000 387,000 412,000

140,000 77,000 48,000* 0 0 265,000

140,000 100,000 68,000** 50,000 4,000 362,000

12,000

50,000

13,000 0 $ 25,000

0 13,200 $ 36,800

EXERCISE 21-20 (a)

GRAND STORES Merchandise Purchases Budget For the Month Ending June 30, 2017 Budgeted cost of goods sold ($500,000 X 75%) .................. Add: Desired ending merchandise inventory ($600,000 X 75% X 30%) .................................................... Total........................................................................................ Less: Beginning merchandise inventory ($375,000 X 30%)......................................................... Required merchandise purchases .......................................

(b)

$375,000 135,000 510,000 112,500 $397,500

GRAND STORES Budgeted Income Statement For the Month Ending June 30, 2017 Sales ...................................................................................... Cost of goods sold (75% X $500,000).................................. Gross profit ...........................................................................

$500,000 375,000 $125,000

EXERCISE 21-21 Emeric and Ellie’s Painting Service Direct Labor Budget For the Month Ending June 30, 2017 Home to be painted Direct labor time (hours) per house Total required direct labor hours Direct labor cost per hour Total direct labor cost

Small 10

Medium 5

Large 2

X 40

X 70

X 120

400 X $18

350 X $18

240 X $18

$7,200

$6,300

$4,320

Total

$17,820

SOLUTIONS TO PROBLEMS PROBLEM 21-1A

COOK FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2017 Quarter Expected unit sales..................... Unit selling price ......................... Total sales ...................................

1 40,000 X $60 $2,400,000

2 56,000 X $60 $3,360,000

Six Months 96,000 X $60 $5,760,000

COOK FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2017 Quarter Expected unit sales....................................... Add: Desired ending finished goods units .................................................... Total required units....................................... Less: Beginning finished goods units ........ Required production units............................

1 40,000

2 56,000

15,000 55,000 8,000 47,000

18,000 74,000 15,000 59,000

Six Months

106,000

PROBLEM 21-1A (Continued) COOK FARM SUPPLY COMPANY Direct Materials Budget—Gumm For the Six Months Ending June 30, 2017 Quarter Units to be produced .................................... Direct materials per unit ............................... Total pounds needed for production .......... Add: Desired ending direct materials (pounds) ............................................. Total materials required ............................... Less: Beginning direct materials (pounds) ............................................ Direct materials purchases .......................... Cost per pound.............................................. Total cost of direct materials purchases ..................................................

1 47,000 X4 188,000

2 59,000 X 4 236,000

10,000 198,000

13,000 249,000

9,000 189,000 X $3.80

10,000 239,000 X $3.80

$718,200

$908,200

Six Months

$1,626,400

COOK FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2017 Quarter Units to be produced ........................... Direct labor time (hours) per unit........ Total required direct labor hours ........ Direct labor cost per hour.................... Total direct labor cost ..........................

1 47,000 X 1/4 11,750 X $16 $188,000

2 59,000 X 1/4 14,750 X $16 $236,000

Six Months

$424,000

PROBLEM 21-1A (Continued) COOK FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2017 Quarter 1 40,000

2 56,000

Six Months 96,000

$360,000 175,000 $535,000

$504,000 175,000 $679,000

$ 864,000 350,000 $1,214,000

Budgeted sales in units Variable (.15 X sales).......................... Fixed.................................................... Total.....................................................

COOK FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2017 Sales............................................................................................. Cost of goods sold (96,000 X $33.20)* ....................................... Gross profit.................................................................................. Selling and administrative expenses ......................................... Income from operations.............................................................. Interest expense .......................................................................... Income before income tax .......................................................... Income tax expense (30%) .......................................................... Net income ...................................................................................

$5,760,000 3,187,200 2,572,800 1,214,000 1,358,800 100,000 1,258,800 377,640 $ 881,160

*Cost Per Bag Cost Element Direct materials Gumm .......................................... Tarr............................................... Direct labor ...................................... Manufacturing overhead (125% of direct labor cost) ......... Total ........................................

Quantity

Unit Cost

Total

4 pounds 6 pounds 1/4 hour

$ 3.80 1.50 16.00

$15.20 9.00 4.00 5.00 $33.20

PROBLEM 21-2A

(a)

DELEON INC. Sales Budget For the Year Ending December 31, 2017

Expected unit sales........... Unit selling price ............... Total sales..........................

(b)

JB 50 400,000 X $20 $8,000,000

JB 60 200,000 X $25 $5,000,000

Total

$13,000,000

DELEON INC. Production Budget For the Year Ending December 31, 2017

Expected unit sales ............................ Add: Desired ending finished goods units .............................. Total required units ............................ Less: Beginning finished goods units ......................................... Required production units .................

JB 50 400,000

JB 60 200,000

30,000 430,000

15,000 215,000

25,000 405,000

10,000 205,000

PROBLEM 21-2A (Continued) (c)

DELEON INC. Direct Materials Budget For the Year Ending December 31, 2017 Units to be produced .................... Direct materials per unit ............... Total pounds needed for production.................................. Add: Desired ending direct materials (pounds)............. Total materials required ............... Less: Beginning direct materials (pounds)............. Direct materials purchases .......... Cost per pound.............................. Total cost of direct materials purchases .................................

(d)

JB 50 405,000 X 2

JB 60 205,000 X 3

810,000

615,000

30,000 840,000

10,000 625,000

40,000 800,000 X $3

15,000 610,000 X $4

$2,400,000

$2,440,000

Total

$4,840,000

DELEON INC. Direct Labor Budget For the Year Ending December 31, 2017

Units to be produced .................... Direct labor time (hours) per unit.............................................. Total required direct labor hours .......................................... Direct labor cost per hour ............ Total direct labor cost...................

JB 50 405,000

JB 60 205,000

X .4

X .6

162,000 X $12 $1,944,000

123,000 X $12 $1,476,000

Total

$3,420,000

PROBLEM 21-2A (Continued) (e)

DELEON INC. Budgeted Income Statement For the Year Ending December 31, 2017

Sales ..................................... Cost of goods sold .............. Gross profit .......................... Operating expenses Selling expenses.............. Administrative expenses ...................... Total operating expenses............... Income from operations ...... Interest expense .................. Income before income taxes ................................. Income tax expense (30%) ................................. Net income ........................... (1) (2)

400,000 X $13. 200,000 X $20.

JB 50 JB 60 Total $8,000,000 $5,000,000 $13,000,000 (1) (2) 5,200,000 4,000,000 9,200,000 2,800,000 1,000,000 3,800,000 560,000

360,000

920,000

540,000

340,000

880,000

1,100,000 $1,700,000

700,000 $ 300,000

1,800,000 2,000,000 150,000 1,850,000 555,000 $ 1,295,000

PROBLEM 21-3A

(a)

HILL INDUSTRIES Sales Budget For the Year Ending December 31, 2017

Expected unit sales ................................... Unit selling price ........................................ Total sales ..................................................

Plan A Plan B (1) 765,000 950,000(2) X $8.40 X $7.50(3) $6,426,000 $7,125,000

(1)

$6,800,000 ÷ $8 = 850,000 X 90% = 765,000. 850,000 + 100,000 = 950,000. (3) $8.00 – $0.50 (2)

(b)

HILL INDUSTRIES Production Budget For the Year Ending December 31, 2017

Expected unit sales.............................................. Add: Desired ending finished goods units ...... Total required units.............................................. Less: Beginning finished goods units............... Required production units .................................. (1) 765,000 X 5%

Plan A Plan B 765,000 950,000 (1) 38,250 60,000 803,250 1,010,000 40,000 40,000 763,250 970,000

(c) Variable costs = $4.40 per unit ($1.80 + $1.40 + $1.20) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b)

$3,358,300 (763,250 X $4.40) 1,895,000 $5,253,300

Plan B $4,268,000 (970,000 X $4.40) 1,895,000 $6,163,000

763,250

970,000

$6.88

$6.35

The difference is due to the fact that fixed costs are spread over a larger number of units (206,750) in Plan B.

PROBLEM 21-3A (Continued) (d)

Gross Profit Plan A Sales Cost of goods sold Gross profit

$6,426,000 5,263,200 (765,000 X $6.88) $1,162,800

Plan B $7,125,000 6,032,500 (950,000 X $6.35) $1,092,500

Plan A should be accepted because it produces a higher gross profit than Plan B.

PROBLEM 21-4A

(a) (1)

Expected Collections from Customers

November ($250,000)................................ December ($320,000) ................................ January ($360,000).................................... February ($400,000) .................................. Total collections .............................. (2)

January $ 50,000 96,000 180,000 .

$326,000

February $ 0 64,000 108,000 200,000 $372,000

Expected Payments for Direct Materials

December ($100,000) ................................ January ($120,000).................................... February ($125,000) .................................. Total payments ................................

January $ 40,000 72,000 .

$112,000

February $ 0 48,000 75,000 $123,000

PROBLEM 21-4A (Continued) (b)

COLTER COMPANY Cash Budget For the Two Months Ending February 28, 2017

Beginning cash balance .................................. Add: Receipts Collections from customers ............ [See Schedule (1)] Notes receivable ............................... Sale of securities .............................. Total receipts ............................ Total available cash ......................................... Less: Disbursements Direct materials ............................... [See Schedule 2] Direct labor ...................................... Manufacturing overhead ................. Selling and administrative expenses* .................................... Cash dividend.................................. Total disbursements ............... Excess (deficiency) of available cash over cash disbursements............................ Financing Add: Borrowings............................................ Less: Repayments .......................................... Ending cash balance .......................................

January $ 60,000

February $ 51,000

326,000

372,000

15,000 341,000 401,000

6,000 378,000 429,000

112,000

123,000

90,000 70,000

100,000 75,000

78,000 350,000

84,000 6,000 388,000

51,000

41,000

0 0 $ 51,000

9,000 0 $ 50,000

*Selling and administrative expenses less $1,000 depreciation.

PROBLEM 21-5A

(a)

SUPPAR COMPANY San Miguel Store Merchandise Purchases Budget For the Months of May and June, 2017

Budgeted cost of goods sold........................... Add: Desired ending merchandise inventory..... Total ................................................................... Less: Beginning merchandise inventory ........ Required merchandise purchases................... (1)

May June $600,000 $630,000(1) 63,000(2) 66,150(3) 663,000 696,150 (4) 60,000 63,000 $603,000 $633,150

$800,000 X 105% = $840,000; $840,000 X 75% = $630,000. $630,000 X 10% = $63,000. (3) $840,000 X 105% = $882,000; $882,000 X 75% = $661,500; $661,500 X 10% = $66,150. (4) $600,000 X 10% = $60,000. (2)

PROBLEM 21-5A (Continued) (b)

SUPPAR COMPANY San Miguel Store Budgeted Income Statement For the Months of May and June, 2017

Sales .................................................................. Cost of goods sold Beginning inventory.................................. Purchases.................................................. Cost of goods available for sale .............. Less: Ending inventory............................ Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Sales salaries ............................................ Advertising* ............................................... Delivery** ................................................... Sales commissions***............................... Rent ............................................................ Depreciation .............................................. Utilities ....................................................... Insurance ................................................... Total.................................................... Income from operations ................................... Interest expense ............................................... Income before income taxes............................ Income tax expense (30%) ............................... Net income ........................................................ *6% of sales. **2% of sales. ***5% of sales.

May $800,000

June $840,000

60,000 603,000 663,000 63,000 600,000 200,000

63,000 633,150 696,150 66,150 630,000 210,000

35,000 48,000 16,000 40,000 5,000 800 600 500 145,900 54,100 2,000 52,100 15,630 $ 36,470

35,000 50,400 16,800 42,000 5,000 800 600 500 151,100 58,900 2,000 56,900 17,070 $ 39,830

PROBLEM 21-6A

KRAUSE INDUSTRIES Budgeted Cost of Goods Sold For the Year Ending December 31, 2017 Finished goods inventory, 1/1/17 ........................... Cost of goods manufactured Direct materials used....................................... Direct labor....................................................... Manufacturing overhead applied .................... Cost of goods available for sale............................. Finished goods inventory 12/31/17 (2,500  $18) .. Cost of goods sold ..................................................

$ 24,000 $62,500 50,900 48,600

162,000 186,000 45,000 $141,000

KRAUSE INDUSTRIES Budgeted Income Statement For the Year Ending December 31, 2017 Sales revenue (8,000  $32) .................................... Cost of goods sold .................................................. Gross profit.............................................................. Selling and administrative expenses ..................... Income from operations.......................................... Interest expense ...................................................... Income before income taxes .................................. Income tax expense (40%) ...................................... Net income ...............................................................

$256,000 141,000 115,000 75,000 40,000 3,500 36,500 14,600 $ 21,900

KRAUSE INDUSTRIES Budgeted Retained Earnings Statement For the Year Ending December 31, 2017 Retained earnings, 1/1/17........................................ Add: Net income ...................................................... Deduct: Dividends ................................................... Retained earnings 12/31/17.....................................

$25,000 21,900 46,900 8,000 $38,900

PROBLEM 21-6A (Continued) KRAUSE INDUSTRIES Budgeted Balance Sheet December 31, 2017 Assets Current assets Cash...................................................................... Accounts receivable ($76,800 X 40%) ................ Finished goods inventory (2,500 X $18)..................................................... Total current assets ..................................... Property, plant, and equipment Equipment ($40,000 + $9,000) ............................. Less: Accumulated depreciation ($10,000 + $4,000) ..................................... Total assets ..................................................

$ 5,880 30,720 45,000 $81,600 $49,000 14,000

35,000 $116,600

Liabilities and Stockholders’ Equity Liabilities Notes payable ($25,000 – $8,000) ....................... Accounts payable ($8,500* + $7,200).................. Income taxes payable.......................................... Total liabilities .............................................. Stockholders’ equity Common stock..................................................... Retained earnings................................................ Total stockholders’ equity ........................... Total liabilities and stockholders’ equity ........................................................ *$17,000 X 50%

$17,000 15,700 5,000 $ 37,700

$40,000 38,900 78,900 $116,600

PROBLEM 21-6A (Continued) Proof of budgeted cash balance December 31, 2017 Beginning Cash ....................................................... Collections Beginning accounts receivable .............................. 2017 sales less ending accounts receivable ($256,000 – $30,720)......................................... Payments Beginning accounts payable .................................. Note payment........................................................... Equipment purchase ............................................... Dividends ................................................................. Direct materials purchases ($62,500 – $8,500) .................................................... Direct labor .................................................................. Manufact overhead and selling and admin exp less depreciation and ending accts payable $48,600 + $75,000 – $4,000 – $7,200 ................... Interest expense .......................................................... Income taxes (14,600 – $5,000)................................... Ending cash .................................................................

7,500

$ 73,500 225,280

298,780 $306,280

45,000 8,000 9,000 8,000 54,000 50,900 112,400 3,500 9,600

300,400 $ 5,880

CD9

CURRENT DESIGNS CURRENT DESIGNS Production Budget For the Year Ending December 31, 2017

Expected unit sales Add: desired ending finished goods units Total required units Less: Beginning finished goods units Required production units

Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total 1,000 1,500 750 750 4,000 300* 1,300

150* 1,650

150* 900

220** 970

220 4,220

200*** 1,100

300 1,350

150 750

150 820

200 4,020

*(20% of next quarter’s sales) **20% X 1,100 ***given in problem

CD9 (Continued) CURRENT DESIGNS Direct materials Budget For the Year Ending December 31, 2017 Units to be produced Pounds of polyethylene powder per unit Total pounds needed for production Add: desired ending inventory of powder Total pounds of powder required Less: Beginning inventory of powder Pounds of Polyethylene powder to be purchased Cost per pound Cost of polyethylene powder to be purchased Cost of required finishing kits (one kit per kayak manufactured) @$170 each Total costs for direct materials

Quarter 1

Quarter 2

Quarter 3

Quarter 4

1,100

1,350

750

820

X 54

Total 4,020

59,400

72,900

40,500

44,280

217,080

18,225*

10,125*

11,070*

15,930**

15,930

77,625

83,025

51,570

60,210

233,010

19,400***

18,225

10,125

11,070

19,400

58,225 X $1.50

64,800 X $1.50

41,445 X $1.50

49,140 X $1.50

$ 87,337.50

$ 97,200.00

$ 62,167.50

$ 73,710.00

$ 320,415.00

187,000.00

229,500.00

127,500.00

139,400.00

683,400.00

$274,337.50

$326,700.00

$189,667.50

$213,110.00

$1,003,815.00

213,610 $1.50

*25% of needs for next quarter **Desired ending inventory for Quarter 4 = 25% of amount needed for first quarter of 2018 production. Production for first quarter of 2018 = 1,100 + 300 – 220 = 1,180 units Desired ending inventory for Quarter 4 of 2017 = 25% *(1,180 units X 54 pounds per unit) = 15,930 pounds ***given in problem

CD9 (Continued) CURRENT DESIGNS Direct labor Budget For the Year Ending December 31, 2017 Quarter 1

Quarter 2

Quarter 3

Quarter 4

750

820

Total

Units to be produced Number of hours of more skilled labor/unit Total number of hours of more skilled labor

1,100

1,350

2,200

2,700

1,500

1,640

8,040

Hourly rate for more skilled labor Total cost of more skilled labor

X $15 $33,000

X $15 $40,500

X $15 $22,500

X $15 $24,600

X $15 $120,600

Units to be produced Number of hours of less skilled labor/unit Total number of hours of less skilled labor Hourly rate for less skilled labor Total cost of less skilled labor Total cost for direct labor

1,100

1,350

750

820

4,020

3,300 X $12 39,600 $72,600

4,050 X $12 48,600 $89,100

2,250 X $12 27,000 $49,500

2,460 X $12 29,520 $54,120

4,020 X

12,060 X $12 144,720 $265,320

CURRENT DESIGNS Manufacturing Overhead Budget For the Year Ending December 31, 2017 Quarter 1 Quarter 2 Quarter 3 Quarter 4

Total

Total costs for direct labor $72,600 $89,100 $49,500 $54,120 $265,320 Manufacturing overhead rate per direct labor X 150% X 150% X 150% X 150% X 150% dollar Manufacturing overhead $108,900 $133,650 $74,250 $81,180 $397,980 costs

CD9 (Continued) CURRENT DESIGNS Selling and Administrative Expense Budget For the Year Ending December 31, 2017 Expected unit sales Variable selling and administrative costs at $45 per unit sold Fixed selling and administrative costs Total selling and administrative costs

Quarter 1 Quarter 2 Quarter 3 Quarter 4 1,000 1,500 750 750

Total 4,000

$45,000

$67,500

$33,750

$180,000

7,500

30,000

$52,500

$75,000

$41,250

$210,000

BYP 21-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) The budget at Palmer Corporation is an imposed “top-down” budget which fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The president has not given any basis for his goals, so one cannot know whether they are realistic for the company. True participation of company employees in preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The budget process is the merging of the requirements of all facets of the company on a basis of sound judgment and equity. Specific instances of poor procedures other than the approach and goals include the following: 1.

The sales by product line should be based upon an accurate sales forecast of potential market. Therefore, the sales by product line should have been developed first to derive the sales target rather than the reverse.

Production costs probably would be the easiest and most certain costs to estimate. Given variable and fixed production costs, one could estimate the sales volume needed to cover manufacturing costs plus the costs of other aspects of the operation. This would be helpful before budgets for marketing costs and corporate office expenses are set.

The initial meeting between the vice president of finance, executive vice president, marketing manager, and production manager should be held earlier. This meeting is held too late in the budgeting process.

(b) Palmer Corporation should consider the adoption of a “bottom to top” (participative) budget process. This means that the people responsible for performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial, and production personnel to define sales and profit goals which are realistic within the constraints under which management operates. Although time-consuming, the approach should produce a more acceptable, honest, and workable goal-control mechanism. It also provides for goal congruence possibilities for both individuals and departments within the firm.

BYP 21-1 (Continued) The sales forecast should be developed considering internal sales forecasts as well as external factors. Costs within departments should be divided into fixed and variable, discretionary and nondiscretionary. (c) The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (one year) is short enough so that many costs are relatively fixed in amount. For those costs which are fixed, there is little hope for a reduction as a consequence of short-run changes in volume. However, the functional areas should be expected to cut costs should sales volume fall below target when: 1.

Control is exercised over the costs within their function.

Budgeted costs were more than adequate for the originally targeted sales; i.e., slack was present.

Budgeted costs vary to some extent with changes in sales.

There are discretionary costs which can be delayed or omitted with no serious effect on the department. (CMA adapted)

BYP 21-2

MANAGERIAL ANALYSIS

(a) Direct materials

Either lower quality materials resulting in an inferior product and possible lost sales, or fewer units produced resulting in lost sales.

Direct labor

Reduced production resulting in lost sales, or reduction in quality of product resulting in lost sales.

Insurance

Less coverage; may increase risk beyond acceptable levels.

Depreciation

To reduce depreciation, fixed assets would have to be disposed of. Could result in less production and lost sales.

Machine repairs

Less efficient operations, or lost production and sales.

Sales salaries

Lost sales.

Office salaries

Less effective administrative functions.

Factory salaries

Lost production due to inefficiency, and therefore lost sales.

(b) Given the nature of their product, a decline in quality should be avoided, since this could result in lower future sales. Direct materials represent the largest single cost, and thus perhaps the greatest potential savings. Perhaps substitute materials of similar quality can be found, or less expensive materials can be used for aspects of the product where quality is not as critical. Additionally, it may be possible to renegotiate prices with the supplier. Elliot & Hesse should be very reluctant to reduce repair costs, since in the long run this can be very expensive. Perhaps salaried and hourly employees can be encouraged to take pay cuts if a profit-sharing mechanism is introduced.

BYP 21-3

REAL-WORLD FOCUS

(a) According to Mr. LaFaive, zero-based budgeting requires that the existence of a government program or programs be justified in each fiscal year, as opposed to simply basing budgeting decisions on a previous year’s funding level. Zero-based budgeting is often encouraged by fiscal watchdog groups as a way to ensure against unnecessary spending. (b) In addition to saving money and improving services, zero-based budgeting may:   

Increase restraint in developing budgets; Reduce the entitlement mentality with respect to cost increases; and Make budget discussions more meaningful during review sessions.

May increase the time and expense of preparing a budget; May be too radical a solution for the task at hand. You don’t need a sledgehammer to pound in a nail; Can make matters worse if not done in the right way. A substantial commitment must be made by all involved to ensure that this doesn’t happen.

(d) In Oklahoma, which has recently adopted zero-based budgeting, officials are applying the method to two departments and several agencies each year. Once those reviews are complete, the same departments and agencies will not see another zero-based review for eight years.

BYP 21-4

COMMUNICATION ACTIVITY

Date 2017 Mrs. Megan Parcells, CEO Life Protection Products Dear Mrs. Parcells: Allow me to congratulate you on the success of your new venture! The growth in sales you have experienced is phenomenal. You have managed the business side of the venture very well also. At the same time, I understand your concern about cash flow. You are selling these kits as fast as you can make them, and yet you are running out of cash. There is a solution to your problem. Before describing that, it may be helpful for you to understand why this situation occurred. The primary reason is that you are purchasing kit supplies at least two months in advance of sales. As your business expands, these materials costs continue to increase. Sales do not “catch up” until the Drs. Parcells have a seminar. You did not describe in detail how often these seminars are, but I would guess that they tend to run in cycles rather than being regularly spaced. Eventually, as sales stabilize, you will find that cash inflows exceed cash outflows, and your need for additional cash will subside. Presently, I think it would be a good idea to try to borrow additional funds. I have not seen all your financial data, but judging only from the cash budget you showed me, it appears that you have the basis of a very successful company. If so, your banker will be able to see the potential in your business and should be happy to provide the cash you need. You will need to prepare a full set of financial statements. I will be happy to assist you, if you desire. There is also a possibility that you have underpriced your product. You are providing a valuable service in assembling this information and these materials. The fact that every seminar results in a sellout of the materials may mean that you have priced your product too low. I know that your husband wishes to have these materials available to every family, but increasing the price a little may not make the price too high, and would better compensate you for your efforts.

BYP 21-4 (Continued) However, even if you raised prices, you will find that you need additional cash as long as the business continues to expand. It certainly does not mean that you and Sue are doing anything wrong. It just means that you will be investing additional funds as long as you continue to grow. In my opinion, the best way to make sure these kits are available to as many families as possible is for you and Sue to have a consultant evaluate and determine the size of the market for you. Then you can decide whether to expand to meet the need, or whether to keep your own business small and allow competitors to imitate your product. Congratulations again on a very successful product. Call or email this office if we may be of further assistance preparing financial statements or providing additional advice. Sincerely, Ima Student Best and Superior, Certified Public Accountants

BYP 21-5

ETHICS CASE

(a) At best, if you disclose the errors in your calculations, you will be embarrassed. At worst, you will be dismissed without a recommendation for another job. (b) The president will continue making presentations using data that are grossly overstated. In time, your error may be detected when the events you projected do not materialize. (c) The most ethical scenario would be to admit your error, let the president know about the error, provide the president with corrected projections, and allow the president to decide how to alter his presentations during the second week of his speech-making.

BYP 21-6

ALL ABOUT YOU

Personal Budget Typical Month Income: Wages earned .................................................. Interest income................................................ Income subtotal.......................................................... Income tax withheld ................................................... Spendable income........................................... Expenses: Rent ............................................................................. Utilities Electricity ......................................................... Telephone and Internet ................................... Food: Groceries ......................................................... Eating out......................................................... Insurance .................................................................... Transportation ............................................................ Student loan payments .............................................. Entertainment ............................................................. Savings ....................................................................... Miscellaneous............................................................. Total investments and expenses .............. Surplus/Shortage........................................................

$2,500 50 2,550 300 $2,250 500 85 125 100 150 100 150 375 250 50 210 2,095 $ 155

BYP 21-7

CONSIDERING YOUR COSTS AND BENEFITS

We are concerned that the personal budgets presented on websites and in financial planning textbooks often list student loans among the sources of income. This type of thinking can lead to an overreliance on debt during college, and will result in accumulation of large amounts of debt that must be repaid. We would prefer a format that lists nondebt sources of income, then subtracts expenses, then shows debt borrowed. This format emphasizes an important point: Just like a business, in the short run you can borrow money when your cash inflows are not sufficient to meet your outflows, but in the long run you need to learn to live within your income, and your budget.

CHAPTER 22 Budgetary Control and Responsibility Accounting ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

A Problems

Describe budgetary control and static budget reports.

1, 2, 3, 4, 5

1, 2

1, 2, 8, 9

Prepare flexible budget reports.

6, 7, 8, 9, 10, 11, 12

3, 4, 5

1, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12

1A, 2A, 3A

Apply responsibility accounting to cost and profit centers.

13, 14, 15, 16, 17, 18, 19, 20, 21, 24

6, 7

10, 11, 13, 14, 15, 16

4A, 6A

Evaluate performance in investment centers.

22, 23, 24

8, 9, 10

16, 17, 18, 19

*5.

Explain the difference between ROI and residual income.

25, 26

11, 12

20, 21

*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare flexible budget and budget report for manufacturing overhead.

Simple

20–30

Prepare flexible budget, budget report, and graph for manufacturing overhead.

Moderate

30–40

State total budgeted cost formula, and prepare flexible budget reports for two time periods.

Simple

20–30

Prepare responsibility report for a profit center.

Moderate

20–30

Prepare responsibility report for an investment center, and compute ROI.

Moderate

40–50

Prepare reports for cost centers under responsibility accounting, and comment on performance of managers.

Moderate

40–50

*7A

Compare ROI and residual income.

Moderate

25–35

ANSWERS TO QUESTIONS 1.

(a) Budgetary control is the use of budgets in controlling operations. (b) The steps in budgetary control are: (1) Develop the planned objectives (budget). (2) Analyze differences between actual and budgeted results. (3) Take corrective action. (4) Modify future plans, if necessary.

Purpose

Name of Report

Frequency

(a) (b) (c)

Scrap Departmental overhead costs Income statement

Daily Monthly Monthly and Quarterly

Primary Recipient(s) Production manager Department manager Top management

The budget report for the second quarter can include year-to-date information as well as data for the second quarter.

There is no justification for Ken’s concern. The sales budget is derived from the sales forecast and it represents management’s best estimate of sales. Thus, it is a useful basis for evaluating sales performance.

A static budget is an appropriate basis for evaluating a manager’s effectiveness in controlling costs when: (1) The actual level of activity closely approximates the master budget activity level and/or (2) The behavior of the costs in response to changes in activity is fixed.

Yes, this is true. A flexible budget is a series of static budgets at different levels of activity.

The performance is unfavorable. The budgeted indirect labor cost in the static budget is $1.35 per direct labor hour ($54,000 ÷ 40,000). At 45,000 direct labor hours, budgeted costs are $60,750 (45,000 X $1.35). Thus, indirect labor is $3,250 over budget ($64,000 – $60,750).

The performance is favorable. Factory insurance is a fixed cost. At 50,000 direct labor hours, the budgeted cost is still $6,500. Thus, factory insurance is $200 under budget ($6,500 – $6,300).

The steps in preparing a flexible budget are: (1) Identify the activity index and the relevant range of activity. (2) Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost. (3) Identify the fixed costs, and determine the budgeted amount for each cost. (4) Prepare the budget for selected increments of activity within the relevant range.

10.

Cali Company can say that total budgeted costs are $20,000 fixed plus $6.50 per direct labor hour [($85,000 – $20,000) ÷ 10,000].

11.

(a) At 9,000 hours, total budgeted costs are $86,000, or [$50,000 + ($4 X 9,000)]. (b) At 12,345 hours, total budgeted costs are $99,380, or [$50,000 + ($4 X 12,345)].

Questions Chapter 22 (Continued) 12.

Management by exception means that top management’s review of a budget report is focused either entirely or primarily on differences between actual results and planned objectives. The criteria for identifying exceptions are materiality and controllability of the item.

13.

Responsibility accounting is a method of controlling operations that involves accumulating and reporting costs (and revenues, where relevant) on the basis of the manager who has the authority to make the day-to-day decisions about the items. The purpose of responsibility accounting is to evaluate a manager’s performance on the basis of matters directly under that manager’s control.

14.

Eve should know that the following conditions contribute to the effective use of responsibility accounting: (1) Costs and revenues can be directly associated with the specific level of management responsibility. (2) The costs and revenues are controllable at the level of responsibility with which they are associated. (3) Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues.

15.

A cost is controllable at a given level of managerial responsibility if the manager has the power to incur the cost within a given period of time. Most costs incurred directly are controllable, whereas costs incurred indirectly and allocated to a responsibility level are noncontrollable at that level.

16.

Responsibility reports differ from budget reports in two respects: (1) a distinction is made between controllable and noncontrollable items and (2) performance reports either emphasize, or only include, items controllable by the individual manager.

17.

Usually there is a relationship between a responsibility reporting system and a company’s organization chart. In a responsibility reporting system, reports are prepared for each level of responsibility in the organization chart.

18.

There are three types of responsibility centers: (a) A cost center incurs costs (and expenses) but does not generate revenues. (b) A profit center incurs costs (and expenses) and also generates revenues. (c) An investment center incurs costs (and expenses), generates revenues, and controls the investment funds available for use.

19.

(a) Only controllable costs are included in a performance report for a cost center. (b) Variable and fixed costs are not identified in the report.

20.

Direct fixed costs relate specifically to one center and are incurred for the sole benefit of that center. An indirect fixed cost relates to the company’s overall activities and is incurred for the benefit of more than one profit center. Both types of fixed costs are controllable. A direct fixed cost is controllable by a specific center manager and an indirect fixed cost is controllable by an officer higher up in the organization.

21.

Controllable margin is contribution margin less controllable fixed costs in a profit center. The purpose of controllable margin is to provide a basis for evaluating the manager’s effectiveness in controlling revenues and costs.

Questions Chapter 22 (Continued) 22. The primary basis for evaluating the performance of the manager of an investment center is return on investment (ROI). The formula is: Controllable Margin divided by Average Operating Assets. 23. ROI can be improved by: (1) increasing controllable margin and (2) reducing average operating assets. Controllable margin can be increased by increasing sales or by reducing variable and controllable fixed costs. 24. (a) The manager being evaluated should have direct input into the process of establishing budget goals and have the opportunity to respond to the evaluation. (b) Top management should make the evaluation entirely on matters controllable by the manager, and should fully support the evaluation process. *25. ROI fails to indicate the dollar amount of change in residual income. That is, a positive increase in residual income may result from a project that is rejected because of its negative effect on ROI. *26. Residual income is the income that remains after subtracting from the controllable margin the minimum rate of return on a company’s average operating assets. Residual income as a performance measure ignores the amount of difference in investments (average operating assets) by concentrating only on the amount of additional residual income.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 22-1 CROIX COMPANY Sales Budget Report For the Quarter Ended March 31, 2017 Product Line

Budget $315,000

Guitar: The Edge

Actual $305,000

Difference $10,000 U

BRIEF EXERCISE 22-2 CROIX COMPANY Sales Budget Report For the Quarter Ended June 30, 2017 Product Line Guitar: The Edge

Second Quarter Budget Actual Difference

Budget

Year to Date Actual Difference

$380,000

$695,000

$689,000

$384,000

$4,000 F

$6,000 U

BRIEF EXERCISE 22-3 (a)

Direct Labor

(b)

Direct Labor

ROONEY COMPANY Static Direct Labor Budget Report For the Month Ended January 31, 2017 Budget $200,000

(10,000 X $20)

Actual $206,000

Difference $6,000 U

ROONEY COMPANY Flexible Direct Labor Budget Report For the Month Ended January 31, 2017 Budget $208,000

(10,400 X $20)

Actual $206,000

Difference $2,000 F

BRIEF EXERCISE 22-3 (Continued) The static budget does not provide a proper basis for evaluating performance because the budget is not based on the hours actually worked. In contrast, the flexible budget provides the proper basis for evaluating performance because the budget is based on the hours actually worked.

BRIEF EXERCISE 22-4 GUNDY COMPANY Monthly Flexible Manufacturing Budget For the Year 2017 Activity level Finished units Variable costs Direct materials ($5) Direct labor ($6) Overhead ($8) Total variable costs ($19) Fixed costs Depreciation (1) Supervision (2) Total fixed costs Total costs (1) (2)

($2 X 1,200,000) ÷ 12 ($1 X 1,200,000) ÷ 12

80,000

100,000

120,000

$ 400,000 480,000 640,000 $1,520,000

$ 500,000 600,000 800,000 $1,900,000

$ 600,000 720,000 960,000 $2,280,000

200,000 100,000 300,000 $1,820,000

200,000 100,000 300,000 $2,200,000

200,000 100,000 300,000 $2,580,000

BRIEF EXERCISE 22-5 GUNDY COMPANY Manufacturing Flexible Budget Report For the Month Ended March 31, 2017

Units produced Variable costs Direct materials Direct labor Overhead Total variable costs Fixed costs Depreciation Supervision Total fixed costs Total costs

Budget

Actual

100,000

Difference Favorable F Unfavorable U

$ 500,000 600,000 800,000 $1,900,000

$ 520,000 596,000 805,000 $1,921,000

$20,000 U 4,000 F 5,000 U $21,000 U

200,000 100,000 300,000 $2,200,000

200,000 100,000 300,000 $2,221,000

–0– –0– –0– $21,000 U

Costs were not entirely controlled as evidenced by the difference between budgeted and actual for the variable costs.

BRIEF EXERCISE 22-6 HANNON COMPANY Assembly Department Manufacturing Overhead Cost Responsibility Report For the Month Ended April 30, 2017 Controllable Cost

Budget

Actual

Indirect materials Indirect labor Utilities Supervision

$16,000 20,000 10,000 5,000 $51,000

$14,300 20,600 10,850 5,000 $50,750

Difference Favorable F Unfavorable U $1,700 F 600 U 850 U 0 $ 250 F

BRIEF EXERCISE 22-7 TORRES COMPANY Water Division Responsibility Report For the Year Ended December 31, 2017

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget

Actual

$2,000,000 1,000,000 1,000,000 300,000 $ 700,000

$2,080,000 1,050,000 1,030,000 305,000 $ 725,000

Difference Favorable F Unfavorable U $80,000 F 50,000 U 30,000 F 5,000 U $25,000 F

BRIEF EXERCISE 22-8 COBB COMPANY Plastics Division Responsibility Report For the Year Ended December 31, 2017 Budget

Actual

Contribution margin Controllable fixed costs Controllable margin

$700,000 300,000 $400,000

$710,000 302,000 $408,000

Return on investment

20%

20.4%

.4% F

($400,000 ÷ $2,000,000)

($408,000 ÷ $2,000,000)

($8,000 ÷ $2,000,000)

BRIEF EXERCISE 22-9 I II III

28% ($1,400,000 ÷ $5,000,000) 25% ($2,000,000 ÷ $8,000,000) 36% ($3,600,000 ÷ $10,000,000)

Difference Favorable F Unfavorable U $10,000 F 2,000 U $ 8,000 F

BRIEF EXERCISE 22-10 I

A $300,000 ($2,000,000 X .15) increase in sales will increase contribution margin and controllable margin $210,000 ($300,000 X 70%). The new ROI is 32.2% ($1,610,000 ÷ $5,000,000).

A decrease in costs results in a corresponding increase in controllable margin. The new ROI is 30% ($2,400,000 ÷ $8,000,000).

III

A decrease in average operating assets reduces the denominator. The new ROI is 37.9% ($3,600,000 ÷ $9,500,000).

*BRIEF EXERCISE 22-11 Controllable Margin $630,000

÷ ÷

Average Operating Assets $3,000,000

= ROI = 21%

Controllable Margin $630,000 $630,000

– – –

(Minimum Rate of Return X Average Operating Assets) (10% X $3,000,000) $300,000

= = =

Residual Income Residual Income $330,000

= = =

Residual Income Residual Income $200,000

*BRIEF EXERCISE 22-12 Controllable Margin $800,000

÷ ÷

Average Operating Assets $4,000,000

= ROI = 20%

Controllable Margin $800,000 $800,000

– – –

(Minimum Rate of Return X Average Operating Assets) (15% X $4,000,000) $600,000

SOLUTIONS FOR DO IT! EXERCISES DO IT! 22-1 Difference Favorable F Unfavorable U

Production in units

Budget 6,000

Actual 6,500

Variable costs Direct materials ($7) Direct labor ($13) Overhead ($18) Total variable costs

$ 42,000 78,000 108,000 228,000

$ 38,850 76,440 116,640 231,930

$3,150 F 1,560 F 8,640 U 3,930 U

Fixed costs Depreciation* Supervision** Total fixed costs Total costs

8,000 3,800 11,800 $239,800

8,000 4,000 12,000 $243,930

0 200 U 200 U $4,130 U

The static budget indicates that actual variable costs exceeded budgeted amounts by $3,930. Fixed costs were unfavorable by $200. The static budget gives the impression that the company did not control its variable costs. However, the static budget does not give consideration to the fact that the company produced 500 more units than planned. As a consequence, the static budget is not a good tool to evaluate variable costs. It is, however, a good tool to evaluate fixed costs, since those should not vary with changes in production volume. DO IT! 22-2 Using the graph data, fixed costs are $90,000, and variable costs are $5.20 per direct labor hour [($350,000 – $90,000) ÷ 50,000]. Thus, at 65,000 direct labor hours, total budgeted costs are $428,000 [$90,000 + (65,000 X $5.20)].

DO IT! 22-3 ROCKIES DIVISION Responsibility Report For the Year Ended December 31, 2017

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget $2,000,000 800,000 1,200,000 550,000 $ 650,000

Actual $1,890,000 760,000 1,130,000 550,000 $ 580,000

Difference Favorable F Unfavorable U $110,000 U 40,000 F 70,000 U –0– $ 70,000 U

DO IT! 22-4 (a)

Controllable margin for 2017: Sales ..................................................... Variable costs ...................................... Contribution margin ............................ Controllable fixed costs ...................... Controllable margin ............................. Return on investment for 2017:

(b)

$500,000 300,000 200,000 75,000 $125,000 $125,000 $625,000

Expected return on investment for alternative 1: $125,000* = 25% $500,000 *Controllable margin remains unchanged from (a)

20%

DO IT! 22-4 (Continued) Controllable margin for alternative 2: Sales ($500,000 + 100,000) ........................ Variable costs ($300,000/$500,000 X $600,000) ............. Contribution margin .................................. Controllable fixed costs ............................ Controllable margin ................................... Expected return on investment for alternative 2:

$600,000 360,000 240,000 75,000 $165,000 $165,000 $625,000

26.4%

SOLUTIONS TO EXERCISES EXERCISE 22-1 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

True. False. Budget reports are prepared as frequently as needed. True. True. False. Budgetary control works best when a company has a formalized reporting system. False. The primary recipients of the sales report are the sales manager and top management. True. True. False. Top management’s reaction to unfavorable differences is often influenced by the materiality of the difference. True.

EXERCISE 22-2 (a)

CREDE COMPANY Selling Expense Report For the Quarter Ending March 31

Month January February March

Budget

By Month Actual Difference

Budget

Year-to-Date Actual Difference

$30,000 $35,000 $40,000

$31,200 $34,525 $46,000

$ 30,000 $ 65,000 $105,000

$ 31,200 $ 65,725 $111,725

$1,200 U $ 475 F $6,000 U

$1,200 U $ 725 U $6,725 U

(b)

The purpose of the Selling Expense Report is to help management control selling expenses. The primary recipient is the sales manager.

(c)

Most likely, when management scrutinized the results for January and February, they would determine that the difference was insignificant (4% in January and 1.4% in February), and require no action. When the March results are examined, however, the fact that the difference is 15% of budget would probably cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the amounts of budgeted selling expense for future months to reflect changing conditions.

EXERCISE 22-3 MYERS COMPANY Monthly Manufacturing Overhead Flexible Budget For the Year 2017 Activity level Direct labor hours Variable costs Indirect labor ($1) Indirect materials ($.70) Utilities ($.40) Total variable costs ($2.10) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

7,000

8,000

9,000

10,000

$ 7,000 4,900 2,800 14,700

$ 8,000 5,600 3,200 16,800

$ 9,000 6,300 3,600 18,900

$10,000 7,000 4,000 21,000

4,000 1,200 800 6,000 $20,700

4,000 1,200 800 6,000 $22,800

4,000 1,200 800 6,000 $24,900

4,000 1,200 800 6,000 $27,000

EXERCISE 22-4 (a)

MYERS COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2017

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Utilities Total variable costs Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

Budget at 9,000 DLH

Actual Costs 9,000 DLH

Difference Favorable F Unfavorable U

$ 9,000 6,300 3,600 18,900

$ 8,800 5,800 3,200 17,800

$200 F 500 F 400 F 1,100 F

4,000 1,200 800 6,000 $24,900

4,000 1,200 800 6,000 $23,800

— — — — $1,100 F

EXERCISE 22-4 (Continued) (b)

MYERS COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2017

Direct labor hours (DLH) Variable costs Indirect labor ($1.00) Indirect materials ($0.70) Utilities ($0.40) Total variable costs ($2.10) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs

Budget at 8,500 DLH

Actual Costs 8,500 DLH

Difference Favorable F Unfavorable U

$ 8,500 5,950 3,400

$ 8,800 5,800 3,200

$300 U 150 F 200 F

17,850

17,800

50 F

4,000 1,200 800 6,000 $23,850

4,000 1,200 800 6,000 $23,800

— — — — $50 F

(c) In case (a) the performance for the month was satisfactory. In case (b) management may need to determine the causes of the differences for indirect labor and utilities, or since the differences are small, 3.5% of budgeted cost for indirect labor and 5.9% for utilities, they might be considered immaterial.

EXERCISE 22-5 FALLON COMPANY Monthly Selling Expense Flexible Budget For the Year 2017 Activity level Sales Variable expenses Sales commissions (6%) Advertising (4%) Traveling (3%) Delivery (2%) Total variable expenses (15%) Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses

$170,000

$180,000

$190,000

$200,000

$ 10,200 6,800 5,100 3,400

$ 10,800 7,200 5,400 3,600

$ 11,400 7,600 5,700 3,800

$ 12,000 8,000 6,000 4,000

25,500

27,000

28,500

30,000

35,000 7,000 1,000 43,000 $ 68,500

35,000 7,000 1,000 43,000 $ 70,000

35,000 7,000 1,000 43,000 $ 71,500

35,000 7,000 1,000 43,000 $ 73,000

EXERCISE 22-6 (a)

FALLON COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2017

Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses

Budget $170,000

Actual $170,000

Difference Favorable F Unfavorable U

$ 10,200 6,800 5,100 3,400 25,500

$ 11,000 6,900 5,100 3,450 26,450

$800 U 100 U 0 50 U 950 U

35,000 7,000 1,000 43,000 $ 68,500

35,000 7,000 1,000 43,000 $ 69,450

0 0 0 0 $950 U

EXERCISE 22-6 (Continued) (b)

FALLON COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2017

Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed costs Sales salaries Depreciation Insurance Total fixed expenses Total expenses

Budget $180,000

Actual $180,000

Difference Favorable F Unfavorable U

$ 10,800 7,200 5,400 3,600

$ 11,000 6,900 5,100 3,450

$200 U 300 F 300 F 150 F

27,000

26,450

550 F

35,000 7,000 1,000 43,000 $ 70,000

35,000 7,000 1,000 43,000 $ 69,450

0 0 0 0 $550 F

(c) Flexible budgets are essential in evaluating a manager’s performance in controlling variable expenses because the budget allowance varies directly with changes in the activity index. At $170,000 of sales, the manager was over budget (unfavorable) by $950 but at $180,000 of sales, the manager was under budget (favorable) by $550.

EXERCISE 22-7 (a)

APPLIANCE POSSIBLE INC. Flexible Production Cost Budget Activity level Production levels Variable costs: Manufacturing ($6) Administrative ($4) Selling ($3) Total variable costs ($13) Fixed costs: Manufacturing Administrative Total fixed costs Total costs

90,000

100,000

110,000

$ 540,000 360,000 270,000 1,170,000

$ 600,000 400,000 300,000 1,300,000

$ 660,000 440,000 330,000 1,430,000

160,000 80,000 240,000 $1,410,000

160,000 80,000 240,000 $1,540,000

160,000 80,000 240,000 $1,670,000

(b) Let (X) represent number of units Sales price(X) = Variable costs(X) + Fixed costs + Profit Sales price(X) = Variable costs(X) + $240,000 + $60,000 (Sales price – Variable costs)(X) = $300,000 ($16 – $13)(X) = $300,000 $3(X) = $300,000 X = 100,000 units to be sold

EXERCISE 22-8 (a)

RENSING GROOMERS Flexible Budget Activity level Direct labor hours Variable costs: Grooming supplies ($5) Direct labor ($14) Overhead ($1) Total variable costs ($20) Fixed costs: Overhead Total fixed costs Total costs

550

600

700

$ 2,750 7,700 550 11,000

$ 3,000 8,400 600 12,000

$ 3,500 9,800 700 14,000

10,000 10,000 $21,000

10,000 10,000 $22,000

10,000 10,000 $24,000

(b) A flexible budget presents expected costs at various levels of production volume, not just one, so that comparisons can be made between actual costs and budgeted costs at the same volume. This allows the person to determine whether a difference between the actual results and budget is due to better or worse cost control than expected or due to achieving a different volume than that upon which the fixed budget was predicated. (c) $21,000 ÷ 550 = $38.18 $22,000 ÷ 600 = $36.67 $24,000 ÷ 700 = $34.29 (d) Cost formula is $10,000 + $20(X), where (X) = direct labor hours Total cost = $10,000 + ($20 X 650) = $23,000. Number of clients = 650 hrs ÷ 1.30 hrs/client = 500 Cost per client = $23,000 ÷ 500 = $46.00 Charge per client = $46.00 X 1.40 = $64.40

EXERCISE 22-9 (a)

SORIA COMPANY Selling Expense Flexible Budget Report Clothing Department For the Month Ended October 31, 2017

Sales in units Variable expenses Sales commissions ($.30) Advertising expense ($.09) Travel expense ($.45) Free samples ($.20) Total variable expenses ($1.04) Fixed expenses Rent Sales salaries Office salaries Depreciation—sale staff autos Total fixed expenses Total expenses

Budget 10,000

Actual 10,000

Difference Favorable F Unfavorable U

$ 3,000 900 4,500 2,000

$ 2,600 850 4,100 1,400

$ 400 F 50 F 400 F 600 F

10,400

8,950

1,450 F

1,500 1,200 800 500 4,000 $14,400

1,500 1,200 800 500 4,000 $12,950

0 0 0 0 0 $1,450 F

(b) No, Joe should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,450 below budget.

EXERCISE 22-10 (a)

CHUBBS INC. Manufacturing Overhead Flexible Budget Report For the Quarter Ended March 31, 2017

Variable costs Indirect materials Indirect labor Utilities Maintenance Total variable costs Fixed costs Supervisory salaries Depreciation Property taxes and insurance Maintenance Total fixed costs Total costs

(b)

Budget

Actual

Difference Favorable F Unfavorable U

$12,000 10,000 8,000 6,000 36,000

$13,500 9,500 8,700 5,000 36,700

$1,500 U 500 F 700 U 1,000 F 700 U

36,000 7,000

8,000 5,000 56,000 $92,000

8,300 5,000 56,300 $93,000

0 0 300 U 0 300 U $1,000 U

CHUBBS INC. Manufacturing Overhead Responsibility Report For the Quarter Ended March 31, 2017

Controllable Costs Indirect materials Indirect labor Utilities Maintenance* Supervisory salaries

Budget $12,000 10,000 8,000 11,000 36,000 $77,000

*Includes variable and fixed costs

Actual $13,500 9,500 8,700 10,000 36,000 $77,700

Difference Favorable F Unfavorable U $1,500 U 500 F 700 U 1,000 F 0 $ 700 U

EXERCISE 2211 (a) URLINK COMPANY Home Internet Services Segment Responsibility Report For the Quarter Ended March 31, 2017

Service revenue Variable costs: Material and supplies Wages Gas and oil Total variable costs Contribution margin Controllable fixed costs: Supervisory salaries Insurance Equipment depreciation Total controllable fixed costs Controllable margin

Budget $25,000

Actual $26,200

Difference Favorable F Unfavorable U $1,200 F

1,600 3,000 2,800 7,400 17,600

1,200 3,250 3,400 7,850 18,350

400 F 250 U 600 U 450 U 750 F

9,000 4,000 1,500 14,500 $ 3,100

9,500 3,900 1,300 14,700 $ 3,650

500 U 100 F 200 F 200 U $ 550 F

(b) MEMO TO:

Lenny Kirkland

FROM:

Student

SUBJECT:

The Reporting Principles of Performance Reports

When evaluating the performance of a company’s segments, the performance reports should: 1. Contain only data that are controllable by the segment’s manager. 2. Provide accurate and reliable budget data to measure performance. 3. Highlight significant differences between actual results and budget goals. 4. Be tailor-made for the intended evaluation. 5. Be prepared at reasonable intervals. I hope these suggested guidelines will be helpful in establishing the performance reporting system to be used by UrLink Company.

EXERCISE 22-12 (a) Fabricating Department = $50,000 fixed costs plus total variable costs of $2.00 per direct labor hour [($150,000 – $50,000) ÷ 50,000]. Assembling Department = $40,000 fixed costs plus total variable costs of $1.60 per direct labor hour [($120,000 – $40,000) ÷ 50,000]. (b) Fabricating Department = $50,000 + ($2.00 X 53,000) = $156,000. Assembling Department = $40,000 + ($1.60 X 47,000) = $115,200. (c)

$300

Total Budgeted Cost Line

250

Costs in (000)

200 Budgeted Variable Costs

150

100 Budgeted Fixed Costs

Direct Labor Hours in (000)

90 100

EXERCISE 2213 (a) To Dallas Department Manager—Finishing Controllable Costs: Direct Materials Direct Labor Manufacturing Overhead Total

Budget $ 44,000 82,000 49,200 $175,200

Month: July Actual $ 42,500 83,400 51,000 $176,900

(b) To Assembly Plant Manager—Dallas Controllable Costs: Dallas Office Departments: Machining Finishing Total

Month: July

Budget $ 92,000

Actual $ 95,000

Fav/Unfav $3,000 U

219,000 175,200 $486,200

220,000 176,900 $491,900

1,000 U 1,700 U $5,700 U

Fav/Unfav $1,500 F 1,400 U 1,800 U $1,700 U

Month: July

Budget $ 130,000

Actual $ 132,000

Fav/Unfav $2,000 U

420,000 486,200 496,500 $1,532,700

424,000 491,900 494,200 $1,542,100

4,000 U 5,700 U 2,300 F $9,400 U

EXERCISE 22-14 (a)

MALONE COMPANY Mixing Department Responsibility Report For the Month Ended January 31, 2017 Controllable Cost Indirect labor Indirect materials Lubricants Maintenance Utilities

Budget $12,000 7,700 1,675 3,500 5,000 $29,875

Actual $12,250 10,200 1,650 3,500 6,400 $34,000

Difference $ 250 U 2,500 U 25 F -01,400 U $4,125 U

(b) Most likely, when management examined the responsibility report for January, they would determine that the differences were insignificant for indirect labor (2.1% of budget), lubricants (1.5%), and maintenance (0%) and require no action. However, the differences for indirect materials (32.5%) and utilities (28%) would cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the budgeted amounts for future months to reflect changing conditions.

EXERCISE 22-15 (a) 1. 2. 3. 4. 5. 6.

Controllable margin ($270,000 – $100,000) Variable costs ($600,000 – $270,000) Contribution margin ($450,000 – $320,000) Controllable fixed costs ($130,000 – $90,000) Controllable fixed costs ($180,000 – $95,000) Sales ($250,000 + $180,000)

$170,000 330,000 130,000 40,000 85,000 430,000

EXERCISE 22-15 (Continued) (b)

HORATIO INC. Women’s Shoe Division Responsibility Report For the Month Ended June 30, 2017

Sales Variable costs Contribution margin Controllable fixed costs Controllable margin

Budget $600,000 325,000 275,000 100,000 $175,000

Actual $600,000 330,000 270,000 100,000 $170,000

Difference Favorable F Unfavorable U $ 0 5,000 U 5,000 U 0 $5,000 U

EXERCISE 22-16 (a)

HARRINGTON COMPANY Sports Equipment Division Responsibility Report 2017

Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable fixed costs Cost of goods sold Selling and administrative Total Controllable margin

Budget

Actual

Difference

$900,000

$880,000

$20,000 U

440,000 60,000 500,000 400,000

408,000 61,000 469,000 411,000

32,000 F 1,000 U 31,000 F 11,000 F

100,000 90,000 190,000 $210,000

105,000 66,000 171,000 $240,000

5,000 U 24,000 F 19,000 F $30,000 F

(b) ($240,000 – $90,000)/$1,000,000 = 15%

EXERCISE 22-17 (a) Controllable margin = ($3,000,000 – $1,950,000 – $600,000) = $450,000 ROI = $450,000 ÷ $5,000,000 = 9% (b) 1.

Contribution margin percentage is 35%, or ($1,050,000 ÷ $3,000,000) Increase in controllable margin = $300,000 X 35% = $105,000 ROI = ($450,000 + $105,000) ÷ $5,000,000 = 11.1%

($450,000 + $150,000) ÷ $5,000,000 = 12%

$450,000 ÷ ($5,000,000 – $200,000) = 9.4%

EXERCISE 22-18 (a) DINKLE AND FRIZELL DENTAL CLINIC Preventive Services Responsibility Report For the Month Ended May 31, 2017

Service revenue Variable costs Filling materials Novocain Dental assistant wages Supplies Utilities Total variable costs Contribution margin Controllable fixed costs Dentist salary Equipment depreciation Total controllable fixed costs Controllable margin Return on investment*

Budget $39,000

Actual $40,000

Difference Favorable F Unfavorable U $1,000 F

4,900 3,800 2,500 2,250 390 13,840 25,160

5,000 3,900 2,500 1,900 500 13,800 26,200

100 U 100 U 0 350 F 110 U 40 F 1,040 F

9,400 6,000 15,400 $ 9,760

9,800 6,000 15,800 $10,400

400 U 0 400 U $ 640 F

12.2%

13.0%

0.8% F

*Average investment = ($82,400 + $77,600) ÷ 2 = $80,000 Budget ROI = $9,760 ÷ $80,000 Actual ROI = $10,400 ÷ $80,000 ROI Difference = $640 ÷ $80,000

EXERCISE 22-18 (Continued) (b) MEMO TO: Drs. Reese Dinkle and Anita Frizell FROM: Student SUBJECT: Deficiencies in the Current Responsibility Reporting System The current reporting system has the following deficiencies: 1. 2. 3. 4.

It does not clearly show both budgeted goals and actual performance. It does not indicate the contribution margin generated by the center, showing the amount available to go towards covering controllable fixed costs. It does not report only those costs controllable by the manager of the center. Instead, it includes both controllable and common fixed costs. This results in the center appearing to be unprofitable. It does not indicate the return on investment earned by the center.

All of these deficiencies have been addressed in the recommended responsibility report attached. As can be seen from that report, the Preventive Services center is profitable. The service revenues generated in this center are adequate to cover all of its costs, both variable and controllable fixed costs, and contribute toward the covering of the clinic’s common fixed costs. In addition, the report indicates the return on investment earned by the center and that it exceeds the budget goal.

EXERCISE 22-19 Planes: ROI = Controllable margin ÷ Average operating assets 12%= Controllable margin ÷ $25,000,000 Controllable margin = $25,000,000 X 12% = $3,000,000 Contribution margin = Controllable margin + Controllable fixed costs = $3,000,000 + $1,500,000 = $4,500,000 Service revenue = Contribution margin + Variable costs = $4,500,000 + $5,500,000 = $10,000,000 Taxis: ROI = Controllable margin ÷ Average operating assets 10% = $80,000 ÷ Average operating assets Average operating assets = $80,000 ÷ 10% = $800,000 Controllable margin = Contribution margin – Controllable fixed costs $80,000 = $250,000 – Controllable fixed costs Controllable fixed costs = $250,000 – $80,000 = $170,000 Contribution margin = Service revenue – Variable costs $250,000 = $500,000 – Variable costs Variable costs = $500,000 – $250,000 = $250,000

EXERCISE 22-19 (Continued) Limos: ROI = Controllable margin ÷ Average operating assets = $210,000 ÷ $1,500,000 = 14% Controllable margin = Contribution margin $210,000 = $480,000 Controllable fixed costs

– Controllable fixed costs – Controllable fixed costs = $480,000 – $210,000 = $270,000

Contribution margin = Service revenue – Variable costs $480,000 = Service revenue – $300,000 Sales = $480,000 + $300,000 = $780,000

*EXERCISE 22-20 (a)

North Division: ROI = $140,000 ÷ $1,000,000 = 14% West Division: ROI = $360,000 ÷ $2,000,000 = 18% South Division: ROI = $210,000 ÷ $1,500,000 = 14%

(b)

North Division: Residual Income = $140,000 – (.13 X $1,000,000) = $10,000 West Division: Residual Income = $360,000 – (.16 X $2,000,000) = $40,000 South Division: Residual Income = $210,000 – (.10 X $1,500,000) = $60,000

*EXERCISE 22-20 (Continued) (c)

1. If ROI is used to measure performance, only the North Division (with a 14% ROI) and the South Division (with a 14% ROI) would make the additional investment that provides a 16% ROI. The West Division presently earns an 18% return ($360,000 ÷ $2,000,000), and therefore would decline the investment. 2. If residual income is used to measure performance, all three divisions would probably make the additional investment because each would realize an increase in residual income.

*EXERCISE 22-21 (a)

ROI = Controllable margin 16% = $200,000 Average operating assets =

÷ Average operating assets ÷ Average operating assets $1,250,000

(b)

Controllable margin – (Minimum rate of return X Average operating assets) = Residual income $200,000 – (Minimum rate of return X $1,250,000) = $100,000 $100,000 = Minimum rate of return X $1,250,000 Minimum rate of return = 8%

(c)

Controllable margin Controllable margin Controllable margin

(d)

ROI = 28% =

– (Minimum rate of return X Average operating assets) = Residual income – (11% X $1,200,000) = $204,000 = $336,000

Controllable margin $336,000

÷ ÷

Average operating assets $1,200,000

SOLUTIONS TO PROBLEMS PROBLEM 22-1A

(a)

BUMBLEBEE COMPANY Packaging Department Monthly Manufacturing Overhead Flexible Budget For the Year 2017

Activity level Direct labor hours Variable costs Indirect labor ($.42)* Indirect materials ($.30) Repairs ($.23) Utilities ($.24) Lubricants ($.06) Total variable costs ($1.25) Fixed costs Supervision** Depreciation Insurance Rent Property taxes Total fixed costs Total costs *$126,000/300,000 **$96,000/12

27,000

30,000

33,000

36,000

$11,340 8,100 6,210 6,480 1,620 33,750

$12,600 9,000 6,900 7,200 1,800 37,500

$13,860 9,900 7,590 7,920 1,980 41,250

$15,120 10,800 8,280 8,640 2,160 45,000

8,000 6,000 2,500 2,000 1,500 20,000 $53,750

8,000 6,000 2,500 2,000 1,500 20,000 $57,500

8,000 6,000 2,500 2,000 1,500 20,000 $61,250

8,000 6,000 2,500 2,000 1,500 20,000 $65,000

PROBLEM 22-1A (Continued) (b)

BUMBLEBEE COMPANY Packaging Department Manufacturing Overhead Flexible Budget Report For the Month Ended October 31, 2017

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Repairs Utilities Lubricants Total variable costs Fixed costs Supervision Depreciation Insurance Rent Property taxes Total fixed costs Total costs

Budget at 27,000 DLH

Actual Costs 27,000 DLH

Difference Favorable F Unfavorable U

$11,340 8,100 6,210 6,480 1,620 33,750

$12,432 7,680 6,100 6,840 1,920 34,972

$1,092 U 420 F 110 F 360 U 300 U 1,222 U

8,000 6,000 2,500 2,000 1,500 20,000 $53,750

8,000 6,000 2,460 2,000 1,500 19,960 $54,932

0 0 40 F 0 0 40 F $1,182 U

(c) The overall performance of management was slightly unfavorable. However, none of the unfavorable differences exceeded 10% of budget except for lubricants (19%).

PROBLEM 22-2A

(a)

ZELMER COMPANY Monthly Manufacturing Overhead Flexible Budget Ironing Department For the Year 2017

Activity level Direct labor hours Variable costs Indirect labor ($.40) Indirect materials ($.50) Factory utilities ($.30) Factory repairs ($.20) Total variable costs ($1.40) Fixed costs Supervision Depreciation Insurance Rent Total fixed costs Total costs

35,000

40,000

45,000

50,000

$14,000 17,500 10,500 7,000 49,000

$16,000 20,000 12,000 8,000 56,000

$18,000 22,500 13,500 9,000 63,000

$20,000 25,000 15,000 10,000 70,000

4,000 1,500 1,000 2,500 9,000 $58,000

4,000 1,500 1,000 2,500 9,000 $65,000

4,000 1,500 1,000 2,500 9,000 $72,000

4,000 1,500 1,000 2,500 9,000 $79,000

PROBLEM 22-2A (Continued) (b)

ZELMER COMPANY Ironing Department Manufacturing Overhead Flexible Budget Report For the Month Ended June 30, 2017

Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Factory utilities Factory repairs Total variable costs Fixed costs Supervision* Depreciation Insurance Rent Total fixed costs Total costs (1) 41,000 X $0.40 (5) 41,000 X $0.44

Budget at 41,000 DLH

Actual Costs 41,000 DLH

Difference Favorable F Unfavorable U

$16,400 (1) 20,500 (2) 12,300 (3) 8,200 (4) 57,400

$18,040 (5) 19,680 (6) 13,120 (7) 10,250 (8) 61,090

$1,640 U 820 F 820 U 2,050 U 3,690 U

4,000 1,500 1,000 2,500 9,000 $66,400

4,000 1,500 1,000 2,500 9,000 $70,090

0 0 0 0 0 $3,690 U

(3) 41,000 X $0.30 (7) 41,000 X $0.32

(4) 41,000 X $0.20 (8) 41,000 X $0.25

(2) 41,000 X $0.50 (6) 41,000 X $0.48

*$48,000/12 (c) The manager was ineffective in controlling variable costs ($3,690 U). Fixed costs were effectively controlled. (d) The formula is fixed costs of $9,000 plus total variable costs of $1.40 per direct labor hour.

PROBLEM 22-2A (Continued) (e)

Total Budgeted Cost Line

$80 70

Costs in (000)

60 50 Budgeted Variable Costs

40 30 20 10

Budgeted Fixed Costs

Direct Labor Hours in (000)

PROBLEM 22-3A

(a) The formula is fixed costs $35,000 plus variable costs of $2.85 per unit ($171,000 ÷ 60,000 units). (b)

RATCHET COMPANY Assembling Department Flexible Budget Report For the Month Ended August 31, 2017 Difference

Units Variable costs* Direct materials ($.80 X 58,000) Direct labor ($.90 X 58,000) Indirect materials ($.40 X 58,000) Indirect labor ($.30 X 58,000) Utilities ($.25 X 58,000) Maintenance ($.20 X 58,000) Total variable ($2.85 X 58,000) Fixed costs Rent Supervision Depreciation Total fixed Total costs

Budget at 58,000 Units

Actual Costs 58,000 Units

Favorable F Unfavorable U

$ 46,400 52,200 23,200 17,400 14,500 11,600 165,300

$ 47,000 51,200 24,200 17,500 14,900 12,400 167,200

$ 600 U 1,000 F 1,000 U 100 U 400 U 800 U 1,900 U

12,000 17,000 6,000 35,000 $200,300

12,000 17,000 6,000 35,000 $202,200

0 0 0 0 $1,900 U

*Note that the per unit variable costs are computed by taking the budget amount at 60,000 units and dividing it by 60,000. For example, $48, 000 direct materials per unit is therefore $0.80 or . 60, 000 This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved. The manager should be criticized because every variable cost was over budget except for direct labor.

PROBLEM 22-3A (Continued) (c)

RATCHET COMPANY Assembling Department Flexible Budget Report For the Month Ended September 30, 2017 Difference Units Variable costs Direct materials ($.80 X 64,000) Direct labor ($.90 X 64,000) Indirect materials ($.40 X 64,000) Indirect labor ($.30 X 64,000) Utilities ($.25 X 64,000) Maintenance ($.20 X 64,000) Total variable costs Fixed costs Rent Supervision Depreciation Total fixed costs Total costs

Budget at 64,000 Units

Actual Costs 64,000 Units

Favorable F Unfavorable U

$ 51,200 57,600 25,600 19,200 16,000 12,800 182,400

$ 51,700 56,320 26,620 19,250 16,390 13,640 183,920

$ 500 U 1,280 F 1,020 U 50 U 390 U 840 U 1,520 U

12,000 17,000 6,000 35,000 $217,400

12,000 17,000 6,000 35,000 $218,920

0 0 0 0 $1,520 U

The manager’s performance was slightly better in September than it was in August. However, each variable cost was slightly over budget again except for direct labor. Note that actual variable costs in September were 10% higher than the actual variable costs in August. Therefore to find the actual variable costs in September, the actual variable costs in August must be increased 10% as follows:

Direct materials Direct labor Indirect materials Indirect labor Utilities Maintenance

August September (actual) (actual) $ 47,000 X 110% = $ 51,700 51,200 X 110% 56,320 24,200 X 110% 26,620 17,500 X 110% 19,250 14,900 X 110% 16,390 12,400 X 110% 13,640 $167,200 $183,920

PROBLEM 22-4A

(a)

CLARKE INC. Patio Furniture Division Responsibility Report For the Year Ended December 31, 2017 Difference Budget

Actual

Favorable F Unfavorable U

Sales

$2,500,000

$2,550,000

$50,000 F

Variable costs Cost of goods sold Selling and administrative Total

1,300,000 220,000 1,520,000

1,259,000 226,000 1,485,000

41,000 F 6,000 U 35,000 F

Contribution margin

980,000

1,065,000

85,000 F

Controllable fixed costs Cost of goods sold Selling and administrative Total

200,000 50,000 250,000

203,000 52,000 255,000

3,000 U 2,000 U 5,000 U

$ 730,000

$ 810,000

$80,000 F

Controllable margin

(b) The manager effectively controlled revenues and costs. Contribution margin was $85,000 favorable and controllable margin was $80,000 favorable. Contribution margin was favorable primarily because sales were $50,000 over budget and variable cost of goods sold was $41,000 under budget. Apparently, the manager was able to control variable cost of goods sold when sales exceeded budget expectations. The manager was ineffective in controlling fixed costs. However, the unfavorable difference of $5,000 was only 6% of the favorable difference in controllable margin. (c) Two costs are excluded from the report: (1) noncontrollable fixed costs and (2) indirect fixed costs. The reason is that neither cost is controllable by the Patio Furniture Division Manager.

PROBLEM 22-5A

(a)

OPTIMUS COMPANY Home Division Responsibility Report For the Year Ended December 31, 2017 (in thousands of dollars)

Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable direct fixed costs Cost of goods sold Selling and administrative Total Controllable margin ROI (1)

  $330   $2,000   



(2)  $360    $2,000  

Difference Favorable F Unfavorable U $100 F

Budget $1,300

Actual $1,400

620 100 720 580

665 125 790 610

45 U 25 U 70 U 30 F

170 80 250 $ 330

170 80 250 $ 360

0 0 0 $ 30 F

16.5% (1)

18.0% (2)

1.5% F (3)

(3)  $30   $2,000   

 (b) The performance of the manager of the Home Division was slightly above budget expectations for the year. The item that top management would likely investigate is the reason why variable cost of goods sold is $45,000 unfavorable. In making the inquiry, it should be recognized that the budget amount should be  adjusted for the increased sales as follows: $1,400,000 X  $620 = $667,692.    $1,300 



PROBLEM 22-5A (Continued) (c) 1.

$360,000 + ($665,000 X 5%) = 19.7%. $2,000,000 $360,000 $2,000,000 – ($2,000,000 X 10%) $360,000 + $80,000 = 22%. $2,000,000

= 20%.

PROBLEM 22-6A

(a) To Cutting Department Manager—Seattle Division Controllable Costs: Budget Actual Indirect labor $ 70,000 $ 73,000 Indirect materials 46,000 47,900 Maintenance 18,000 20,500 Utilities 17,000 20,100 Supervision 20,000 22,000 Total $171,000 $183,500

To Division Production Manager—Seattle Controllable Costs: Budget Seattle Division $ 51,000 Departments: Cutting 171,000 Shaping 148,000 Finishing 205,000 Total $575,000

To Vice President—Production Controllable Costs: Budget V-P Production $ 64,000 Divisions: Seattle 575,000 Denver 673,000 San Diego 715,000 Total $2,027,000

No. 1 Month: January Fav/Unfav $ 3,000 U 1,900 U 2,500 U 3,100 U 2,000 U $12,500 U

No. 2 Month: January Actual Fav/Unfav $ 52,500 $ 1,500 U 183,500 158,000 210,000 $604,000

12,500 U 10,000 U 5,000 U $29,000 U

No. 3 Month: January Actual Fav/Unfav $ 65,000 $ 1,000 U 604,000 678,000 722,000 $2,069,000

29,000 U 5,000 U 7,000 U $42,000 U

PROBLEM 22-6A (Continued)

To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total

Budget $ 74,200

No. 4 Month: January Actual Fav/Unfav $ 76,400 $ 2,200 U

2,027,000 130,000 104,000 $2,335,200

2,069,000 133,600 109,000 $2,388,000

42,000 U 3,600 U 5,000 U $52,800 U

(b) 1. Within the Seattle division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. If the rankings were done on a percentage basis, they would rank as follows: (1) Finishing – 2.4% U (2) Shaping – 6.8% U and (3) Cutting – 7.3% U. 2.

At the division manager level, the rankings were: (1) Denver, (2) San Diego, and (3) Seattle.

Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) production, 2.1%; (2) marketing, 2.8%; and (3) finance, 4.8%.

*PROBLEM 22-7A

(a)

(b)

ROI = Controllable Margin ÷ Average Operating Assets ROI = $2,460,000 ÷ $12,300,000 ROI = 20%

Residual Income = Controllable Margin – (Minimum Rate of Return X Average Operating Assets) Residual Income = $2,460,000 – (.18 X $12,300,000) Residual Income = $2,460,000 – $2,214,000 = $246,000

The management of Jensen Division would clearly have accepted the investment opportunity it had in 2017 if residual income had been used as the performance measure because an increase in residual income results from a project whose ROI is greater than the minimum rate of return. If management of the Jensen Division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 19% is less than Jensen’s ROI experience range of 20.1% to 23.5%. With bonuses based in part on ROI, the 19% project would have a negative effect on bonuses.

CD22

(a)

CURRENT DESIGNS

Current Designs Rotomolded Line Manufacturing Budget For the Year Ended December 31, 2017 Units to be produced Costs: Variable costs Polyethylene powder Finishing kits Labor—type I Labor—type II Indirect materials Manufacturing supplies Maintenance and utilities Total variable costs Fixed costs Supervision Insurance Depreciation Total fixed costs Total costs

Calculation

4,000 X 54 X $1.50 4,000 X $170 4,000 X 2 X $15 4,000 X 3 X $12

4,000 kayaks Amount budgeted

$ 324,000 680,000 120,000 144,000 40,000 53,800 88,000 1,449,800 90,000 14,400 109,800 214,200 $1,664,000

CD22 (Continued) (b)

Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2017 Units to be produced Costs: Variable costs Polyethylene powder (54 X 1.50 per unit) Finishing kits ($170 per unit) Labor—type I (2 hours per unit X $15 per hour) Labor—type II (3 hours per unit X $12 per hour) Indirect materials ($10* per unit) Manufacturing supplies ($13.45** per unit) Maintenance and utilities ($22*** per unit) Total variable costs ($362.45 per unit) Fixed costs Supervision (a.) Insurance (b.) Depreciation (c.) Total fixed costs Total costs *$40,000 ÷ 4,000 **$53,800 ÷ 4,000 ***$88,000 ÷ 4,000

900 kayaks 1,000 kayaks

1,050 kayaks

$ 72,900

$ 81,000

$ 85,050.00

153,000

170,000

178,500.00

27,000

30,000

31,500.00

32,400

36,000

37,800.00

9,000

10,000

10,500.00

12,105

13,450

14,122.50

19,800

22,000

23,100.00

326,205

362,450

380,572.50

22,500 3,600 27,450 53,550 $379,755

22,500 3,600 27,450 53,550 $416,000

22,500.00 3,600.00 27,450.00 53,550.00 $434,122.50

a. $ 90,000 ÷ 4 b. $ 14,400 ÷ 4 c. $109,800 ÷ 4

CD22 (Continued) (c)

Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2017

Units to be produced Costs: Variable costs Polyethylene powder Finishing kits Labor—type I Labor—type II Indirect materials Manufacturing supplies Maintenance and utilities Total variable costs Fixed costs Supervision Insurance Depreciation Total fixed costs Total costs

Difference Budget for Actual costs for F = favorable U = unfavorable 1,050 kayaks 1,050 kayaks

$ 85,050.00 178,500.00 31,500.00 37,800.00 10,500.00

$ 87,000.00 178,840.00 31,500.00 39,060.00 10,500.00

$1,950.00 340.00 0 1,260.00 0

U U

14,122.50

14,150.00

27.50

23,100.00 380,572.50

26,000.00 387,050.00

2,900.00 6,477.50

U U

22,500.00 3,600.00 27,450.00 53,550.00 $434,122.50

20,000.00 3,600.00 27,450.00 51,050.00 $438,100.00

2,500.00 0 0 2,500.00 $3,977.50

F U

BYP 22-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) 1. The primary causes of the loss in net income were the decrease in the number of boarding days and the decrease in the boarding fee. The number of boarding days decreased by 2,900 or approximately 13% (2,900 days ÷ 21,900 days), and the boarding fee decreased from $25(a) per day to $20(b) per day, a decrease of 20% ($5 ÷ $25). Together these resulted in a $167,500 decrease in sales revenue, a decrease of approximately 31% ($167,500 ÷ $547,500). (a)

$547,500 ÷ 21,900 days = $25 per day $380,000 ÷ 19,000 days = $20 per day

(b)

Management did a poor job in controlling variable expenses. Given that boarding days declined by about 13%, variable expenses should decline by about 13%, or more precisely, variable expenses should decline by $25,520  $192,720 X 2,900  . However, variable expenses only declined   21,900   by $14,330 or about 7.4% ($14,330 ÷ $192,720). Thus, management did a poor job in controlling variable expenses. Management did a better job in controlling fixed expenses. Fixed expenses were under budget by $4,000 and this includes the additional expenses incurred in advertising and entertainment.

Management’s decisions to stay competitive probably were sound. Given the decline in boarding days, the decision not to replace the worker was sound. The decision to reduce rates was probably forced by the competition. Without the additional advertising and entertainment expenses, the loss in net income might have been even greater.

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

BYP 22-1 (Continued) (b)

GREEN PASTURES Income Statement Flexible Budget Report For the Year Ended December 31, 2017

Boarding days (BD) Sales ($25) Less variable expenses Feed ($5) Veterinary fees ($3) Blacksmith fees ($.25) Supplies ($.55) Total variable expenses ($8.80) Contribution margin Less fixed expenses Depreciation Insurance Utilities Repairs and maintenance Labor Advertising Entertainment Total fixed expenses Net income

Difference Favorable F Unfavorable U $ 95,000 U

Budget at 19,000 BD $475,000

Actual at 19,000 BD $380,000

95,000 57,000 4,750 10,450

104,390 58,838 4,984 10,178

9,390 U 1,838 U 234 U 272 F

167,200 307,800

178,390 201,610

11,190 U 106,190 U

40,000 11,000 14,000 11,000 95,000 8,000 5,000 184,000 $123,800

40,000 11,000 12,000 10,000 88,000 12,000 7,000 180,000 $ 21,610

0 0 2,000 F 1,000 F 7,000 F 4,000 U 2,000 U 4,000 F $102,190 U

(c) 1. The primary causes of the decrease in net income are the decreases in boarding rates and volume. The average daily rate charged was $20 = ($380,000 ÷ 19,000). This rate resulted in a decrease in sales revenue of $95,000 or 20% = ($95,000 ÷ $475,000). Given that it is “an extremely competitive business,” if Green Pastures had not reduced rates, boarding days almost certainly would have declined even more.

BYP 22-1 (Continued) 2.

Management did a poor job of controlling variable expenses. These expenses in total were $11,190 over budget or 6.7%, or ($11,190 ÷ $167,200). Moreover, each individual variable expense was over budget, except for supplies. Management did a good job of controlling fixed expenses as noted in part (a).

As noted in part (a), management’s decisions to stay competitive probably were sound.

(d) Given that the industry is “extremely competitive,” management should consider two options. One, become the lowest cost operator. If Green Pastures is the company with the lowest operating costs, it can underprice its competitors and take customers away from them (increasing its sales). Eventually, some of its competitors (those with the highest operating costs) will go out of business, and Green Pastures will get their customers, or at least some of them. (Wal-Mart is an example of this strategy.) Option two is to offer its customers a superior product or service. If customers perceive that Green Pastures is the “best” boarding stable in Kentucky, the company will take customers away from its competitors. Also, if Green Pastures is perceived as the “best,” many customers will be willing to pay a premium for its boarding service, and Green Pastures will be able to raise its rates. (Gillette is an example of this strategy.)

BYP 22-2

MANAGERIAL ANALYSIS

(a) Mary Gammel—Profit Center: Responsible for sales, inventory cost, advertising, sales personnel, printing, and travel. She is not responsible for the assets invested in her division and probably does not control the rent or depreciation costs either. As a profit center manager she might have control of the insurance, but she probably does not. Stephen Flott—Cost Center: Responsible for inventory cost, advertising, sales personnel, printing, and travel. As a cost center manager, he might or might not have control of rent and insurance costs, but he probably does not. He does not have control of the assets invested in his department; thus, he does not have control of the depreciation. Jose Gomez—Investment Center: Responsible for all items shown. (b) Mary Gammel Budget differences: The cost of goods sold is 28% ($42,000 ÷ $150,000) above budget and so should definitely be brought to her attention. Travel is 30% ($6,000 ÷ $20,000) below budget. Students may differ as to whether they believe that this should be brought to her attention. The differences in rent and depreciation should not be brought to her attention because she does not control those costs. Stephen Flott Budget differences: The cost of goods sold, which is 22% ($22,000 ÷ $100,000) above budget, should definitely be brought to his attention. Travel costs are 30% ($9,000 ÷ $30,000) below budget. This should probably be brought to his attention, so that he can verify that the goal of travel is being adequately accomplished by other means. The 67% ($20,000 ÷ $30,000) increase in rent and 10% ($10,000 ÷ $100,000) decrease in depreciation are not under his control and so should not be brought to his attention. It should probably be pointed out to students that all budget differences are monitored by someone within the company. These differences that are not the responsibility of the various managers are still within the scope of top management’s responsibility.

BYP 22-2 (Continued) Jose Gomez Budget differences: As manager of an investment center, Mr. Gomez is responsible for all categories of the budget. The selection in this case would be which differences merit his attention. Any decrease in a company’s gross profit rate (gross profit ÷ sales) is a cause for concern. (Remember the gross profit is sales minus cost of goods sold.) Thus, the 6% [($26,500 – $25,000) ÷ $25,000] increase in cost of goods sold should be brought to his attention. Travel is below budget 25% ($500 ÷ $2,000), which is $500. This is not a large percentage of total costs, nor is it a large dollar amount, so there could be an argument that this should be left out. The 23% ($2,300 ÷ $10,000) increase in rent is only a $2,300 increase, so it could be included, though it might be left out as immaterial. The 40% ($16,000 ÷ $40,000) increase in depreciation should definitely be included.

BYP 22-3

REAL-WORLD FOCUS

(a) The company’s costs do not increase proportionately with the revenues increase in the third and fourth quarter because the behavior of the costs is primarily fixed. (b) Static budgeting seems to be most appropriate for Computer Associates because costs do not respond proportionately with changes in the activity level (revenues).

BYP 22-4

REAL-WORLD FOCUS

(a) The two most common pain points are (1) dealing with other managers and (2) technology issues, mainly frustration of budgeting in Excel spreadsheets. (b) Of those companies that participated in the survey, 97 percent said that they prepare annual budgets. Of those that prepare annual budgets, 60 percent say that they begin the process by determining sales forecasts. (c) The most common amount of time for the budgeting process is 4 to 8 weeks. (d) The most commonly defined range of acceptable tolerance levels was that variances were tolerated up to 5 to 10 percent. Beyond that level there were consequences. (e) Severe consequences were defined as: Compensation is affected or other sanctions applied, the manager receives a formal reprimand, or job losses result (the manager responsible for the variance, or the variance drives company layoffs due to missed numbers).

BYP 22-5

COMMUNICATION ACTIVITY

(a) Fred Bedner should be able to control all the variable costs and the fixed costs of supervision (but not his portion) and inspection. Insurance and depreciation ordinarily are not the responsibility of the department manager. (b) The total variable cost per unit is $25 ($50,000 ÷ 2,000). The total cost during the month to manufacture 1,500 units is variable costs $37,500 (1,500 X $25) plus fixed costs ($35,000) or $72,500 ($37,500 + $35,000). (c)

FLEMING COMPANY Production Department Manufacturing Overhead Flexible Budget Report For the Month Ended Difference Budget at 1,500 units

Actual at 1,500 units

Favorable F Unfavorable U

$16,500 9,000 7,500

$22,500 13,500 8,200

$ 6,000 U 4,500 U 700 U

4,500 37,500

5,000 49,200

500 U 11,700 U

Fixed costs Supervision Inspection costs Insurance expense Depreciation Total fixed

17,000 1,000 2,000 15,000 35,000

18,400 1,200 2,200 14,700 36,500

1,400 U 200 U 200 U 300 F 1,500 U

Total costs

$72,500

$85,700

$13,200 U

Variable costs Indirect materials ($11) Indirect labor ($6) Maintenance expense ($5) Manufacturing supplies ($3) Total variable ($25)

(d) A production department is a cost center. Thus, the report should include only the costs that are controllable by the production manager. This report is shown in Illustration 10–21. In this type of report, no distinction is made between variable and fixed costs.

BYP 22-5 (Continued) FLEMING COMPANY Production Department Manufacturing Overhead Responsibility Report For the Month Ended

Controllable Cost Indirect materials Indirect labor Maintenance expense Manufacturing supplies Supervision* Inspection costs Total

Budget $16,500 9,000 7,500 4,500 7,000 1,000

Actual $22,500 13,500 8,200 5,000 8,400 1,200

Difference Favorable F Unfavorable U $ 6,000 U 4,500 U 700 U 500 U 1,400 U 200 U

$45,500

$58,800

$13,300 U

*$10,000 is deducted from both budget and actual for Mr. Bedner’s cost.

To: From: Subject:

Mr. Fred Bedner, Production Manager , Vice President of Production Performance Evaluation for the Month of XXXXX

Your performance in controlling costs that are your responsibility was very disappointing in the month of XXXXX. As indicated in the accompanying responsibility report, total costs were $13,300 over budget. On a percentage basis, costs were 29% over budget. As you can see, actual costs were over budget for every cost item. In two instances, costs were more significantly over budget (Indirect materials 36% and Indirect labor 50%).

BYP 22-5 (Continued) Fred, it is imperative that you get costs under control in your department as soon as possible. I think we need to talk about ways to implement more effective cost control measures. I would like to meet with you in my office at 9 a.m. on Wednesday to discuss possible alternatives.

BYP 22-6

ETHICS CASE

(a) The stakeholders in this ethical situation are: ⯈ The employees and managers of each investment center. ⯈ The central management and chief executive officer. ⯈ The customers who buy the product. ⯈ The owners or stockholders. (b) Pressure to perform is a frequently identified cause for unethical conduct. Employees are more prone to engage in unethical conduct when unreasonable demands are made upon them. Rather than lose their jobs or be demoted, if given no alternatives, employees may seek to cut corners, reduce quality control, use questionable sales tactics, and bend the rules. (c) The company might maintain open lines of communication with its employees to better know the pressures of its managers. By “keeping in touch,” the company may avoid making unreasonable demands on its managers and employees. The company might also develop a company code of ethical conduct and enforce it. However, if dismissal or demotion continues to be the probable consequence of failure to meet objectives, some managers are likely to engage in unethical behavior in an attempt to meet the objectives.

BYP 22-7

ALL ABOUT YOU

(a)

The basic idea is to set up individual envelopes for different expense categories. Once you have used up the money in a particular envelope, you can’t use more. Begin by preparing a monthly budget. Identify those items that you will pay in cash. These would include things like groceries, eating out at restaurants, clothing, gasoline, car repairs, gifts, and entertainment. These are the categories for which you will have envelopes. Next, decide how often to fill the envelopes and determine the amount to put in each envelope. If you continually run out of money in a particular envelope you many need to re-evaluate your allocation. If you don’t use up all the money in an envelope in one month, you can carry it over to the next month.

(b)

Answers will vary by student.

BYP 22-8

CONSIDERING YOUR COSTS AND BENEFITS

In general, in past years it has usually been considered prudent to purchase a home rather than to rent. As noted, over time, home prices have usually appreciated in most parts of the country. Mortgage interest provides some tax relief, and by purchasing a home you get some control over your housing costs. However, recent turbulence in the housing market has made the decision more complicated. In some parts of the country home prices have fallen considerably, and there is no indication how soon they will recover. In some areas renting appears to be an attractive alternative to purchasing. In the scenario described, there is considerable uncertainty surrounding this individual’s life. Purchasing a home is a huge decision, with very high transactions costs. It is often suggested that, because of the high transactions costs, you should not purchase a home unless you intend on living in it for a number of years. The person in the case is starting a new job in a new community. Until they are more certain that they will like their job, that the job is stable, and that they like the community, they should delay the purchase of a home.

CHAPTER 23 Standard Costs and Balanced Scorecard ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Do It!

Exercises

A Problems

Describe standard costs.

1, 2, 3, 4, 5, 6, 7, 8, 9

1, 2, 3

1, 2, 3, 4, 17

Determine direct materials variances.

5, 6, 7, 8, 9, 13, 14, 21

1A, 2A, 3A, 4A, 5A, 6A

Determine direct labor and total manufacturing overhead variances.

11, 12

5, 6

4, 6, 7, 8, 9, 10, 11, 12, 13, 21

1A, 2A, 3A, 4A, 5A, 6A

Prepare variance reports and balanced scorecards.

13, 14, 15, 16, 17, 18

10, 14, 15, 16, 17, 18, 19

2A, 3A, 5A, 6A

*5.

Identify the features of a standard cost accounting system.

8, 9

20, 21, 22

*6.

Compute overhead controllable and volume variance.

20, 21, 22, 23

10, 11

23, 24, 25

7A, 8A, 9A, 10A

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compute variances.

Simple

20–30

Compute variances, and prepare income statement.

Simple

30–40

Compute and identify significant variances.

Moderate

20–30

Answer questions about variances.

Complex

30– 0

Compute variances, prepare an income statement, and explain unfavorable variances.

Moderate

30–40

*6A

Journalize and post standard cost entries, and prepare income statement.

Moderate

40–50

*7A

Compute overhead controllable and volume variances.

Simple

10–15

*8A

Compute overhead controllable and volume variances.

Simple

10–15

*9A

Compute overhead controllable and volume variances.

Moderate

10–15

*10A

Compute overhead controllable and volume variances.

Moderate

10–15

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises an 1.

Learning Objective Describe standard costs.

Knowledge Comprehension Q23-3 Q23-1 Q23-6 Q23-8 Q23-2 Q23-7 Q23-4 Q23-9 Q23-5 E23-17 Q23-10 Q23-11

Kimmel, Accounting, 6/e, Solutions Manual (For Instructor Use Only)

Determine direct materials variances.

Determine direct labor and total manufacturing overhead variances.

Q23-12

Prepare variance reports and balanced scorecard.

*5.

Identify the features of a standard cost accounting system. Compute overhead controllable and volume variance.

Q23-13 Q23-14 Q23-15 Q23-16 Q23-17 Q23-18 E23-17 E23-18 E23-19 Q23-19

*6.

Broadening Your Perspective

Q23-20 Q23-21 Q23-22 Q23-23 BYP23-4 BYP23-6

Application BE23-1 BE23-2 BE23-3 DI23-1 BE23-4 DI23-2 E23-5 E23-7

E23-9 E23-10 E23-13 E23-14

BE23-5 E23-13 BE23-6 E23-19 DI23-3 P23-1A E23-4 P23-2A E23-6 P23-5A E23-7 E23-10 E23-12 BE23-7 P23-6A DI23-4 E23-10 E23-14 E23-15 E23-16 P23-2A P23-5A BE23-8 E23-22 BE23-9 P23-6A E23-20 BE23-10 P23-7A BE23-11 P23-8A E23-23 P23-9A E23-24 P23-10A E23-25 BYP23-2

Analysis Synthes E23-1 E23-2 E23-3 E23-17 P23-1A E23-8 P23-2A E23-9 P23-5A E23-19 P23-6A E23-21 P23-3A P23-4A P23-6A E23-8 P23-4A E23-9 E23-11 E23-21 P23-3A

P23-3A

E23-21

E23-23 E23-24

23-3

ANSWERS TO QUESTIONS 1.

(a) This is incorrect. Standard costs are predetermined unit costs. (b) Agree. Examples of governmental regulations that establish standards for a business are the Fair Labor Standards Act, the Equal Employment Opportunity Act, and a multitude of environmental laws.

(a) Standards and budgets are similar in that both are predetermined costs and both contribute significantly to management planning and control. The two terms differ in that a standard is a unit amount and a budget is a total amount. (b) There are important accounting differences between budgets and standards. Except in the application of manufacturing overhead to jobs and processes, budget data are not journalized in cost accounting systems. In contrast, standard costs may be incorporated into cost accounting systems. It is possible for a company to report inventories at standard costs in its financial statements, but it is not possible to report inventories at budgeted costs.

In addition to facilitating management planning, standard costs offer the following advantages to an organization: (1) They promote greater economy by making employees more “cost-conscious.” (2) They may be useful in setting selling prices. (3) They contribute to management control by providing a basis for evaluating cost control. (4) They are useful in highlighting variances in “management by exception.” (5) They simplify the costing of inventories and reduce clerical costs.

The management accountant provides input to the setting of standards through the accumulation of historical cost data and knowledge of the behavior of costs in response to changes in activity levels. Management has the responsibility for setting the standards.

Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions.

(a) The direct materials price standard should be based on the purchasing department’s best estimate of the cost of raw materials and an amount for related costs such as receiving, storing, and handling. (b) The direct materials quantity standard should be based on both quality and quantity requirements plus allowances for unavoidable waste and normal spoilage.

Agree. The direct labor quantity standard should include allowances for rest periods, cleanup, machine setup, and machine downtime.

With standard costs, the predetermined overhead rate is determined by dividing budgeted overhead costs by an expected standard activity index.

A favorable cost variance has a positive connotation. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labor, and manufacturing overhead. An unfavorable cost variance has a negative connotation. It suggests that too much was paid for one or more of the manufacturing cost elements or that the elements were used inefficiently.

Questions Chapter 23 (Continued) 10.

(a) (1) actual price. (b) (3) actual quantity. (c) (5) standard price.

(2) standard price. (4) standard price. (6) standard quantity.

11.

(1) – (3) = total labor variance; (1) – (2) = labor price variance; and (2) – (3) = labor quantity variance.

12.

Overhead applied = $9 X 27,000 = $243,000.

13.

Variances should be reported to appropriate levels of management as soon as possible. The principle of “management by exception” may be used with variance reports.

14.

The purchasing department would be responsible for an unfavorable materials price variance when it paid more than the standard price for the materials. The purchasing department would also be responsible for an unfavorable materials quantity variance if it purchased materials of inferior quality which caused an excess use of materials.

15.

The four perspectives of the balanced scorecard are: financial, customer, internal process, and learning and growth. The financial perspective employs financial measures of performance used by most firms. The customer perspective evaluates the company from the viewpoint of those people who buy its product in terms of price, quality, product innovation, customer service, and other dimensions. The internal process perspective evaluates the value chain—product development, production, delivery and after-sale service—to ensure that the company is operating effectively and efficiently. The learning and growth perspective evaluates how well the company develops and retains its employees. The four perspectives are linked in that the results in one perspective influence the results in the next.

16.

Kerry James is not correct. The balanced scorecard does not replace financial measures, it instead integrates both financial and nonfinancial measures. In fact, financial measures are very critical to the balanced scorecard, since they represent the final “destination” of all the company’s efforts.

17.

The possibilities for nonfinancial measures are limitless. Some that were mentioned in the chapter were: capacity utilization of plants, average age of key assets, impact of strikes, brand-loyalty statistics, market profile of customer-end products, number of new products, employee stock ownership percentages, number of scientists and technicians used in R&D, customer satisfaction data, factors affecting customer product selection, number of patents and trademarks held, customer brand awareness, number of ATMs by state, number of products used by average customer, percentage of customer service calls handled by interactive voice response units, personnel cost per employee, credit card retention rates.

18.

(a) Variances are reported in income statements for management below gross profit which is reported at standard costs. Each variance is identified and the total variance is shown. (b) Standard costs may be used in costing inventories when there is no significant difference between actual costs and standard costs. When there are significant differences, actual costs must be reported.

Questions Chapter 23 (Continued) *19. (a) A standard cost accounting system is a double-entry system of accounting in which standard costs are used in making entries and standard cost variances are formally recognized in the accounts. (b) The variance account will have: (1) a debit balance when the materials price variance is unfavorable and (2) a credit balance when the labor quantity variance is favorable. *20. Overhead controllable variance = actual overhead costs ($248,000) – overhead budgeted. Overhead budgeted is based on standard hours allowed as follows: variable costs (27,000 X $5 = $135,000) + fixed costs (28,000 X $4 = $112,000) = total overhead budgeted ($247,000). Thus, the controllable variance is $1,000 unfavorable. *21. The purpose of computing the overhead volume variance is to determine whether plant facilities were efficiently used during the period. The basic formula is fixed overhead rate X (normal capacity – standard hours allowed). *22. Fixed costs remain the same at every level of activity within the relevant range. Since the predetermined overhead rate is based on normal capacity, it follows that if standard hours allowed are less than standard hours at normal capacity, fixed overhead costs will be underapplied. The reverse is true when production exceeds normal capacity. *23.

John should include the following points about overhead variances: (1) Standard hours allowed are used in each of the variances. (2) Budgeted costs for the controllable variance are derived from the flexible budget. (3) The controllable variance generally pertains to variable costs. (4) The volume variance pertains solely to fixed costs.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 23-1 (a) Standards are stated as a per unit amount. Thus, the standards are materials $2.80 ($1,400,000 ÷ 500,000) and labor $3.40 ($1,700,000 ÷ 500,000). (b) Budgets are stated as a total amount. Thus, the budgeted costs for the year are materials $1,400,000 and labor $1,700,000.

BRIEF EXERCISE 23-2 (a) Standard direct materials price per gallon = $2.60 ($2.30 + $.20 + $.10). (b) Standard direct materials quantity per gallon = 4 pounds (3.6 + .4). (c) Standard materials cost per gallon = $10.40 ($2.60 X 4). BRIEF EXERCISE 23-3 (a) Standard direct labor rate per hour = $16.00 ($14.00 + $.80 + $1.20). (b) Standard direct labor hours per gallon = 1.5 hours (1.1 + .25 + .15). (c) Standard labor cost per gallon = $24.00 ($16.00 X 1.5). BRIEF EXERCISE 23-4 Total materials variance = $1,192 U (3,200 X $5.06*) – (3,000** X $5.00). Materials price variance = $192 U (3,200 X $5.06) – (3,200 X $5.00). Materials quantity variance = $1,000 U (3,200 X $5.00) – (3,000 X $5.00). *$16,192 ÷ 3,200

**1,500 X 2

BRIEF EXERCISE 23-5 Total labor variance = $1,220 U (2,150 X $10.80) – (2,000* X $11.00). Labor price variance = $430 F (2,150 X $10.80) – (2,150 X $11.00). Labor quantity variance = $1,650 U (2,150 X $11.00) – (2,000 X $11.00). *1,000 X 2

BRIEF EXERCISE 23-6 The formula is:

Actual Overhead Overhead – Applied = Total Overhead Variance $118,000 – $123,600* $5,600 F

*20,600 X $6 = $123,600

BRIEF EXERCISE 23-7 1. 2. 3. 4.

financial ...................................... customer..................................... internal process ......................... learning and growth ...................

*BRIEF EXERCISE 23-8 (a) Raw Materials Inventory ............................................. Materials Price Variance ..................................... Accounts Payable ...............................................

12,000

(b) Work in Process Inventory (5,800 X $2*) ................... Materials Quantity Variance ............................... Raw Materials Inventory (5,600 X $2) .................

11,600

500 11,500 400 11,200

*$12,000 ÷ 6,000

*BRIEF EXERCISE 23-9 (a) Factory Labor.............................................................. Labor Price Variance........................................... Factory Wages Payable ......................................

24,900

(b) Work in Process Inventory (3,150 X $8.30*) .............. Labor Quantity Variance ..................................... Factory Labor ......................................................

26,145

*$24,900 ÷ 3,000

900 24,000 1,245 24,900

*BRIEF EXERCISE 23-10 The formula is:

Overhead Overhead Actual Overhead – Budgeted = Controllable Variance $118,000 – $132,400* $14,400 F

*(20,600 X $4) + $50,000 = $132,400 *BRIEF EXERCISE 23-11 The formula is: Overhead Fixed Overhead X (Normal Capacity Hours – Standard Hours Allowed) = Volume Variance Rate (25,000 – 20,600)

$2.00*/hr. X

= $8,800 U

*($50,000 ÷ 25,000 hrs.) SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 23-1 Manufacturing Cost Standard Quantity Standard X Element Direct materials 2 pounds Direct labor 0.2 hours Manufacturing overhead 0.2 hours Total

Price

Standard

$ 5.00 16.00 20.00*

DO IT! 23-2 The variances are: Total materials variance = (29,000 X $6.30) – (32,000* X $6.00) = $9,300 favorable Materials price variance = (29,000 X $6.30) – (29,000 X $6.00) = $8,700 unfavorable Materials quantity variance = (29,000 X $6.00) – (32,000* X $6.00) = $18,000 favorable

*(16,000 X 2)

DO IT! 23-3 The variances are: Total labor variance = (4,000 X $14.30) – (3,800* X $14.00) = $4,000 unfavorable Labor price variance = (4,000 X $14.30) – (4,000 X $14.00) = $1,200 unfavorable Labor quantity variance = (4,000 X $14.00) – (3,800* X $14.00) = $2,800 unfavorable Total overhead variance = $81,300 – $83,600** = $2,300 favorable *2,000 X 1.9 **3,800 hours X $22.00

DO IT! 23-4 Sales revenue Cost of goods sold (at standard) Standard gross profit Variances $350 U Materials price 1,700 F Materials quantity Labor price 800 F Labor quantity 500 F Overhead 1,200 U Total variance favorable Gross profit (actual)

$92,100 51,600 40,500

1,450 $41,950

SOLUTIONS TO EXERCISES EXERCISE 23-1 (a) Direct materials: (2,000 X 3) X $5 = $30,000 Direct labor: (2,000 X 1/2) X $16 = $16,000 Overhead: $16,000 X 70% = $11,200 (b) Direct materials: 3 X $5 = $15.00 Direct labor: 1/2 X $16 = 8.00 Overhead: $8.00 X 70% = 5.60 Standard cost: $28.60 (c) The advantages of standard costs which are carefully established and prudently used are: 1. Management planning is facilitated. 2. Greater economy is promoted by making employees more costconscious. 3. Setting selling prices is facilitated. 4. Management control is enhanced by having a basis for evaluation of cost control. 5. Variances are highlighted in management by exception. 6. Costing of inventories is simplified and clerical costs are reduced. EXERCISE 23-2

Ingredient Grape concentrate Sugar (54 ÷ 50) Lemons (60 ÷ 50) Yeast Nutrient Water (2,600 ÷ 50)

Amount Per Gallon 60* oz. 1.08 lb. 1.2 1 tablet 1 tablet 52 oz.

Standard Standard Waste Usage 4% (a) 62.5 oz. 10% (b) 1.20 lb. 25% (c) 1.6 0% 1 tablet 0% 1 tablet 0% 52 oz.

*3,000 ÷ 50 (a) (b) (c)

.96X = 60 ounces; or X = (60 ounces) /.96. .90X = 1.08 pounds; or X = (1.08 pounds)/.90. .75X = 1.2 lemons; or X = (1.2 lemons) /.75.

Standard Price $.06 .30 .60 .25 .20 .005

Standard Cost Per Gallon $3.75 .36 .96 .25 .20 .26 $5.78

EXERCISE 23-3 Direct materials Cost per pound [($5 – (2% X $5)) + $0.25] Pounds per unit (4.5 + 0.5)

$5.15 X 5

$25.75

Direct labor Cost per hour ($12 + $3) Hours per unit (2 + .4)

$ 15 X 2.4

36.00

Manufacturing overhead 2.4 hours X $7 Total standard cost per unit

16.80 $78.55

EXERCISE 23-4 (a) Actual service time Setup and downtime Cleanup and rest periods Standard direct labor hours per oil change

1.0 hours 0.2 hours 0.3 hours 1.5 hours

(b) Hourly wage rate Payroll taxes ($12 X 10%) Fringe benefits ($12 X 25%) Standard direct labor hourly rate

$12.00 1.20 3.00 $16.20

(c) Standard direct labor cost per oil change = 1.50 hours X $16.20 per hour = $24.30 (d) Direct labor quantity variance = (1.60 hours X $16.20) – (1.50 hours X $16.20) = $25.92 – $24.30 = $1.62 U

EXERCISE 23-5 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (29,000 X $4.70) (28,200* X $5.00) $136,300 – $141,000 = $4,700 F *9,400 X 3 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (29,000 X $4.70) (29,000 X $5.00) $136,300 – $145,000 = $8,700 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (29,000 X $5.00) (28,200 X $5.00) $145,000 – $141,000 = $4,000 U (b) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (28,000 X $5.15) (28,200 X $5.00) $144,200 – $141,000 = $3,200 U Materials price variance: (AQ X AP ) – ( AQ X SP ) (28,000 X $5.15) (28,000 X $5.00) $144,200 – $140,000 = $4,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (28,000 X $5.00) (28,200 X $5.00) $140,000 – $141,000 = $1,000 F

EXERCISE 23-6 (a) Total labor variance: ( AH X AR ) – ( SH X SR ) (40,600 X $12.15) (40,000* X $12.00) $493,290 – $480,000 = $13,290 U *10,000 X 4 (b) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.00) $493,290 – $487,200 = $6,090 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.00) (40,000 X $12.00) $487,200 – $480,000 = $7,200 U (c) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.25) $493,290 – $497,350 = $4,060 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.25) (41,000* X $12.25) $497,350 – $502,250 = $4,900 F *4.1 X 10,000 EXERCISE 23-7 Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,900 X $2.65*) (1,840** X $2.50) $5,035 – $4,600 = $435 U Materials price variance: ( AQ X AP ) – (1,900 X $2.65) $5,035 – *$5,035 ÷ 1,900

( AQ X SP ) (1,900 X $2.50) $4,750 = $285 U **230 X 8

EXERCISE 23-7 (Continued) Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,900 X $2.50) (1,840 X $2.50) $4,750 – $4,600 = $150 U Total labor variance: ( SH X SR ) ( AH X AR ) – (700 X $11.60*) (690** X $12.00) $8,280 = $160 F $8,120 – *$8,120 ÷ 700

**230 X 3

Labor price variance: ( AH X AR ) – ( AH X SR ) (700 X $11.60) (700 X $12.00) $8,120 – $8,400 = $280 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (700 X $12.00) (690 X $12.00) $8,400 – $8,280 = $120 U

EXERCISE 23-7 (Continued) (Not Required) Materials Variance Matrix (1)

(2)

(3)

Actual Quantity X Actual Price 1,900 X $2.65 = $5,035

Actual Quantity X Standard Price 1,900 X $2.50 = $4,750

Standard Quantity X Standard Price 1,840 X $2.50 = $4,600

Price Variance (1) – (2) $5,035 – $4,750 = $285 U

Quantity Variance (2) – (3) $4,750 – $4,600 = $150 U

Total Variance (1) – (3) $5,035 – $4,600 = $435 U

Labor Variance Matrix (1)

(2)

(3)

Actual Hours X Actual Rate 700 X $11.60 = $8,120

Actual Hours X Standard Rate 700 X $12.00 = $8,400

Standard Hours X Standard Rate 690 X $12.00 = $8,280

Price Variance (1) – (2) $8,120 – $8,400 = $280 F

Quantity Variance (2) – (3) $8,400 – $8,280 = $120 U

Total Variance (1) – (3) $8,120 – $8,280 = $160 F

EXERCISE 23-8 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,220 X $128) (1,200 X $130) $156,160 – $156,000 = $160 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (1,220 X $128) (1,220 X $130) $156,160 – $158,600 = $2,440 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,220 X $130) (1,200 X $130) $158,600 – $156,000 = $2,600 U Total labor variance: ( AH X AR ) – ( SH X SR ) (4,150 X $13) (4,300 X $12.50) $53,950 – $53,750 = $200 U Labor price variance: ( AH X AR ) – ( AH X SR ) (4,150 X $13) (4,150 X $12.50) $53,950 – $51,875 = $2,075 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (4,150 X $12.50) (4,300 X $12.50) $51,875 – $53,750 = $1,875 F (b) The unfavorable materials quantity variance may be caused by the carelessness or inefficiency of production workers. Alternatively, the excess quantities may be caused by inferior quality materials acquired by the purchasing department. The unfavorable labor price variance may be caused by misallocation of the work force by the production department. In this case, more experienced workers may have been assigned to tasks normally done by inexperienced workers. An unfavorable labor variance may also occur when workers are paid higher wages than expected. The manager who authorized the wage increase is responsible for this variance.

EXERCISE 23-9 (a)

Number of units = Total standard cost ÷ Standard cost per unit Number of units = $410,000 ÷ $20.00 (5 lb X $4 per lb) = 20,500

(b) AQ = [(SQ X SP) ± Quantity variance] ÷ SP AQ = ($410,000 + $9,000) ÷ $4.00 per lb = 104,750 pounds (c)

AP = [(AQ X SP) ± Price variance] ÷ AQ AP = [(104,750 X $4) – $2,095] = $416,905 ÷ 104,750 lb = $3.98/lb

(d) AH = [(SH X SR) ± Quantity variance] ÷ SR AH = ($180,000 + $6,000) ÷ $10.00/hr = 18,600 hours (e)

AR = [(AH X SR) ± Price variance] ÷ AH AP = [(18,600 X $10) + $3,840] = $189,840 ÷ 18,600 hr = $10.21/hr

EXERCISE 23-10 TOBY TOOL & DIE COMPANY Direct Labor Variance Report For the Month Ended March 31, 2017 Job No.

Actual Hours

Standard Hours

Quantity Variance (a)

Actual Standard (1) Rate Rate (2)

Price Variance (b) Explanation

A257 A258 A259

221 450 300

225 430 300

$ 80.00 F 400.00 U 0

$20.00 $21.00 $20.60

$20.00 $20.00 $20.00

A260

116 110 Totals

120.00 U $ 440.00 U

$18.00

$20.00

LQV = SR X (AH – SH) (b) LPV = AH X (AR – SR) (a)

(1)

0 Repeat job 450.00 U Rush job 180.00 U Replacement worker 232.00 F New trainee $398.00 U

Actual costs ÷ actual hours Standard costs ÷ standard hours

(2)

EXERCISE 23-11 Total overhead variance: Actual Overhead – Overhead Applied $260,000 $263,000 – (52,000 X $5)

= $3,000 U

EXERCISE 23-12 (a)

Overhead Budget (at normal capacity) Variable $250,000 Fixed 600,000 (b)

(c)

Standard Hours Allowed 95,000

Actual Overhead – $856,000 – ($256,000 + $600,000)

Direct Labor Hours (at normal capacity) 100,000 100,000 Predetermined Overhead Rate $8.50 Overhead Applied $807,500 (95,000 X $8.50)

Predetermined Overhead Rate $2.50 $6.00

Overhead Applied $807,500

Total Overhead Variance = = $48,500 U

EXERCISE 23-13 (a)

(AQ X AP) – ( SQ X SP) = Total Materials Variance ( $10,200) – (2,100* X $5) = $300 F (AQ X AP) – ( AQ X SP) = Materials Price Variance ( $10,200) – (2,400 X $5) = $1,800 F ( AQ X SP) – ( SQ X SP) = Materials Quantity Variance (2,400 X $5) – (2,100* X $5) = $1,500 U *1,050 X 2

(b) One possible cause of an unfavorable materials quantity variance is the purchase of substandard materials. Such materials would normally be purchased at a lower price than normal, which means there would also be favorable materials price variance. Substandard materials could also cause work slowdowns and delays, causing an unfavorable labor quantity variance. Therefore, the purchase of substandard materials could cause all three variances mentioned.

EXERCISE 23-14 (a) PICARD LANDSCAPING Variance Report – Purchasing Department For the Current Month

Project Remington Chang Wyco

(1) Actual Actual Price Pounds Per Purchased Pound 500 400 550

$2.40 2.30 2.60

(2) Price Standard Price Variance (a) $2.50 2.50 2.50

Total price variance

$50 F 80 F 55 U

Explanation Purchased poor-quality seeds Seeds on sale Price increased

$75 F

(a)

MPV = AQ X (AP – SP) (1)Actual costs ÷ actual quantity (2)Standard costs ÷ standard quantity.

(b) PICARD LANDSCAPING Variance Report – Production Department For the Current Month

Project Remington Chang Wyco

Actual Pounds

Standard Pounds

Standard Price Per Pound

Quantity (b) Variance

Explanation

500 400 550

460 410 480

$2.50 2.50 2.50

$100 U 25 F 175 U

Purchased poor-quality seeds Purchased higher-quality seeds New employee

Total quantity variance

MQV = SP X (AQ – SQ)

(b)

$250 U

EXERCISE 23-15 URBAN CORPORATION Variance Report – Purchasing Department For Week Ended January 9, 2017 Type of Materials Rogue 11 Storm 17 Beast 29

Quantity Purchased 27,500 lbs. 7,000 oz. 22,000 units.

Actual Price $5.20

$3.45

Standard Price $5.00 $3.30

$0.40

$0.43

Price Variance $5,500 U $1,050 U $ 660 F

Explanation Price increase Rush order Bought larger quantity

27,500 = $5,500/($5.20 – $5.00). $5,000 U because the actual price ($5.20) exceeds the standard price ($5.00). $1,050/7,000 = $0.15; $3.30 + $0.15 = $3.45 $660/22,000 = $0.03; $0.40 + $0.03 = $0.43

EXERCISE 23-16 FISK COMPANY Income Statement For the Month Ended January 31, 2017 Sales revenue (8,000 X $8)............................................. Cost of goods sold (8,000 X $5) .................................... Gross profit (at standard) .............................................. Variances Materials price ........................................................ $1,200 U Materials quantity ................................................... 800 F Labor price .............................................................. 550 U Labor quantity......................................................... 750 U Overhead ................................................................. 800 U Total variance—unfavorable .......................... Gross profit (actual) ....................................................... Selling and administrative expenses ............................ Net income......................................................................

$64,000 40,000 24,000

2,500 21,500 8,000 $13,500

EXERCISE 23-17 1.

Balanced scorecard—(c) An approach that incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company’s strategic goals.

Variance—(a) The difference between total actual costs and total standard costs.

Learning and growth perspective—(d) A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees.

Nonfinancial measures —(e) An evaluation tool that is not based on dollars.

Customer perspective—(f) A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy its products or services.

Internal process perspective—(h) A viewpoint employed in the balanced scorecard to evaluate the efficiency and effectiveness of the company’s value chain.

Ideal standards—(g) An optimum level of performance under perfect operating conditions.

Normal standards—(b) An efficient level of performance that is attainable under expected operating conditions.

EXERCISE 23-18 1. 2. 3. 4. 5. 6.

Customer perspective. Learning and growth perspective. Financial perspective. Customer perspective. Learning and growth perspective. Internal process perspective.

EXERCISE 23-19 1. 2. 3. 4. 5. 6.

Learning and growth perspective. Financial perspective. Customer perspective. Internal process perspective. Learning and growth perspective. Customer perspective.

*EXERCISE 23-20 1.

Raw Materials Inventory (18,000 X $4.40) ................ Materials Price Variance (18,000 X $.10) .................. Accounts Payable (18,000 X $4.50) ...................

79,200 1,800

Work in Process Inventory (17,500 X $4.40) ............ Materials Quantity Variance (500 X $4.40) ............... Raw Materials Inventory (18,000 X $4.40) .........

77,000 2,200

Factory Labor (15,300 X $5.50) ................................. Labor Price Variance (15,300 X $.50) ................ Factory Wages Payable (15,300 X $5.00)..........

84,150

Work in Process Inventory (15,400 X $5.50) ............ Labor Quantity Variance (100 X $5.50) ............. Factory Labor (15,300 X $5.50)..........................

84,700

Work in Process Inventory ($84,700 X 100%) .......... Manufacturing Overhead ...................................

84,700

*EXERCISE 23-21 (a) $136,000 ($138,000 – $2,000). (b) $139,000 ($136,000 + $3,000). (c) $143,500 ($145,000 – $1,500). (d) $145,900 ($145,000 + $900). (e) $163,800 ($165,000 – $1,200).

81,000

79,200 7,650 76,500 550 84,150 84,700

*EXERCISE 23-22 Raw Materials Inventory (1,900 X $2.50) ........................... Materials Price Variance (1,900 X $0.15) ........................... Accounts Payable (1,900 X $2.65)..............................

4,750 285

Work in Process Inventory (1,840* X $2.50)...................... Materials Quantity Variance (60 X $2.50) .......................... Raw Materials Inventory (1,900 X $2.50)....................

4,600 150

5,035

4,750

*230 X 8 Factory Labor (700 X $12) .................................................. Labor Price Variance (700 X $0.40)............................ Factory Wages Payable (700 X $11.60)......................

8,400

Work in Process Inventory (690* X $12)............................ Labor Quantity Variance (10 X $12)................................... Factory Labor (700 X $12) ..........................................

8,280 120

280 8,120

8,400

*230 X 3 *EXERCISE 23-23 (a) Item Variable overhead................................... Fixed overhead ....................................... Total overhead ........................................ (b) Total overhead variance: Actual Overhead – Overhead Applied $55,500 – $53,460 (16,200* X $3.30)

Amount $34,650 19,800 $54,450

Hours 16,500 16,500 16,500

= $2,040 U

*4,050 X 4 hrs. = 16,200 hrs. Overhead controllable variance: Actual Overhead – Overhead Budgeted $55,500 – $53,820 = $1,680 U (16,200 X $2.10) + $19,800]

Rate $2.10 1.20 $3.30

EXERCISE 23-23 (Continued) Overhead volume variance: Fixed Overhead Normal Capacity Standard Hours Rate X Hours – Allowed (4,050 X 4)] = $360 U $1.20 X [(16,500 – (c) The overhead controllable variance is generally associated with variable overhead costs. Thus, this variance indicates the production manager’s inefficiency in controlling variable overhead costs. The overhead volume variance relates to fixed overhead costs. This variance indicates whether plant facilities were efficiently used. In this case 300 (16,500 – 16,200) hours of plant capacity were not utilized.

*EXERCISE 23-24 (a)

1. Total actual overhead cost

Overhead Budgeted

Overhead Controllable Variance

= ($18,000 + $12,600) +

$1,200

= $31,800 2.

Actual variable overhead cost

= Actual Overhead – Fixed Overhead –

= $31,800

$12,600

= $19,200 3.

Variable overhead cost applied = 2,000 hours X $9 = $18,000

Fixed overhead cost applied

= 2,000 hours X $6 = $12,000

Overhead volume variance

Fixed  Normal Overhead X Capacity  Hours Rate 

(2,100* –

–

Standard Hours   Allowed   2,000)

= $600 U *$12,600 ÷ $6 per hour = 2,100 hours (b)

Number of loans processed

= Standard hours allowed ÷ Standard hours per application = 2,000 ÷ 2 = 1,000 loans processed

EXERCISE 23-25 (a) (Actual) – (Applied) = Total Overhead Variance ($19,500) – (1,800 X $10*) = $1,500 U (Actual) – ($19,500) – Fixed OH Rate $3**

(Budgeted) ($17,600)

*$200,000/20,000

Normal Capacity (1,667***

= Overhead Controllable Variance = $1,900 U

– –

Standard Hours Allowed 1,800)

**($5,000 X 12)/20,000

Overhead Volume = Variance = $400 F ***20,000/12

(b) The cause of an unfavorable controllable variance could be higher than expected use of indirect materials, indirect labor, and factory supplies, or increases in indirect manufacturing costs, such as fuel and maintenance costs. A favorable volume variance would be caused by production of more units than what is considered normal capacity.

SOLUTIONS TO PROBLEMS PROBLEM 23-1A

(a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (5,100 X $7.20) (4,800 X $7.00) $36,720 – $33,600 = $3,120 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (5,100 X $7.20) (5,100 X $7.00) $36,720 – $35,700 = $1,020 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (4,800 X $7.00) (5,100 X $7.00) $35,700 – $33,600 = $2,100 U Total labor variance: ( AH X AR ) – ( SH X SR ) (7,400 X $12.50) (7,680* X $12.00) $92,500 – $92,160 = $340 U *4,800 X 1.6 Labor price variance: ( AH X AR ) – ( AH X SR ) (7,400 X $12.50) (7,400 X $12.00) $92,500 – $88,800 = $3,700 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (7,400 X $12.00) (7,680 X $12.00) $88,800 – $92,160 = $3,360 F (b) Total overhead variance: Actual Overhead Overhead – Applied ($59,700 + $21,000) – (7,680 X $10.00) $76,800 = $3,900 U $80,700

PROBLEM 23-2A

(a) 1. Total materials variance: ( AQ X AP ) – ( SQ X SP ) (10,600 X $2.25) (10,000 X $2.10) $23,850 – $21,000 = $2,850 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (10,600 X $2.25) (10,600 X $2.10) $23,850 – $22,260 = $1,590 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (10,600 X $2.10) (10,000 X $2.10) $22,260 – $21,000 = $1,260 U 2. Total labor variance: ( AH X AR ) – ( SH X SR ) (14,400 X $8.40*) (15,000 X $8.00**) $120,960 – $120,000 = $960 U *$120,960 ÷ 14,400

**$120,000 ÷ 15,000

Labor price variance: (AH X AR ) – ( AH X SR ) (14,400 X $8.40) (14,400 X $8.00) $120,960 – $115,200 = $5,760 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,400 X $8.00) (15,000 X $8.00) $115,200 – $120,000 = $4,800 F (b)

Total overhead variance: Actual Overhead Overhead – Applied – $193,500 = $4,000 F $189,500 (45,000* X $4.30) *15,000 X 3

PROBLEM 23-2A (Continued) (c)

AYALA CORPORATION Income Statement For the Month Ended June 30, 2017 Sales revenue..................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labor price.................................................. Labor quantity ............................................ Overhead..................................................... Total variance—favorable .................. Gross profit (actual)........................................... Selling and administrative expenses ............... Net income .........................................................

$400,000 334,500* 65,500 $ 1,590 U 1,260 U 5,760 U 4,800 F 4,000 F 190 65,690 40,000 $ 25,690

*Materials $21,000 + labor $120,000 + overhead applied $193,500.

PROBLEM 23-3A

(a) 1.

Total materials variance: (AQ X AP ) – ( SQ X SP ) (90,500 X $4.15) (90,000* X $4.40) $375,575 – $396,000 = $20,425 F *11,250 X 8 Materials price variance: (AQ X AP ) – ( AQ X SP ) (90,500 X $4.15) (90,500 X $4.40) $375,575 – $398,200 = $22,625 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (90,500 X $4.40) (90,000 X $4.40) $398,200 – $396,000 = $2,200 U

Total labor variance: ( AH X AR )– ( SH X SR ) (14,250 X $14.10) (13,500* X $13.40) $200,925 – $180,900 = $20,025 U *11,250 X 1.2 Labor price variance: ( AH X AR ) – ( AH X SR ) (14,250 X $14.10) (14,250 X $13.40) $200,925 – $190,950 = $9,975 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,250 X $13.40) (13,500 X $13.40) $190,950 – $180,900 = $10,050 U

(b)

Total overhead variance: Actual Overhead Overhead – Applied $86,000 – $82,350 ($49,000 + $37,000) (13,500* X $6.10**) = $3,650 U *11,250 X 1.2

**$3.50 + $2.60

PROBLEM 23-3A (Continued) (c) The materials price variance is more than 4% from standard. The actual price for materials of $4.15 is $.25 below the standard price of $4.40 or 5.7% ($.25 ÷ $4.40). The same result can be obtained by dividing the total price variance by the total standard price for the quantities purchased ($22,625 ÷ $398,200). The labor price variance is 5.2% from standard ($.70 ÷ $13.40). The same result can be obtained by dividing the total price variance by the total standard price for the direct labor hours used ($9,975 ÷ $190,950). The labor quantity variance is 5.6% (750 ÷ 13,500) from standard. The same result can be obtained by dividing the total quantity variance by the total standard price for the standard hours allowed ($10,050 ÷ $180,900).

PROBLEM 23-4A

(a) $3,510 ÷ 117,000 = $.03; $.92 + $.03 = $.95 standard materials price per pound. OR 117,000 X $.92 = $107,640; $107,640 + $3,510 = $111,150; $111,150 ÷ 117,000 = $.95 per pound. (b) $4,750 ÷ $.95 = 5,000 pounds; 117,000 – 5,000 = 112,000 standard quantity for 28,000 units or 4.0 pounds (112,000 ÷ 28,000) per unit. OR $111,150 – $4,750 = $106,400; $106,400 ÷ $.95 = 112,000; 112,000 ÷ 28,000 = 4.0 pounds per unit. (c) Standard hours allowed are 44,800 (28,000 X 1.6). (d) $7,200 ÷ $12.00 = 600 hours over standard; 44,800 standard hours + 600 hours = 45,400 actual hours worked. OR 44,800 X $12 = $537,600; $537,600 + $7,200 = $544,800; $544,800 ÷ $12 = 45,400 actual hours worked. (e) $9,080 ÷ 45,400 = $.20; $12.00 – $.20 = $11.80 actual rate per hour. OR $544,800 – $9,080 = $535,720; $535,720 ÷ 45,400 = $11.80 actual rate per hour. (f)

$360,000 ÷ 50,000 = $7.20 predetermined overhead rate per direct labor hour.

(g) Direct materials 4.0 pounds X $.95 = $3.80; direct labor 1.6 X $12.00 = $19.20; manufacturing overhead 1.6 X $7.20 = $11.52. $3.80 + $19.20 + $11.52 = $34.52 standard cost per unit. (h) 44,800 X $7.20 = $322,560 overhead applied. (i)

$34.52 [see (g) above] X 28,000 = $966,560 or direct materials $106,400 + direct labor $537,600 + overhead applied $322,560 = $966,560.

PROBLEM 23-5A

(a) Materials price variance: ( AQ X AP ) – ( AQ X SP ) (3,050 X $1.40*) (3,050 X $1.46) $4,270 – $4,453

= $183 F

*$4,270 ÷ 3,050 Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (3,050 X $1.46) (2,950* X $1.46) $4,307 $4,453 – *1,475 X 2 Labor price variance: ( AH X AR) – ( AH X SR) (1,550 X $23*) (1,550 X $24) $35,650 – $37,200 *$35,650 ÷ 1,550 Labor quantity variance: ( AH X SR) – (SH X SR ) (1,550 X $24) (1,475* X $24) $37,200 – $35,400

= $146 U

= $1,550 F

= $1,800 U

*1,475 X 1 hr. (b) Total Overhead variance: Actual Overhead Overhead – Applied $22,400 – $23,600 ($7,400 + $15,000) (1,475 X $16*) *$10 + $6

= $1,200 F

PROBLEM 23-5A (Continued) (c) HART LABS, INC. Income Statement For the Month Ended November 30, 2017 Service revenue ...................................................... Cost of service provided (at standard) (1,475 X $42.92) ................................................... Gross profit (at standard)....................................... Variances Materials price ................................................. Materials quantity............................................ Labor price ...................................................... Labor quantity ................................................. Overhead ......................................................... Total variance—favorable....................... Gross profit (actual) ............................................... Selling and administrative expenses .................... Net income ..............................................................

$75,000 63,307 11,693 $ 183 F 146 U 1,550 F 1,800 U 1,200 F 987 12,680 5,000 $ 7,680

(d) The unfavorable materials quantity variance could be caused by poor quality materials or inexperienced workers or faulty test procedures. The unfavorable labor quantity variance could be caused by inexperienced workers, poor quality materials, or faulty test procedures.

*PROBLEM 23-6A

(a) 1.

Raw Materials Inventory (6,200 X $1.00)............ Materials Price Variance [6,200 X ($1.05 – $1.00)] .................................. Accounts Payable (6,200 X $1.05) ..............

6,200

Work in Process Inventory (5,700* X $1) ........... Materials Quantity Variance [(6,200 – 5,700) X $1.00] .................................. Raw Materials Inventory..............................

5,700

310 6,510

500 6,200

*1,900 X 3 3.

Factory Labor (2,000 X $8).................................. Labor Price Variance [2,000 X ($8.00 – $7.80)]........................... Factory Wages Payable (2,000 X $7.80) ..... Work in Process Inventory (1,900 X $8.00) ................................................. Labor Quantity Variance [(2,000 – 1,900) X $8.00] .................................. Factory Labor .............................................. Manufacturing Overhead .................................... Accounts Payable........................................ Work in Process Inventory (3,800* X $6.25**) ............................................. Manufacturing Overhead ............................ *1,900 X 2

16,000 400 15,600 15,200 800 16,000 25,000 25,000 23,750 23,750

**$4.00 + $2.25

Finished Goods Inventory (1,900 X $23.50) ............................................... Work in Process Inventory .........................

44,650 44,650

Accounts Receivable .......................................... Sales Revenue .............................................

65,000

Cost of Goods Sold............................................ Finished Goods Inventory .........................

44,650

65,000 44,650

*PROBLEM 23-6A (Continued) (b)

Raw Materials Inventory (1) 6,200 (2) 6,200

Materials Price Variance (1) 310

Work in Process Inventory (2) 5,700 (7) 44,650 (4) 15,200 (6) 23,750

Factory Labor 16,000 (4) 16,000

Materials Quantity Variance (2) 500

Finished Goods Inventory (7) 44,650 (8) 44,650

Manufacturing Overhead (5) 25,000 (6) 23,750

Labor Price Variance (3) 400

(3)

(8)

Cost of Goods Sold 44,650

Labor Quantity Variance (4) 800

1,250 1,250

JORGENSEN CORPORATION Income Statement For the Month Ended January 31, 2017 Sales revenue ........................................................ Cost of goods sold (at standard) (1,900 X $23.50) .................................................. Gross profit (at standard)...................................... Variances Materials price ................................................ Materials quantity........................................... Labor price ..................................................... Labor quantity ................................................ Overhead ........................................................ Total variance—unfavorable.................. Gross profit (actual) .............................................. Selling and administrative expenses ................... Net income .............................................................

$65,000 44,650 20,350 $ 310 U 500 U 400 F 800 U 1,250 U 2,460 17,890 2,000 $15,890

*PROBLEM 23-7A

Overhead controllable variance: Overhead Actual Budgeted Overhead – $77,600 $80,700 – = $3,100 U [(7,680* X $7.50) + $20,000] *(4,800 X 1.6 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Hours Rate Allowed (8,000 $2.50/hr. X – 7,680)

= $800 U

*PROBLEM 23-8A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $189,500 – $190,250 [(45,000* X $3.00) + (42,500 X $1.30)]

= $750 F

*(15,000 X 3 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Allowed Hours $1.30/hr. X (42,500 – 45,000) = $3,250 F

*PROBLEM 23-9A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $86,000 – $84,100 = $1,900 U ($49,000 + $37,000) [(13,500* X $2.60) + $49,000] *(11,250 X 1.2 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $3.50/hr. X (14,000 – 13,500)

= $1,750 U

*PROBLEM 23-10A

Overhead controllable variance: Actual Overhead Overhead – Budgeted $22,400 – $22,850 = $450 F ($7,400 + $15,000) [(1,475 X $6) + $14,000] Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $10 X (1,400* – 1,475) *$14,000 ÷ $10

= $750 F

CD23

CURRENT DESIGNS

(a) Quantity variance for polyethylene powder Price variance for polyethylene powder Quantity variance for finishing kits Price variance for finishing kits Quantity variance for type I workers Price variance for type I workers Quantity variance for type II workers Price variance for type II workers

Unfavorable Unfavorable NEI = Not enough information Favorable Favorable NEI = Not enough information Unfavorable NEI = Not enough information

(b) Quantity variance for polyethylene powder ( AQ X SP ) – ( SQ X SP ) (1,200 X $1.50) (1,080* X $1.50) $1,800 – $1,620 = $180 U *54 X 20 Price variance for polyethylene powder ( AQ X AP ) – ( AQ X SP ) (1,200 X $1.70*) (1,200 X $1.50) $2,040 – $1,800

= $240 U

*$2,040 ÷ 1,200 Quantity variance for finishing kits ( AQ X SP ) – ( SQ X SP ) (20 X $170) (20 X $170) $3,400 – $3,400

=$ 0

Price variance for finishing kits ( AQ X AP ) – ( AQ X SP ) (20 X $162*) (20 X $170) $3,240 – $3,400

= $160 F

*$3,240 ÷ 20

CD23 (Continued) Quantity variance for type I workers ( AH X SR ) – ( SH X SR ) (38 X $15) (40* X $15) $570 – $600

= $30 F

*20 X 2 Price variance for type I workers ( AH X AR ) – ( AH X SR ) (38 X $15*) (38 X $15) $570 – $570

=$ 0

*$570 ÷ 38 Quantity variance for type II workers ( AH X SR ) – ( SH X SR ) (65 X $12) (60* X $12) $780 – $720

= $60 U

*20 X 3 Price variance for type II workers ( AH X AR ) – ( AH X SR ) (65 X $12.25*) (65 X $12.00) $796.25 – $780 *$796.25 ÷ 65

= $16.25 U

BYP 23-1

DECISION-MAKING ACROSS THE ORGANIZATION

(a) When setting a standard for computer/labor hours usage, Milton Professionals should consider the following factors: 1.

A standard set conservatively high may discourage clients from purchasing the model.

A standard set too low may encourage sales of the model, but if customers use more hours than the standard suggests, they may be upset at having been misled.

Clients are likely to use the standard as an evaluation tool for their own employees operating the model. Standards set inappropriately may adversely affect productivity and/or morale of client employees.

(b) Logical alternatives for the standard include: 1.

34 hours:

The average number of hours used for one application by all five financial institutions.

45 hours:

The conservatively high number experienced by one financial institution.

25 hours:

The optimistic low number experienced by one financial institution.

30 hours:

The number of hours required most frequently in the sample of five institutions.

(c) In light of earlier factors listed, the second and third choices for the standard should be eliminated (i.e., 45 and 25 hours). The average 34 hours is probably the most representative. However, Milton Professionals may select 30 hours, given that the company has a high incentive to sell the new model. Consequently, it may make the most sense to pick the lower of the two remaining choices (30 hours).

BYP 23-1 (Continued) (d) Standard material cost for one model application: User Manuals:

$320 ÷ 20 manuals = $16/application.

Computer Forms:

$60 ÷ 250 forms = $.24/form $.24/form X 50 forms = $12/application.

BYP 23-2

MANAGERIAL ANALYSIS

(a) The overhead application rate is $144,000 divided by 5,000 hours, or $28.80 per direct labor hour. (b) The standard direct labor hours are used to apply overhead to production, so the calculation is $28.80 X 4,500, or $129,600. (c)

Actual Overhead – Overhead Applied = Total Overhead Variance $150,000 $129,600 = $20,400 U The overhead budgeted for 4,500 direct labor hours is computed below. Fixed:

$22,500 + $13,000 + $27,000 + $8,000 + $3,000 + $1,500 + $500 + $300 = $75,800

Variable: ($12,000 + $43,000 + $10,000 + $2,500 + $700) ÷ 5,000 = $13.64 Fixed Variable (4,500 X $13.64)

$ 75,800 61,380 $137,180

The variances are: Controllable: Volume:

Actual ($150,000) – Budgeted ($137,180) = $12,820 U $15.16*/hr. X (5,000 – 4,500) = $7,580 U

*$75,800 ÷ 5,000 hrs. (d) Both variances appear significant. The controllable variance is 9.3% of budgeted overhead ($12,820 ÷ $137,180), and the volume variance is 5.8% of applied overhead ($7,580 ÷ $129,600). (e) The controllable variance is caused by either spending more than expected on overhead items, or using more than expected of overhead items (for example, more indirect labor hours). The volume variance is caused by underutilizing factory time. To improve performance, management must spend less on overhead items, use them more efficiently, and increase production to 1,000 units.

BYP 23-3

REAL-WORLD FOCUS

(a) Glassmaster is using standard costs because management states that a factor that contributed to improved margins (profit) was a favorable materials price variance. (b) The materials price variance experienced should not lead to changes in the standard for the next fiscal year. Management indicates that the favorable variance is temporary and will begin to reverse itself as stronger worldwide demand for commodity products improves in tandem with the economy.

BYP 23-4

REAL-WORLD FOCUS

(a) The objectives for each perspective are: Financial: Increase profitability, lower costs, increase revenue Customer: Flight is on-time, lowest prices, more customers Internal: Improve turnaround time. Learning: Ground crew alignment. (b) To measure achievement of the customer perspective objectives of ontime flights, lowest prices and more customers, the company will use FAA on time arrival ratings, customer ranking, and number of customers. (c) To achieve the learning perspective objective of ground crew alignment, the company plans to implement an employee stock ownership plan and ground crew training.

BYP 23-5

REAL-WORLD FOCUS

(a) The normal industry standard for plants to be considered operating at 100% capacity is two shifts working about 250 days a year. (b) A government task force urged the company to try to operate at 120% capacity by traditional standards. (c) It is argued that assembly lines need too much scheduled maintenance and restocking. This is normally done during the period that the company is proposing to run a third shift. For example, the paint shop typically requires 4 hours of cleaning per day. To address these issues, the company is considering “overspeeding” some parts of the line so it can be slowed down later. (d) Potential drawbacks of the midnight shift are that midnight-shift workers are prone to above-average rates of on-the-job errors, absenteeism and illness. All of these issues could cause the night shift to deviate materially from standards for materials, labor and overhead. (e) Another potential problem with this approach is that each plant can only make a limited number of car models. Adding a third shift at the Kansas City plant assumes that the market demand for these cars will be sufficient to absorb the additional cars produced. If not, the company will have to discount the selling price and lay off employees.

BYP 23-6

COMMUNICATION ACTIVITY

To:

Professor Standard

From:

I. M. Smart

Subject:

Setting Standard Costs

This memorandum covers two points as follows: (a) The comparative advantages and disadvantages of ideal versus normal standards. Ideal standards represent optimum levels of performance under perfect operating conditions. In contrast, normal standards represent efficient levels of performance that are attainable under expected operating conditions. An advantage of ideal standards is that they stimulate the conscientious worker to ever-increasing improvement. The disadvantage of ideal standards is that because they are so difficult to meet, they lower the morale of the entire work force. Normal standards are rigorous but attainable. Such standards should stimulate the worker to self-improvement without discouraging him or her or lowering the morale of the work force. (b) Factors to be considered in setting standards for direct materials, direct labor, and manufacturing overhead. 1.

Direct materials. The direct materials price standard is the cost per unit of direct materials that should be incurred. This standard should be based on the purchasing department’s best estimate of the cost of raw materials. The price standard should include allowances for related costs such as receiving, storing and handling.

BYP 23-6 (Continued) The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. This standard is a physical measure and it should include allowances for unavoidable waste and normal spoilage. 2.

Direct labor. The direct labor price standard is the rate per hour that should be incurred for direct labor. This standard should be based on current wage rates adjusted for expected cost of living adjustments and employer payroll taxes and fringe benefits. The direct labor quantity standard is the time that should be required to make one unit of product. In setting this standard, allowances should be made for rest periods, cleanup, and machine setup and downtime.

Manufacturing overhead. For this standard, a standard predetermined overhead rate is used. This rate is determined by dividing budgeted overhead costs by an expected standard activity index. The budgeted overhead costs should be based on a realistic estimate of overhead costs at normal capacity.

BYP 23-7

ETHICS CASE

(a) Bill and his fellow painters in the painting department will benefit from Bill’s slow action. The company and its customers are harmed. The company will incur higher costs on the product and therefore will have to set a higher selling price or suffer a smaller gross profit. Customers will have to pay a greater price for the product or stockholders will obtain less benefit from their investment. (b) Deliberately falsifying and distorting the time study was unethical. If every employee in every phase of producing this new product distorted the time study, the company would not be competitive. If the company is not competitive and profitable, it will eventually go out of business and Bill will be out of a job. It is in Bill’s best interest to support the development of reasonable standards and improved efficiency. (c) The company might conduct several time study tests using different employees. Or the company might conduct unannounced time studies. And the standard might be changed more often than every six months by conducting monthly time studies to effect continuous improvements in efficiency. Incentives might be offered to employees who produce the most efficient effort in the time studies, thereby discouraging distorted, inefficient performance.

BYP 23-8

ALL ABOUT YOU

(a) The panel made recommendations regarding a number of areas of concern in higher education. For example, it suggested that new approaches should be used to control costs, and it stated that the cost of tuition should grow no faster than median family income. It made recommendations to strengthen the Pell Grant program, which is the core of the federal financial aid program. It also recommended that public universities should use standardized tests to measure student learning. (b) As discussed in the chapter, standards provide a mechanism for evaluating performance and, if used properly, can be used as a motivational tool. The results of standardized tests might help to evaluate the effectiveness of various approaches to education. They might also be used to “weed out” schools that are not meeting minimum expectations. (c) Potential disadvantages of standards are that they might reduce the willingness of instructors or institutions to experiment with new teaching approaches. In addition, in order to obtain high scores, instructors might feel compelled to “teach to the exam,” thus narrowing the breadth of exposure obtained by the student. Also, by their very nature, standardized tests have a difficult time addressing differences across various instructional settings that can cause differences in results. (d) Answers will vary depending on student response.

BYP 23-9

CONSIDERING YOUR COSTS AND BENEFITS

Discussion Guide: The practice of medicine holds an unusual place in society. On the one hand, it provides a critical, life-sustaining service. We expect and demand the highest-quality service. We measure its success in terms of health improvement and lives saved. On the other hand, it is a business, and like other businesses, it must operate profitably. Some healthcare providers characterize this delicate balance as “The Business of Caring.” How should we balance providing quality health-care and reducing costs? In recent years, managerial accounting has played an important, although not always successful, role in this issue. In the 1990s, health-care providers made extensive use of managerial accounting techniques to reduce costs. By the end of that decade, a number of important studies suggested that the quality of health care had suffered as a result of concentrating too much on cost-controlling efforts and not enough on maintaining quality. Today, many health-care organizations are implementing balanced scorecards in an effort to balance the dual (and in some ways competing) goals of quality health-care and reduced costs. For example, by providing incentives for preventive medicine, health-care providers can reduce costs and at the same time improve patient health. It is likely that, in order to provide health-care to more Americans, we will have to reduce costs. It is hoped that successful implementation of balanced scorecard programs will result in reduced costs through increased efficiency, while increasing the quality of health-care.

CHAPTER 24 Planning for Capital Investments ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Brief Exercises

Questions

Do It!

Exercises

A Problems

Describe capital budgeting inputs and apply the cash payback technique.

1, 2, 3

1, 2, 6, 9, 10, 11

1A, 2A

Use the net present value method.

4, 5, 6, 7

2, 3, 4, 5

1, 2, 3, 4 10, 11

1A, 2A, 3A, 4A, 5A

Identify capital budgeting challenges and refinements.

8, 9, 10, 11

4, 5, 6

3A , 4A, 5A

Use the internal rate of return method.

12, 13, 16

7, 8

5, 6, 7

3A, 5A

Use the annual rate of return method.

3, 14, 15

8, 9, 10, 11

1A, 2A

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Compute annual rate of return, cash payback, and net present value.

Moderate

30–40

Compute annual rate of return, cash payback, and net present value.

Complex

30–40

Compute net present value, profitability index, and internal rate of return.

Moderate

20–30

Compute net present value considering intangible benefits.

Moderate

20–30

Compute net present value and internal rate of return with sensitivity analysis.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

The screening of proposed capital expenditures may be done by a capital budgeting committee which submits its findings to the officers of the company. The officers, in turn, select the projects they believe to be the most worthy of funding and submit them to the board of directors. The directors ultimately approve the capital expenditure budget for the year.

The cash payback technique is relatively easy to compute and understand. However, it should not ordinarily be the only basis for the capital budgeting decision because it ignores the expected profitability of the investment and the time value of money.

Tom is not correct. The formula for the cash payback technique is: Cost of the capital investment ÷ Net annual cash flow. The formula for the annual rate of return is: Expected annual net income ÷ average investment.

The two tables are: (1) The present value of a single future amount (Table 3 in Appendix A). This table is used when a project has uneven cash payments over its useful life and to compute the present value of the salvage value of the project. (2) The present value of an annuity (Table 4 in Appendix A). This table is used when a project has equal cash payments occurring at equal intervals of time over its useful life.

The decision rule is: Accept the project when net present value is zero or positive; reject the project when net present value is negative.

The discount rate has two elements, a cost of capital element and a risk element. Many times companies set the risk element equal to zero; thus, they are setting the discount rate equal to the cost of capital. However, if a project is considered to be riskier than the firm’s other projects, the discount rate should include a risk element.

The following simplifying assumptions were made:  All cash flows come at the end of the year.  All cash flows are immediately reinvested in another project that has a similar return.  All cash flows can be predicted with certainty.

Examples of intangible benefits of investment projects would be increased product quality, improved safety, and enhanced employee loyalty. Intangible benefits often complicate the capital budgeting process because their value can be difficult to quantify. Ignoring intangible benefits may result in rejecting projects that would be financially beneficial to the company.

Two approaches can be taken. Under the first approach, management should ask whether the value of the intangible benefits exceeds the amount by which the net present value of the project is negative. If so, the project should be accepted. Under the second approach, management should make conservative dollar estimates of the value of the intangible benefits and the net present value should be recalculated.

Questions Chapter 24 (Continued) 10.

When trying to choose between competing proposals, simply comparing the net present value of the competing proposals ignores the fact that one proposal may require a considerably larger investment. The profitability index is useful because it incorporates the required initial investment into the evaluation.

11.

A post-audit is a thorough evaluation of how well a project’s actual performance matches the original projections. Performing post-audits can be valuable because: (1) managers are more likely to submit reasonable and accurate data if they know that their estimates will be evaluated subsequently, (2) they provide a process for determining whether projects should be continued, and (3) they improve the development of future investment proposals because, by evaluating their past successes and failures, managers improve their estimation techniques.

12.

When the net annual cash flows are equal each year, the steps are: (1) Compute the internal rate of return factor by dividing Capital Investment by Net Annual Cash Flows. (2) Use the factor and the present value of an annuity of 1 table to find the internal rate of return.

13.

Under the internal rate of return method, the objective is to find the rate that will make the present value of the expected net annual cash flows equal the present value of the proposed capital expenditure. The decision rule under the internal rate of return method is: Accept the project when the internal rate of return is equal to or greater than the required rate of return, and reject the project when the internal rate of return is less than the required rate.

14.

The advantages of this method are the simplicity of its calculation and management’s familiarity with the accounting terms used in the computation. A limitation is that it does not consider the time value of money. Also, by employing accrual accounting numbers rather than cash flows, it ignores the fact that the value of an investment proposal is based on the cash flows that it generates.

15.

The formula for the annual rate of return technique is: Expected annual net income ÷ Average investment.

16.

Cost of capital is the average rate of return that the company must pay to obtain borrowed and equity funds. The decision rule is: Accept the project when the internal rate of return is equal to or greater than the required rate of return (which often is its cost of capital). Reject the project when the internal rate of return is less than the required rate of return.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 24-1 $450,000 ÷ $60,000 = 7.5 years BRIEF EXERCISE 24-2 Net annual cash flows – $40,000 X 5.65 Less: Capital investment Net present value

Present Value $226,000 215,000 $ 11,000

The investment should be made because the net present value is positive.

BRIEF EXERCISE 24-3

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $25,000 X 3.79079 = $ 94,770 60,000 X .62092 = 37,255 132,025 136,000 $ (3,975)

Since the net present value is negative, the project is unacceptable. BRIEF EXERCISE 24-4

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $34,000 X 5.53482 = $188,184 0X .50187 = 0 188,184 200,000 $ (11,816)

The reduction in downtime would have to have a present value of at least $11,816 in order for the project to be acceptable.

BRIEF EXERCISE 24-5 Project A

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $70,000 X 6.41766 = $449,236 = 0 0 X .42241 449,236 400,000 $ 49,236

Profitability index = $449,236/$400,000 = 1.12 Project B

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $55,000 X 6.41766 = $352,971 0 X .42241 = 0 352,971 310,000 $ 42,971

Profitability index = $352,971/$310,000 = 1.14 Project B has a lower net present value than Project A, but because of its lower capital investment, it has a higher profitability index. Based on its profitability index, Project B should be accepted. BRIEF EXERCISE 24-6 Original estimate

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $46,000 X 5.75902 = $264,915 0 X .42410 = 0 264,915 250,000 $ 14,915

BRIEF EXERCISE 24-6 (Continued) Revised estimate

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value $39,000 X 6.49506 = $253,307 0X .35049 = 0 253,307 260,000 $ (6,693)

The original net present value was projected to be a positive $14,915; however, the revised estimate is a negative $6,693. The project is not a success.

BRIEF EXERCISE 24-7 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $176,000/$35,000 = 5.02857 By tracing across on the 7-year row we see that the discount factor for 9% is 5.03295. Thus, the internal rate of return on this project is approximately 9%. BRIEF EXERCISE 24-8 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. Since this exercise has a salvage value, not all cash flows are equal. In this case, the internal rate of return can be approximated by identifying the discount rate that will result in a net present value of zero. By experimenting with various rates, we determined that the net present value is approximately zero when a discount rate of approximately 9% is used.

BRIEF EXERCISE 24-8 (Continued) Net annual cash flows = $400,000 – $150,000 = $250,000

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $250,000 X 7.16073 = $1,790,183 716,000 X .35554 = 254,567 2,044,750 2,045,000 $ (250)

The 9% internal rate of return exceeds the company’s 7% required rate of return; thus, the project should be accepted.

BRIEF EXERCISE 24-9 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $130,000 – $70,000 = $60,000 Its average investment is: $490,000 + $10,000 = $250,000 2 Therefore, its annual rate of return is: $60,000/$250,000 = 24%

SOLUTIONS FOR DO IT! REVIEW EXERCISES

DO IT! 24-1 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow.................................................

$80,000 40,000 $40,000

Cash payback period = $140,000/$40,000 = 3.5 years. DO IT! 24-2 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow.................................................

Present value of net annual cash flows Less: Capital investment Net present value a Table 4, Appendix A.

$80,000 40,000 $40,000

Cash Flow

12% Discount Factor

Present Value

$40,000

3.03735a

$121,494 120,000 $ 1,494

Since the net present value is positive, the project should be accepted DO IT! 24-3

Present value of net annual cash flows Less: Initial investment Net present value Profitability index *$52,580  $39,500

Solar $52,580 $39,500 $13,080 1.33*

Wind $128,450 $105,300 $ 23,150 1.22**

**$128,450  $105,300

While the investment in wind power generates the higher net present value, it also requires a substantially higher initial investment. The profitability index is higher for solar, which suggests that the additional net present value of wind is outweighed by the cost of the initial investment. The company should choose solar.

DO IT! 24-4 Estimated annual cash inflows ................................ Estimated annual cash outflows .............................. Net annual cash flow.................................................

$80,000 40,000 $40,000

$120,000/$40,000 = 3.00. Using Table 4 of Appendix A and the factors that correspond with the four-period row, 3.00 is between the factors for 12% and 15%. Since the project has an internal rate that is more than 12%, the company’s required rate of return, the project should be accepted. DO IT! 24-5 Revenues .................................................................... Less: Expenses (excluding depreciation) .................... Depreciation ($120,000/4 years) .......................... Annual net income .....................................................

$80,000 $41,000 30,000

71,000 $ 9,000

Average investment = ($120,000 + 0)/2 = $60,000. Annual rate of return = $9,000/$60,000 = 15%. Since the annual rate of return, 15%, is greater than Wayne’s required rate of return, 12%, the proposed project is acceptable.

SOLUTIONS TO EXERCISES EXERCISE 24-1 (a) The cash payback period is: $56,000 ÷ $8,000 = 7 years The net present value is:

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

8% Cash Discount Present Flows X Factor = Value $ 8,000 X 5.74664 = $45,973 27,000 X .54027 = 14,587 60,560 56,000 $ 4,560

(b) In order to meet the cash payback criteria, the project would have to have a cash payback period of less than 4 years (8 ÷ 2). It does not meet this criteria. The net present value is positive, however, suggesting the project should be accepted. The reason for the difference is that the project’s high estimated salvage value increases the present value of the project. The net present value is a better indicator of the project’s worth. EXERCISE 24-2 (a) Year 1 2 3

AA Net Annual Cash Flow $ 7,000 9,000 12,000

Cash payback period 2.50 years $22,000 – $16,000 = $6,000 $6,000 ÷ $12,000 = .50

Cumulative Net Cash Flow $ 7,000 16,000 28,000

EXERCISE 24-2 (Continued) BB 22,000 ÷ 10,000 = 2.2 years

Year 1 2 3

CC Net Annual Cash Flow $13,000 12,000 11,000

Cumulative Net Cash Flow $13,000 25,000 36,000

Cash payback period 1.75 years $22,000 – 13,000 = $9,000 $9,000 ÷ $12,000 = .75 The most desirable project is CC because it has the shortest payback period. The least desirable project is AA because it has the longest payback period. As indicated, only CC is acceptable because its cash payback is 1.75 years. (b) Year

Discount Factor

AA Cash Present Flow Value

1 .89286 $ 7,000 2 .79719 9,000 3 .71178 12,000 Total present value Less: Investment Net present value

$ 6,250 7,175 8,541 21,966 (22,000) $ (34)

BB Cash Present Flow Value $10,000 10,000 10,000

CC Cash Flow

Present Value

$ 8,929 $13,000 7,972 12,000 7,118 11,000 24,019(1) (22,000) $ 2,019

$11,607 9,566 7,830 29,003 (22,000) $ 7,003

(1) This total may also be obtained from Table 4: $10,000 X 2.40183 = $24,018. (The difference of $1 is due to rounding)

Project CC is still the most desirable project. Also, on the basis of net present values, project BB is also acceptable. Project AA is not desirable.

EXERCISE 24-3 Investment in new equipment ............. Disposal of old equipment................... Additional training required................. Net initial investment required ............

$2,450,000 (250,000) 85,000 $2,285,000

Calculation of net present value:

Cash flows

Maintenance Net cash flows from operations: Terminal salvage Present value of cash inflows Less: Initial investment Net present value

Year 1 2 3 4 5 6 7

Discount Factor, 9% 0.91743 0.84168 0.77218 0.70843 0.64993 0.59627 0.54703

Amount $ 390,000 400,000 411,000 426,000 434,000 435,000 436,000

Present Value $ 357,798 336,672 317,366 301,791 282,070 259,377 238,505

0.64993

(100,000)

(64,993)

400,000

2,028,586 218,812

0.54703

2,247,398 2,285,000 $ (37,602)

Based on the net present calculation alone, the sewing machine should not be purchased. However, the internal rate of return would be only slightly lower than the 9% minimum required, so the company may want to look at some of the non-quantitative factors involved.

EXERCISE 24-4 Machine A

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value $15,000 X 5.53482 = $83,022 0 X .50187 = 0 83,022 75,500 $ 7,522

Profitability index = $83,022/$75,500 = 1.10 Machine B Cash Flows X Present value of net annual cash flows Present value of salvage value

$30,000 X 0X

Less: Capital investment Net present value

9% Discount Factor 5.53482 .50187

Present Value

= $166,045 = 0 166,045 180,000 $ (13,955)

Profitability index = $166,045/$180,000 = .92 Machine B has a negative net present value, and also a lower profitability index. Machine B should be rejected and Machine A should be purchased.

EXERCISE 24-5 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $430,000/$101,000 = 4.25743 By tracing across on the 6-year row, we see that the discount factor for 11% is 4.23054. Thus, the internal rate of return on this project is approximately 11%. Since this is above the company’s required rate of return, the project should be accepted.

EXERCISE 24-6 (a)

Total net investment = $29,300 + $1,500 – $2,000 = $28,800 Annual net cash flow = $7,000 Payback period = $28,800 ÷ $7,000 = 4.1 years

(b)

Net present value approximates zero when discount rate is 12%. Item Net annual cash flows Less: Capital investment Net present value

(c)

Amount $7,000

Years 1–6

PV Factor 4.11141

Present Value $28,780 28,800 $ (20)

Because the approximate internal rate of return of 12% exceeds the required rate of return of 10%, the investment should be accepted.

EXERCISE 24-7 (a)

Project

Capital Investment ÷

Net Annual Cash Flows*

Internal Rate of Return = Factor

22A 23A 24A

$240,000 $270,000 $280,000

($15,500 + $40,000) ($20,600 + $30,000) ($15,700 + $40,000)

= = =

÷ ÷ ÷

4.324 5.336 5.027

Closest Discount Factor

Internal Rate of Return

4.35526 5.32825 5.03295

10% 12% 9%

*(Annual income + Depreciation expense) (b) The acceptable projects are 22A and 23A because their rates of return are equal to or greater than the 10% required rate of return.

EXERCISE 24-8 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $70,000 – $41,500 = $28,500 Its average investment is: $300,000 + $80,000 = $190,000 2 Therefore, its annual rate of return is: $28,500 ÷ $190,000 = 15% EXERCISE 24-9 (a) Cost of hoist: $32,400 + $3,300 + $700 = $36,400. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $16) Total net annual cash flows (a) X (b) Cash payback period = $36,400 ÷ $5,200 = 7 years. (b) Average investment: ($36,400 + $3,000) ÷ 2 = $19,700. Annual depreciation: ($36,400 – $3,000) ÷ 8 = $4,175. Annual net income: $5,200 – $4,175 = $1,025. Annual rate of return = $1,025 ÷ $19,700 = 5.2% (rounded).

(a) 260 (b) X $20 $5,200

EXERCISE 24-10 (a) 1. 2. (b)

Cash payback period: $190,000 ÷ $50,000 = 3.8 years. Annual rate of return: $12,000 ÷ [($190,000 + $0) ÷ 2] = 12.63%.

Item Net annual cash flows Less: Capital investment Net present value

Amount $ 50,000

Years 1–5

PV Factor 3.60478

Present Value $180,239 190,000 $ (9,761)

EXERCISE 24-11 (a) Year 1 2 3

Net Annual Cash Flow $45,000 40,000 35,000

Cumulative Net Cash Flow $ 45,000 85,000 120,000

Cash payback period 2.57 years (2 + [($105,000 – $85,000) ÷ $35,000]) (b) Average annual net income = ($10,000 + $12,000 + $14,000 + $16,000 + $18,000) ÷ 5 = $14,000 Average investment = ($105,000 + $0) ÷ 2 = $52,500 Annual rate of return = $14,000 ÷ $52,500 = 26.67% (c) Net cash flows

Year 1 2 3 4 5

Present value of cash in flows Less: Initial investment Net present value

Discount Factor, 11% 0.90090 0.81162 0.73119 0.65873 0.59345

Amount $45,000 40,000 35,000 30,000 25,000

Present Value $ 40,541 32,465 25,592 19,762 14,836 133,196 105,000 $ 28,196

SOLUTIONS TO PROBLEMS PROBLEM 24-1A

(a) Project Bono $160,000 ÷ ($14,000 + $32,000) = 3.48 years

Year 1 2 3 4 5

Project Edge Cash Flow $53,000 ($18,000 + $35,000) $52,000 ($17,000 + $35,000) $51,000 ($16,000 + $35,000) $47,000 ($12,000 + $35,000) $44,000 ($ 9,000 + $35,000)

Cumulative Cash Flow $ 53,000 $105,000 $156,000 $203,000 $247,000

Cash payback period 3.40 years $175,000 – $156,000 = $19,000 $19,000 ÷ $47,000 = .40

Year 1 2 3 4 5

Project Clayton Cash Flow $67,000 ($27,000 + $40,000) $63,000 ($23,000 + $40,000) $61,000 ($21,000 + $40,000) $53,000 ($13,000 + $40,000) $52,000 ($12,000 + $40,000)

Cash payback period 3.17 years $200,000 – $191,000 = $9,000 $9,000 ÷ $53,000 = .17

Cumulative Cash Flow $ 67,000 $130,000 $191,000 $244,000 $296,000

PROBLEM 24-1A (Continued) (b)

Project Bono Item Net annual cash flows Less: Capital investment Negative net present value Discount Factor .86957 .75614 .65752 .57175 .49718

Year 1 2 3 4 5 Total Less: Capital investment Positive (negative) net present value

Amount $46,000

Years 1–5

PV Factor 3.35216

Present Value $154,199 160,000 $ (5,801)

Project Edge Cash Flow PV $ 53,000 $ 46,087 52,000 39,319 51,000 33,534 47,000 26,872 44,000 21,876 $237,000 167,688

Project Clayton Cash Flow PV $ 67,000 $ 58,261 63,000 47,637 61,000 40,109 53,000 30,303 25,853 52,000 202,163 $296,000

175,000

200,000 $

$ (7,312)

2,163

(c) Project Bono = $14,000 ÷ [($160,000 + $0) ÷ 2] = 17.5%. Project Edge = $14,400 ÷ [($175,000 + $0) ÷ 2] = 16.5%. Project Clayton = $19,200 ÷ [($200,000 + $0) ÷ 2] = 19.2%. (d) Project Bono Edge Clayton

Cash Payback 3 2 1

The best project is Clayton.

Net Present Value 2 3 1

Annual Rate of Return 2 3 1

PROBLEM 24-2A

(a)

Sales Expenses Drivers’ salaries Out-of-pocket expenses Depreciation Total expenses Net income Cash inflow

(1) Annual Net Income

(2) Annual Cash Inflow

$108,000*

$108,000

48,000 30,000 25,000 103,000 $ 5,000

48,000 30,000 0 78,000 $ 30,000

*5 vans X 10 trips X 6 students X 30 weeks X $12.00 = $108,000. (b) 1.

Cash payback period = $75,000 ÷ $30,000 = 2.50 years.

Annual rate of return = $5,000 ÷ ($75,000 + 0) = 13.33%. 2

(c) Present value of annual cash inflows ($30,000 X 2.28323*) = $68,497 Less: Capital investment = 75,000 Net present value $ (6,503) *3 years at 15%, PV of annuity of 1. (d) The computations show that the commuter service is not a wise investment for these reasons: (1) annual net income will only be $5,000, (2) the annual rate of return (13.33%) is less than the cost of capital (15%), (3) the cash payback period is 83% (2.5 ÷ 3) of the useful life of the vans, and (4) net present value is negative.

PROBLEM 24-3A (a) (1) Option A Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value

Cash 8% Discount Flows X Factor a $41,000 X 5.20637 (50,000) X .73503 0 X .58349

Less: Capital investment Net present value

Present = Value = $213,461 = (36,752) = 0 $176,709 160,000 $ 16,709

aNet annual cash flows = $71,000 – $30,000 = $41,000

(2) Profitability index = $176,709/$160,000 = 1.10 (3) The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately zero. This is accomplished with a 11% discount rate.

Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Less: Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value a $41,000 X 4.71220 = $193,200 (50,000) X .65873 = (32,937) 0 X .48166 = 0 $160,263 160,000 $ 263

aNet annual cash flows = $71,000 – $30,000 = $41,000

(1) Option B Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value

Cash 8% Discount Flows X Factor b $49,000 X 5.20637 0 X .73503 8,000 X .58349

Less: Capital investment Net present value bNet annual cash flows = $80,000 – $31,000 = $49,000

(2) Profitability index = $259,780/$227,000 = 1.14

Present = Value = $255,112 = 0 = 4,668 $259,780 227,000 $ 32,780

PROBLEM 24-3A (Continued) (3) Internal rate of return on Option B is 12%, as calculated below:

Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Less: Capital investment Net present value

Cash 12% Discount Present Flows X Factor = Value $49,000b X 4.56376 = $223,624 0 X .63552 = 0 8,000 X .45235 = 3,619 $227,243 227,000 $ 243

bNet annual cash flows = $80,000 – $31,000 = $49,000

(b) Option A has a lower net present value than Option B, and also a lower profitability index and internal rate of return. Therefore, Option B is the preferred project.

PROBLEM 24-4A

(a) The net present value based on the original estimates is as follows:

Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value

Cash 9% Discount Flows X Factor = $ 8,000 X 5.53482 = (6,000) X .70843 = 12,000 X .50187 =

Less: Capital investment Net present value

Present Value $ 44,279 (4,251) 6,022 $ 46,050 60,000 $(13,950)

Based on its negative net present value, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows:

Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value

Cash Flows $13,500* (6,000) 12,000

Less: Capital investment Net present value

X X X X

9% Discount Present Factor = Value 5.53482 = $74,720 .70843 = (4,251) .50187 = 6,022 $76,491 60,000 $16,491

*$8,000 + ($3,000 + $750 + $1,000 + $750) Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c) The present value of the intangible benefits was $30,441 (the increase in the net present value from a negative $13,950 to a positive $16,491). Rick’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $13,950. That is the amount by which the original estimate fell short of having a positive net present value.

PROBLEM 24-5A

(a) Using the original estimates, the net present value is calculated as follows: Cash 8% Discount Present Flows X Factor = Value a Present value of net annual cash flows $ 80,000 X 9.81815 = $ 785,452 Present value of salvage value 1,500,000 X .21455 = 321,825 1,107,277 Less: Capital investment ($300,000 + $600,000) 900,000 Net present value $ 207,277 aNet annual cash flows = $920,000 – $840,000

The positive net present value of the project suggests that it should be accepted. (b) Using the revised estimates, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 8% Discount Present Flows X Factor = Value $ 55,000b X 9.81815 = $ 539,998 1,500,000 X .21455 = 321,825 $ 861,823 900,000 $ (38,177)

bNet annual cash flows = $805,000 – $750,000

Under these revised estimates, the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of players declines, cash inflows decline, but cash outflows don’t decline proportionately.

PROBLEM 24-5A (Continued) (c) Using the original estimates, but an 10% discount rate, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 10% Discount Present Flows X Factor = Value c $ 80,000 X 8.51356 = $ 681,085 1,500,000 X .14864 = 222,960 $ 904,045 900,000 $ 4,045

cNet annual cash flows = $920,000 – $840,000

The positive net present value of the project suggests that it should be accepted; however, it is not nearly as profitable using an 10% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately zero. In this case the internal rate of return was approximately 12%.

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 12% Discount Present Flows X Factor = Value $ 40,000 X 3.60478 = $144,191 1,332,000 X .56743 = 755,817 $900,008 900,000 $ 8

The project had a high internal rate of return, even though the business itself was not generating much cash flows, because the property increased significantly in value during the 5-year period.

CD24

CURRENT DESIGNS

(a) Average investment = ($256,000 + 0) ÷ 2 = $128,000 Annual rate of return = $15,200 ÷ $128,000 = 11.88% (b) Net annual cash flow = $15,200 + $32,000 = $47,200 Payback period = $256,000 ÷ $47,200 = 5.42 years (c) Event Net annual cash flow Less: Oven purchase Net present value

Time Period 1-8 0

Cash Flows $ 47,200 256,000

9% Discount Factor 5.53482 1.00000

Present Value $ 261,244 256,000 $ 5,244

Time Period 1-8 0

Cash 15% Discount Present Flows Factor Value $ 47,200 4.48732 $ 211,802 256,000 1.00000 256,000 $ (44,198)

Accept the proposal (d) Event Net annual cash flow Less: Oven purchase Net present value

Do not accept the proposal

BYP 24-1

DECISION-MAKING ACROSS THE ORGANIZATION

Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Depreciation Loss on disposal of machine Total costs and expenses Net income (1) (2) (3) (4) (5) (6)

Purchase New Machine $5,000,000 (1) $3,500,000 704,000 448,000 130,000 40,000

(2) (3) (4) (5) (6) 4,822,000 $ 178,000

10,000 X $100 X 4 years = $4,000,000 X 125% = $5,000,000 $5,000,000 X (100% – 30%) = $3,500,000 $160,000 X 110% X 4 years = $704,000 $112,000 X 4 years = $448,000 $122,000 + $3,000 + $5,000 = $130,000 Assuming old machine has zero scrap value

(a) Annual rate of return = 68.5%; ($178,000 ÷ 4) ÷ [($130,000 + $0) ÷ 2] (b) Cash payback period = 1.49 yrs.; $130,000 ÷ [($178,000 + $130,000 + $40,000) ÷ 4] (c) Net present value = Net annual cash flows Less: Capital investment Net present value

Amount $ 87,000* $130,000

Factor 2.85498 1.00000

Present Value $248,383 130,000 $118,383

*($178,000 + $130,000 + $40,000) ÷ 4 (d) The new machine should be purchased. The analysis shows that net income will be $178,000 over the four years with the new machine, which results in a 68.5% annual rate of return. The cash payback period of 1.49 years meets management’s minimum requirement of three years. In addition, net present value is $118,383 positive, which indicates that the investment meets the required minimum rate of return of 15%.

BYP 24-2

MANAGERIAL ANALYSIS

(a) Using the original estimates, the present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value a $ 460,000 X 7.19087 = $3,307,800 2,000,000 X .20900 = 418,000 3,725,800 4,000,000 $ (274,200)

aNet annual cash flows = $4,000,000 – $3,540,000

The negative net present value of the project suggests that it should be rejected. (b) Using the revised estimates, the net present value is calculated as follows: Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 11% Discount Present Flows X Factor = Value b $ 720,000 X 7.19087 = $5,177,426 2,000,000 X .20900 = 418,000 5,595,426 4,000,000 $1,595,426

bNet annual cash flows = $4,200,000 – $3,480,000

Under these revised estimates, the project should be accepted.

BYP 24-2 (Continued) (c) Using the original estimates, but a 9% discount rate, the net present value is calculated as follows:

Present value of net annual cash flows Present value of salvage value Less: Capital investment Net present value

Cash 9% Discount Present Flows X Factor = Value c $ 460,000 X 8.06069 = $3,707,917 2,000,000 X .27454 = 549,080 $4,256,997 4,000,000 $ 256,997

Net annual cash flows = $4,000,000 – $3,540,000

Using the original estimates, but the lower discount rate, the net present value is positive, suggesting the project should be accepted. (d) If Bob is correct in either his belief that the estimated net annual cash flows are too conservative, or that the discount rate being used is too high, then the project is acceptable. At a minimum, this analysis suggests that further investigation is warranted.

BYP 24-3

REAL-WORLD FOCUS

This disclosure, provided by the company’s management in its annual report, suggests that the scroll compressor project has not achieved the goals originally hoped for. In deciding whether to continue with this project, management should undertake a post-audit. This would involve collecting data on results obtained thus far and comparing those results with original projections. Those people responsible for the original projections should then be asked to provide explanations for differences between the results and projections. Careful consideration of the nature of these differences and their implications for future performance should provide valuable information regarding the decision to continue or terminate the project.

BYP 24-4

REAL-WORLD FOCUS

Answers to this problem will vary depending on the year chosen by the student. The following solution is provided for the year ended July 28, 2013. (a) The statement of cash flows indicates that capital expenditures (purchase of plant assets) were $336 million in 2013, an increase of $13 million from the prior year. (b) The statement of cash flows indicates $1,250 million of long-term borrowings were made in 2013. Note 13 indicates that interest rates on existing long-term borrowing ranged from 2.50% to 8.88% during the year. (c) The internal rate of return on these capital expenditures is approximately 8%, computed as follows: $336 million ÷ $50 million = 6.72 Note that the factor for n = 10, i = 8% is 6.71008 (Table A-4, n = 10, i = 8%), so the IRR is estimated to be 8%.

BYP 24-5

To: From: Subject:

COMMUNICATION ACTIVITY

Maria Fierro, Supervisor , Assistant Chief Accountant Recommendation for New Hoist

The quantitative analysis pertaining to this management decision is as follows: Cost of hoist: $32,400 + $3,300 + $700 = $36,400. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $16) Total net annual cash flows (a) X (b) Cash payback period = $36,400 ÷ $5,200 = 7 years.

(a) 260 (b) X $20 $5,200

Average investment: ($36,400 + $3,000) ÷ 2 = $19,700. Annual depreciation: ($36,400 – $3,000) ÷ 8 = $4,175. Annual net income: $5,200 – $4,175 = $1,025. Annual rate of return = $1,025 ÷ $19,700 = 5.2% (rounded). These data indicate that the cash payback period is 88% of the new asset’s useful life. This would generally be considered fairly high, indicating a less desirable project. The data also show a 5.2% annual rate of return. This is a low return and it is below what management would consider an acceptable return. The quantitative data do not include any technique that considers the time value of money. However, I believe there is a strong probability that the discounted cash flow technique would show a negative net present value for the new hoist. I believe that the information I have presented would indicate that, based on the current data, the investment should not be made.

BYP 24-6

ETHICS CASE

(a) The stakeholders are:     

Yourself. Your spouse and children. Employees of NuComp Company. Citizens of the town where the company is presently located. The stockholders of NuComp Company.

(b) The ethical issue is:  An employee’s personal interests and those of his co-workers and the town versus the best interests of the company and its stockholders. (c) The student should recognize a conflict of interest. The company should hire an outside consultant to study and evaluate such a move rather than place one of its employees in this dilemma. You should rise above the conflict of interest and perform an objective economic evaluation, but also be prepared to remind management, should they be so oblivious, of the consequences to the employees and the town. Knowingly preparing a biased or false report is unethical.

BYP 24-7

ALL ABOUT YOU

Results will vary depending on article selected by the student. Some common signals identified in articles are: bills more than two months in arrears; must make decisions about who to pay; you have a debt judgment filed against you; spending exceeds income; all credit cards are at their maximum.

BYP 24-8

CONSIDERING YOUR COSTS AND BENEFITS

(a) The total cost of the installed solar panels was $80,000. The “out-ofpocket” cost to the couple was $27,200. (b) Using the total annual electricity bill of $5,000 mentioned in the story, the cash payback of the project using the total costs of $80,000 is 16 years ($80,000 ÷ $5,000). The cash payback based on the “out-of-pocket” cost of $27,200 is 5.4 years ($27,200 ÷ $5,000). (c) The net present value of the project using the total cost is: Cash X 6% Discount = Flows Factor Present value of net annual cash flows Less: Capital investment Net present value

$5,000 X

11.46992

Present Value

= $ 57,350 80,000 $(22,650)

The net present value of the project using the out-of-pocket cost is:

Present value of net annual cash flows Less: Capital investment Net present value

Cash X 6% Discount = Flows Factor

Present Value

$5,000 X

$57,350 27,200 $30,150

11.46992

(d) The wholesale price of panels per watt at the time the article was written was $1.70 per watt. The price per watt the article says that subsidies no longer would be needed is $1.00. One solar panel provider said that it would be providing panels that cost $1.00 per watt within three years of the time the article was written.

APPENDIX G Time Value of Money SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE G-1 (a) Interest = p X i X n I = $6,000 X .05 X 12 years I = $3,600 Accumulated amount = $6,000 + $3,600 = $9,600 (b) Future value factor for 12 periods at 5% is 1.79586 (from Table 1) Accumulated amount = $6,000 X 1.79586 = $10,775.16 LO 1 BT: AP Difficulty: Easy TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-2 (1) Case A Case B

5% 6%

3 periods 8 periods

(2) Case A Case B

3% 4%

8 periods 12 periods

LO 1 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE G-3 FV = p X FV of 1 factor = $9,600 X 1.60103 = $15,369.89 LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-4 FV of an annuity of 1 = p X FV of an annuity factor = $78,000 X 13.18079 = $1,028,101.62 LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-5 FV = (p X FV of 1 factor) + (p X FV of an annuity factor) = ($8,000 X 2.40662) + ($1,000 X 28.13238) = $19,252.96 + $28,132.38 = $47,385.34 ((p X FV of 1 factor) + (p X FV of an annuity factor)) LO 1 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-6 FV = p X FV of 1 factor = $35,000 X 1.46933 = $51,426.55 LO 1 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-7 FV of an annuity = p X FV of an annuity factor $20,000 = p X 9.89747 p = $20,000 ÷ 9.89747 p = $2,020.72 (FV of an annuity = Annuity X FV of an annuity factor) LO 1 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-8 (a) (1) 12% 8% 5%

(b) 7 periods 11 periods 16 periods

(2) 10% 10% 3%

20 periods 7 periods 10 periods

LO 2 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting

BRIEF EXERCISE G-9 (a)

i = 10% ?

$25,000

Discount rate from Table 3 is .42410 (9 periods at 10%). Present value of $25,000 to be received in 9 years discounted at 10% is therefore $10,602.50 ($25,000 X .42410). (PV of an amount = Amount X PV of 1 factor)

(b)

i = 9% ?

$25,000 $25,000 $25,000 $25,000 $25,000 $25,000

Discount rate from Table 4 is 4.48592 (6 periods at 9%). Present value of 6 payments of $25,000 each discounted at 9% is therefore $112,148.00 ($25,000 X 4.48592). (PV of an annuity = Annuity X PV of an annuity factor) LO 2 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-10 i = 8% ?

$900,000

Discount rate from Table 3 is .63017 (6 periods at 8%). Present value of $900,000 to be received in 6 years discounted at 8% is therefore $567,153 ($900,000 X .63017). Messi Company should therefore invest $567,153 to have $900,000 in six years. (PV of an amount = Amount X PV of 1 factor) LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-11 i = 6% ?

$450,000

Discount rate from Table 3 is .62741 (8 periods at 6%). Present value of $450,000 to be received in 8 years discounted at 6% is therefore $282,334.50 ($450,000 X .62741). Lloyd Company should invest $282,334.50 to have $450,000 in eight years. (PV of an amount = Amount X PV of 1 factor) LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-12 i = 8% ?

$40,000 $40,000 $40,000 $40,000

$40,000 $40,000

Discount rate from Table 4 is 8.55948. Present value of 15 payments of $40,000 each discounted at 8% is therefore $342,379.20 ($40,000 X 8.55948). Robben Company should pay $342,379.20 for this annuity contract. (PV of an annuity = Annuity X PV of an annuity factor) LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-13 i = 5% ?

$80,000

Discount rate from Table 4 is 5.07569. Present value of 6 payments of $80,000 each discounted at 5% is therefore $406,055.20 ($80,000 X 5.07569). Kaehler Enterprises invested $406,055.20 to earn $80,000 per year for six years. (PV of an annuity = Annuuity X PV of an annuity factor) LO 2 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-14 i = 5% ?

$400,000

Diagram for Principal

i = 5% ?

$22,000 $22,000 $22,000 $22,000

$22,000 $22,000

Diagram for Interest

Present value of principal to be received at maturity: $400,000 X 0.37689 (PV of $1 due in 20 periods at 5% from Table 3) .............................................................. Present value of interest to be received periodically over the term of the bonds: $22,000* X 12.46221 (PV of $1 due each period for 20 periods at 5% from Table 4) ........................................................................ Present value of bonds ...............................................................

$150,756

274,169** $424,925**

*$400,000 X .055 **Rounded. (PV of bond = (Face value of bond X PV of 1 factor) + (Annual interest X PV of an annuity factor)) LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-15 The bonds will sell at a discount (for less than $400,000). This may be proven as follows: Present value of principal to be received at maturity: $400,000 X .31180 (PV of $1 due in 20 periods at 6% from Table 3).............................................................. Present value of interest to be received periodically over the term of the bonds: $22,000 X 11.46992 (PV of $1 due each period for 20 periods at 6% from Table 4) ........................................................................ Present value of bonds ...............................................................

$124,720

252,338* $377,058*

*Rounded.

(PV of bond = (Face value of bond X PV of 1 factor) + (Annual interest X PV of an annuity factor) LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-16 i = 6% ?

$75,000

Diagram for Principal

i = 6% ?

$3,000

Diagram for Interest

Present value of principal to be received at maturity: $75,000 X .70496 (PV of $1 due in 6 periods at 6% from Table 3) ............................................................. Present value of interest to be received annually over the term of the note: $3,000* X 4.91732 (PV of $1 due each period for 6 periods at 6% from Table 4) ................................................................. Present value of note received ..................................................

$52,872.00

14,751.96 $67,623.96

*$75,000 X .04 (PV of note = (PV of principal X PV of 1 factor ) + (Annual interest X PV of an annuity factor)) LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

BRIEF EXERCISE G-17 i = 4% ?

$2,500,000

Diagram for Principal

i = 4% ?

$75,000 $75,000 $75,000 $75,000

$75,000 $75,000 $75,000

Diagram for Interest

Present value of principal to be received at maturity: $2,500,000 X 0.53391 (PV of $1 due in 16 periods at 4% from Table 3) .................................................................$1,334,775 Present value of interest to be received periodically over the term of the bonds: $75,000* X 11.65230 (PV of $1 due each period for 16 periods at 4% from Table 4) .......................................................................... 873,923** Present value of bonds and cash proceeds ................................ $2,208,698** *($2,500,000 X .06 X 1/2)

**Rounded

(PV of bond = (Face value of bond X PV of 1 factor) + (Annual interest X PV of an annuity factor)) LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-18 i = 5% ?

$48,850

Discount rate from Table 4 is 7.72173. Present value of 10 payments of $48,850 each discounted at 5% is therefore $377,206.51 ($48,850 X 7.72173). Frazier Company should receive $377,206.51 from the issuance of the note. (PV of proceeds = Annual payment × PV of an annuity factor) LO 2 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-19 i=? $4,765.50

$12,000

Present value = Future value X Present value of 1 factor $4,765.50 = $12,000 X Present value of 1 factor Present value of 1 factor = $4,765.50 ÷ $12,000 = .39713 The .39713 for 12 periods approximates the value found in the 8% column (.39711) in Table 3. Colleen Mooney will receive a 8% return.

(PV of 1 factor = Present amount ÷ Future amount) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-20 i = 11% $36,125

$75,000

n=? Present value = Future value X Present value of 1 factor $36,125 = $75,000 X Present value of 1 factor Present value of 1 factor = $36,125 ÷ $75,000 = .48166 The .48166 at 11% is found in the 7 years row in Table 3. Tim Howard therefore must wait 7 years to receive $75,000. (PV of 1 factor = Present amount ÷ Future amount) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-21 i=? ?

$1,200 $1,200 $1,200 $1,200 $1,200 $1,200

$1,200 $1,200

$10,271.38

Present value = Future amount X Present value of an annuity factor $10,271.38 = $1,200 X Present value of an annuity factor Present value of an annuity factor = $10,271.38 ÷ $1,200 = 8.55948

The 8.55948 for 15 periods is found in the 8% column in Table 4. Joanne Quick will therefore earn a rate of return of 8%. (PV of an annuity factor = Present amount ÷ Annuity) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-22 i = 9% $1,300 $1,300 $1,300 $1,300 $1,300 $1,300

$7,793.83 n=? Present value = Future amount X Present value of an annuity factor $7,793.83 = $1,300 X Present value of an annuity factor Present value of an annuity factor = $7,793.83 ÷ $1,300 = 5.99525

The 5.99525 at an interest rate of 9% is shown in the 9-year row in Table 4. Therefore, Kevin will receive 9 payments. (PV of an annuity factor = Present amount ÷ Annuity) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-23 i = 11%

PV of an annuity = p X Present value of an annuity factor $2,650.15 = p X 5.88923 p = $2,650.15 ÷ 5.88923 p = $450 (Annuity = PV of an annuity ÷ PV of an annuity factor) LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-24 10*

–18,000

50,000

I/YR.

PMT

10.76% *2027 – 2017 LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-25 10

42,000

–6,500

I/YR.

PMT

8.85% LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-26 40

178,000*

–8,400

I/YR.

PMT

3.55% (semiannual) *$198,000 – $20,000 LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-27 (a) Inputs:

7.35

16,000

PMT

–85,186.34

Answer: (b) Inputs:

Answer:

*200 X $1,000

10.65

16,000**

200,000*

PMT

–168,323.64

**$200,000 X .08

LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

BRIEF EXERCISE G-28 (a) Note—set payments at 12 per year. Inputs: 96 7.8

42,000

PMT

–589.48

Answer: (b) Note—set payments to 1 per year. Inputs: 5 7.25

8,000

PMT

Answer:

–1,964.20

LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Reporting

APPENDIX H Reporting and Analyzing Investments Learning Objectives 1. Explain how to account for debt investments. 2. Explain how to account for stock investments. 3. Discuss how debt and stock investments are reported in the financial statements.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item

Item

Questions 1.

13.

17.

10.

14.

18.

11.

15.

12.

16.

2, 3

Brief Exercises 1.

Exercises 1.

2. 1, 2, 3 AN

Problems 1.

2, 3,

2, 3

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

PH-1

Journalize debt investment transactions.

Moderate

30–40

PH-2

Journalize investment transactions, prepare adjusting entry, and show financial statement presentation.

Moderate

30–40

PH-3

Journalize transactions, prepare adjusting entry for stock investments, and show balance sheet presentation.

Moderate

30–40

PH-4

Prepare entries under cost and equity methods, and prepare memorandum.

Simple

20–30

PH-5

Journalize stock transactions, and show balance sheet presentation.

Moderate

40–50

PH-6

Prepare a balance sheet.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

Companies invest because (1) they have excess cash for a short period of time, or (2) they want to generate investment income or (3) they have strategic reasons such as controlling a competitor or supplier or entering a new industry.

LO 1 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 2.

(a) The cost of an investment in bonds consists of the market price of the bonds plus any brokerage fees. (b)

Interest is recorded as it is earned; that is, over the life of the investment in bonds.

LO 1 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 3.

(a)

Losses and gains on the sale of debt investments are computed by comparing the cost of the securities to the net proceeds from the sale.

(b)

Losses are reported in the income statement under other expenses and losses whereas gains are reported under other revenues and gains.

LO K BT: K Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting 4.

Heliy Company is incorrect. The gain is the difference between the net proceeds, exclusive of interest, and the cost of the bonds. The correct gain is $4,000 [($45,000 – $1,000) – $40,000].

LO 1 BT: AN Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 5.

The cost of an investment in stock includes all expenditures necessary to acquire the investment. These expenditures include the actual purchase price plus any commissions or brokerage fees.

LO 2 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 6.

Brokerage fees are part of the cost of the investment. Therefore, the entry is: Stock Investments........................................................................... Cash ......................................................................................

61,500 61,500

LO 2 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 7.

(a) Whenever the investor’s influence on the operating and financial affairs of the investee is significant, the equity method should be used. The major factor in determining significant influence is the percentage of ownership interest held by the investor in the investee. The general guideline for use of the equity method is 20% or more ownership interest. Companies are required to use judgement, however, rather than blindly follow the 20% guideline. For example, 25% ownership in a company that is 75% controlled by another organization would not indicate significant influence. (b)

Revenue is recognized as it is earned by the investee.

LO 2 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

Since Stetson Corporation uses the equity method, the income reported by Pike Packing ($80,000) should be multiplied by Stetson’s ownership interest (30%) and the result ($24,000) should be debited to Stock Investments and credited to Revenue from Stock Investments. Also, of the total dividend declared and paid by Pike ($10,000) Stetson will receive 30% or $3,000. This amount should be debited to Cash and credited to Stock Investments.

LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting 9.

Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, or material intercompany transactions. An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary.

LO 2 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting 10.

Under the cost method, an investment is originally recorded and reported at cost. Dividends are recorded as revenue. In subsequent periods, it is adjusted to fair value and an unrealized holding gain or loss is recognized and included in income (trading security) or as separate component of stockholders’ equity (available-for-sale security). Under the equity method, the investment is originally recorded and reported at cost; subsequently, the investment account is adjusted during each period for the investor’s share of the earnings or losses of the investee. The investor’s share of the investee's earnings is recognized in the earnings of the investor. Dividends received from the investee are reductions in the carrying amount of the investment. LO 3 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting

11.

Consolidated financial statements present the assets and liabilities controlled by the parent company and the total revenues and expenses of the affiliated companies. Consolidated financial statements are useful to the stockholders, board of directors, and management of the parent company.

LO 2 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 12.

The valuation and reporting of investments is as follows: Category Trading Available-for-sale

Valuation and Reporting At fair value with changes reported in net income At fair value with changes adjusted through equity

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 13.

Pat should report the data as follows: (1) (2)

Under current assets in the balance sheet: Short-term investments, at fair value....................................................... Under other expenses and losses in the income statement: Unrealized Loss—Income .......................................................................

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

$70,000 $(4,000)

14.

Pat should report as follows: (1) (2)

Under investments in the balance sheet: Investments in stock of less than 20% owned companies, at fair value ... Under stockholders’ equity in the balance sheet: Accumulated other comprehensive loss ..................................................

$70,000 $(4,000)

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting 15.

The entry is: Fair Value Adjustment—Available-for-Sale ..................................... Unrealized Gain or Loss—Equity ...........................................

8,000 8,000

LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 16. The entry is: Fair Value Adjustment—Trading ..................................................... Unrealized Gain—Income ......................................................

8,000 8,000

LO 3 BT: AP Difficulty: Easy TOT: 2 min. AACSB: Analytic AICPA FC: Reporting 17.

Accumulated other comprehensive loss is reported in stockholders’ equity. It is not included in the computation of net income.

LO 3 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting 18. The investment in Cyrus Corporation stock is not a short-term investment because there is no intent to convert the stock into cash within a year or the operating cycle, whichever is longer. LO 3 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE H-1 Jan. July

Debt Investments.......................................... Cash .......................................................

40,800

1 Cash .............................................................. Interest Revenue ...................................

1,660

40,800 1,660

LO 1 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-2 Aug. Dec.

Stock Investments ........................................ Cash .......................................................

35,600

1 Cash .............................................................. Stock Investments................................. Gain on Sale of Stock Investments ........................................

38,000

35,600 35,600 2,400

LO 2 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-3 Dec. 31

Stock Investments ........................................ Revenue from Stock Investments (25% X $150,000) ................................

37,500

Cash (25% X $60,000) ................................... Stock Investments.................................

15,000

37,500 15,000

LO 2 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-4 Dec. 31

Unrealized Loss—Income ............................ Fair Value Adjustment—Trading ($62,000 – $59,600) .............................

2,400 2,400

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-5 Balance Sheet Current assets Short-term investments, at fair value ..............................

$59,600

Income Statement Other expenses and losses Unrealized Loss—Income.................................................

2,400

LO 3 BT: AN Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-6 Dec. 31

Unrealized Gain or Loss—Equity .................. Fair Value Adjustment— Available-for-Sale .................................

3,000 3,000

LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-7 Balance Sheet Investments Investments in stock of less than 20% owned companies, at fair value....................................................

$69,000

Stockholders’ Equity Accumulated other comprehensive loss...........................

$(3,000)

LO 3 BT: AN Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement & Reporting

BRIEF EXERCISE H-8 Investments Bond sinking fund............................................................... Investments in stock of less than 20% owned companies, at fair value................................................... Investment in stock of 20–50% owned company, at equity ............................................................................ Total investments.........................................................

$150,000 112,000 230,000 $492,000

LO 3 BT: AP Difficulty: Easy TOT: 4 min. AACSB: Analytic AICPA FC: Measurement & Reporting

SOLUTIONS TO EXERCISES EXERCISE H-1 (a) Jan. July

1 1 1

(b) Dec. 31

Debt Investments .................................... Cash ..................................................

90,000

Cash ($90,000 X 10% X 1/2) .................... Interest Revenue ..............................

4,500

Cash ........................................................ Debt Investments ($90,000 X 30/90) ........................... Gain on Sale of Debt Investments ($32,000 – $30,000)........................

32,000

Interest Receivable ................................. Interest Revenue ($60,000 X 10% X 1/2) ....................

3,000

90,000 4,500

30,000 2,000

3,000

LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-2 (a) Feb. 1 July 1 Sept. 1

Dec. 1

Stock Investments ................................. Cash .................................................

8,400

Cash (1,200 X $2).................................... Dividend Revenue ...........................

2,400

Cash ........................................................ Stock Investments ($8,400 X 500/1,200) ..................... Gain on Sale of Stock Investments ($5,400 – $3,500)...........................

5,400

Cash (700 X $1)....................................... Dividend Revenue ...........................

700

8,400 2,400

3,500 1,900 700

(b) Dividend revenue and the gain on sale of stock investments are reported under other revenues and gains in the income statement. LO 2, 3 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-3 Jan.

July

Dec.

Stock Investments ...................................... Cash ....................................................

59,200

Cash (1,200 X $7) ........................................ Dividend Revenue ...............................

8,400

Cash ........................................................... Stock Investments ($59,200 X 900/1,200) ....................... Gain on Sale of Stock Investments ....

47,200

Cash (300 X $7) ........................................... Dividend Revenue ...............................

2,100

Dec. 31

59,200 8,400

44,400 2,800 2,100

LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-4 (a) Jan.

Dec. 31 Dec. 31

Stock Investments............................... Cash ..............................................

150,000

Cash ($80,000 X 25%).......................... Stock Investments........................

20,000

Stock Investments............................... Revenue from Stock Investments ($380,000 X 25%)..

95,000

(b) Investment in Shane, January 1 ........................... Less: Dividend received ...................................... Plus: Share of reported income ......................... Investment in Shane, December 31 .....................

150,000

20,000

95,000 $150,000 20,000 95,000 $225,000

LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-5 1.

2017 Mar. 18 June 30

Dec. 31

Jan.

June 15

Dec. 31

Stock Investments ................................ Cash (300,000 X 12% X $14) ..........

504,000

Cash ....................................................... Dividend Revenue ($75,000 X 12%) ...........................

9,000

Fair Value Adjustment— Available-for-Sale ............................... Unrealized Gain or Loss—Equity ($576,000 – $504,000)..................

504,000

9,000 72,000 72,000

Stock Investments ................................ Cash (30,000 X 25% X $11) ............

82,500

Cash ....................................................... Stock Investments ($35,000 X 25%) ...........................

8,750

Stock Investments ................................ Revenue from Stock Investments ($120,000 X 25%) ..........................

30,000

82,500

8,750

30,000

LO 2 BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-6 (a) Dec. 31

(b)

Unrealized Loss—Income..................... Fair Value Adjustment—Trading...

4,800 4,800

Balance Sheet Current assets Short-term investments, at fair value .............

$48,800

Income Statement Other expenses and losses Unrealized Loss—Income ...............................

$ 4,800

LO 3 BT: AP Difficulty: Easy TOT: 5 min. AACSB: Analytic AICPA FC: Measurement & Reporting

EXERCISE H-7 (a) Dec. 31

Unrealized Gain or Loss—Equity................... 4,800 Fair Value Adjustment— Available-for-Sale .............................

(b)

4,800

Balance Sheet Investments Investments in stock of less than 20% owned companies, at fair value.....................................

$48,800

Stockholders’ equity Less: Unrealized loss on available-for-sale securities ...................................................

$ 4,800

(c) Dear Ms. Jenks: Investments which are classified as trading (held for sale in the near term) are reported at fair value in the current asset section of the balance sheet, with unrealized gains or losses reported in net income. Investments which are classified as available-for-sale (held longer than trading but not to maturity) are also reported at fair value in either the current assets section or the investment section of the balance sheet, but unrealized gains or losses are reported as an item of other comprehensive income. Fair value is used as a reporting basis because it represents the cash realizable value of the securities. Unrealized gains or losses on trading investments are reported in the income statement because of the likelihood that the securities will be sold at fair value in the near term. Unrealized gains or losses on available-for-sale securities are reported in other comprehensive income rather than in income because there is a significant chance that future changes in fair value will reverse unrealized gains or losses. To avoid distorting income with these fluctuations, they are reported in other comprehensive income. I hope the preceding discussion clears up any misunderstandings. Please contact me if you have any questions. Sincerely, Student LO 3 BT: AN Difficulty: Medium TOT: 15 min. Measurement, Reporting, & Communication

AACSB: Analytic & Communication

AICPA FC:

EXERCISE H-8 (a) Fair Value Adjustment—Trading ($122,000 – $110,000) ....................................... Unrealized Gain—Income............................

12,000

Unrealized Gain or Loss—Equity....................... Fair Value Adjustment— Available-for-Sale...................................... (b)

12,000 4,000 4,000

Balance Sheet Current assets Short-term investments, at fair value ....................... Investments Investments in stock of less than 20% owned companies, at fair value ......................................... Stockholders’ equity Accumulated other comprehensive loss ................. Income Statement Other revenues and gains Unrealized gain—income ..........................................

$122,000 96,000 $(4,000)

$ 12,000

Comprehensive Income Statement Other comprehensive income Unrealized loss on available-for-sale securities ......

(4,000)

LO 3 BT: AN Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Measurement & Reporting

SOLUTIONS TO PROBLEMS PROBLEM H-1

2017 Jan. 1

July

Dec. 31 2020 Jan. 1

July

Dec. 31

Debt Investments .............................. Cash ............................................

600,000

Cash ($600,000 X .07 X 1/2)............... Interest Revenue ........................

21,000

Interest Receivable............................ Interest Revenue ........................

21,000

Cash ................................................... Interest Receivable.....................

21,000

Cash ($300,000 X 1.10) ..................... Debt Investments ....................... Gain on Sale of Debt Investments .............................

330,000

Cash ($300,000 X .07 X 1/2)............... Interest Revenue ........................

10,500

Interest Receivable............................ Interest Revenue ........................

10,500

600,000

21,000 21,000

21,000

300,000 30,000 10,500 10,500

LO 1 BT: AN Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Measurement & Reporting

PROBLEM H-2

(a) Feb. 1

Stock Investments ..................................... Cash ....................................................

51,600

Stock Investments ..................................... Cash ....................................................

18,500

Debt Investments....................................... Cash ....................................................

70,000

Cash ($0.80 X 1,200) .................................. Dividend Revenue...............................

960

Cash (200 X $42) ........................................ Loss on Sale of Stock Investments .......... Stock Investments [($51,600 ÷ 1,200) X 200]..................

8,400 200

Cash ($2 X 500) .......................................... Dividend Revenue...............................

1,000

Cash ($70,000 X 08% X 1/2) ....................... Interest Revenue.................................

2,800

1 Cash .......................................................... Debt Investments................................ Gain on Sale of Debt Investments ($75,700 – $70,000) ..........................

75,700

Mar. 1 Apr. 1 July 1 Aug. 1

Sept.1 Oct. 1

Stock Investments Feb. 1 51,600 Aug. 1 Mar. 1 18,500 Dec. 31 Bal. 61,500

8,600

51,600 18,500 70,000 960

8,600

1,000 2,800

Debt Investments Apr. 1 70,000 Oct. 1 Dec. 31 Bal. 0

70,000 5,700

70,000

PROBLEM H-2 (Continued) (b) Dec. 31

Unrealized Loss—Income ................. Fair Value Adjustment—Trading

Security LAF common NCL common

Cost $43,000* 18,500 $61,500

7,500 7,500

Fair Value $39,000 (1,000 X $39) 15,000 (500 X $30) $54,000

*$51,600 – $8,600 (c) Current assets Short-term investments, at fair value .......................

$54,000

(d) Other revenues and gains: Dividend Revenue, Interest Revenue, and Gain on Sale of Debt Investments. Other expenses and losses: Loss on Sale of Stock Investments, and Unrealized Loss—Income. LO 1, 2, 3 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement & Reporting

PROBLEM H-3

(a) 2017 July 1

Aug. 1 Sept. 1

Oct.

Nov. 1

Dec. 15 31

Cash (5,000 X $2.00)............................... Dividend Revenue..............................

10,000

Cash (1,000 X $0.50)............................... Dividend Revenue..............................

500

Cash (1,000 X $9).................................... Stock Investments (1,000 X $7.20).... Gain on Sale of Stock Investments ...................................

9,000

Cash (300 X $53)..................................... Stock Investments (300 X $48).......... Gain on Sale of Stock Investments [$15,900 – (300 X $48)] ..................

15,900

Cash (1,200 X $1).................................... Dividend Revenue..............................

1,200

Cash (700 X $0.50).................................. Dividend Revenue..............................

350

Cash (4,000 X $2.20)............................... Dividend Revenue..............................

8,800

2017 Jan. 1 Balance 2017 Dec. 31 Balance

Stock Investments 2017 108,000 Sept. 1 Oct. 1 86,400

10,000

500 7,200 1,800 14,400 1,500 1,200

350 8,800

7,200 14,400

PROBLEM H-3 (Continued) (b) Dec. 31

Fair Value Adjustment—Availablefor-Sale ($89,700 – $86,400)............. Unrealized Gain or Loss—Equity ....

Security C Co. common D Co. common E Co. common

Cost $33,600* 28,800** 24,000 $86,400

3,300 3,300

Fair Value $32,900 ( 700 X $47) 28,000 (4,000 X $ 7) 28,800 (1,200 X $24) $89,700

*$48,000 – $14,400 **$36,000 – $7,200 (c) Investments Investments in stock of less than 20% owned companies, at fair value ..............

89,700

Stockholders’ equity Common stock ............................................ $2,000,000 Retained earnings ....................................... 1,200,000 Total paid-in capital and retained earnings............................................. 3,200,000 Accumulated other comprehensive income 3,300 Total stockholders’ equity................... $3,203,300 LO 2, 3 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement & Reporting

PROBLEM H-4

(a) 2017 Jan.

June 30

Dec. 31

(b) 2017 Jan.

June 30 Dec. 31 31

Stock Investments ............................ Cash ............................................

1,800,000

Cash ................................................... Dividend Revenue (60,000 X $0.50) .......................

30,000

Cash ................................................... Dividend Revenue (60,000 X $0.50) .......................

30,000

Stock Investments ............................ Cash ............................................

1,800,000

Cash ................................................... Stock Investments .....................

30,000

Cash ................................................... Stock Investments .....................

30,000

Stock Investments ............................ Revenue from Stock Investments ($800,000 X 30%).......................

240,000

1,800,000

30,000

1,800,000

30,000 30,000

240,000

PROBLEM H-4 (Continued) (c)

MEMO To:

Board of Directors

From:

Student

Re:

Cost and equity methods

Under the cost method of accounting for investments, the investment is recorded at cost and revenue is recognized only when cash dividends are received. Under the equity method, the investment is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee. The investment account is increased for the investor’s share of the investee’s net income. Dividends received are recorded as a reduction of the investment account instead of as dividend revenue. The table below illustrates the differences in account balances for Wellman Company’s investment in Grinwold Inc. at December 31, 2017.

Stock investments Dividend revenue Revenue from stock investments

Cost Method $1,800,000 60,000 0

Equity Method $1,980,000* 0 240,000

*$1,800,000 – $60,000 + $240,000 LO 2 BT: AN Difficulty: High TOT: 30 min. Measurement, Reporting, & Communication

AACSB: Analytic & Communication

AICPA FC:

PROBLEM H-5

(a) Jan. 20

Cash (1,400 X $55).................................. Investment in Batone Inc. Common Stock............................. Gain on Sale of Stock Investments .................................. Investment in P. Wahl Corporation Common Stock.................................... Cash (400 X $78) .............................

77,000 73,500 3,500 31,200 31,200

Cash ........................................................ Dividend Revenue ($1.25 X 1,200) ...............................

1,500

8 Cash ........................................................ Dividend Revenue ($0.40 X 800).....

320

18 Cash ($35 X 800)..................................... Loss on Sale of Stock Investments ...... Investment in P. Tillman Corporation Preferred Stock ............................

28,000 5,600

July 30 Cash ........................................................ Dividend Revenue ($1.10 X 1,200) ..............................

1,320

Feb.

Sept.

Dec.

6 Investment in P. Wahl Corporation Common Stock.................................... Cash ($82 X 600) ............................. 1 Cash ........................................................ Dividend Revenue ($1.50 X 1,000) ...............................

1,500

320

33,600

1,320 49,200 49,200 1,500 1,500

PROBLEM H-5 (Continued) (b) Investment in Batone Inc. Common Stock 1/1 Bal. 73,500 1/20 73,500 12/31 Bal. 0

Investment in Mendez Corporation Common Stock 1/1 Bal. 84,000 12/31 Bal. 84,000

Investment in P. Tillman Corporation Preferred Stock 1/1 Bal. 33,600 2/18 33,600 12/31 Bal. 0

Investment in P. Wahl Corporation Common Stock 1/28 31,200 9/6 49,200 12/31 Bal. 80,400

Unrealized Gain or Loss—Equity ........... Fair Value Adjustment—Availablefor-Sale ($164,400 – $155,000) ......

Security Mendez Corporation common P. Wahl Corporation common

Cost $ 84,000 80,400 $164,400

9,400 9,400

Fair Value $ 78,000 (1,200 X $65) 77,000 (1,000 X $77) $155,000

(d) Investments Investments in stock of less than 20% owned companies, at fair value..........................................

$155,000

Stockholders’ equity Total paid-in capital and retained earnings Accumulated other comprehensive loss.... Total stockholders’ equity..................................

XXXXX (9,400) $ XXXXX

LO 2, 3 BT: AN Difficulty: Hard TOT: 50 min. AACSB: Analytic AICPA FC: Measurement & Reporting

PROBLEM H-6

MANFREID CORPORATION Balance Sheet December 31, 2017 Current assets Cash ......................................................................... $ 63,000 Short-term investments, at fair value .................... 128,000 Accounts receivable ............................................... $ 90,000 Less: Allowance for doubtful accounts................ 6,000 84,000 Inventory.................................................................. 170,000 Prepaid insurance ................................................... 16,000 Total current assets ......................................... 461,000 Investments Debt investments ...................................................... 400,000 Stock Investments (Horton Inc. stock, 30% ownership, at equity) ......... 240,000 Total investments ............................................ Property, plant, and equipment Land .......................................................... Buildings .................................................. $900,000 Less: Accumulated depreciation— buildings ....................................... 180,000 Equipment ................................................ 275,000 Less: Accumulated depreciation— equipment ..................................... 52,000 Total property, plant, and equipment..................................... Intangibles Goodwill .................................................................... Total assets ....................................................................

640,000

410,000 720,000 223,000 1,353,000 190,000 $2,644,000

PROBLEM H-6 (Continued) MANFREID CORPORATION Balance Sheet (Continued) December 31, 2017 Liabilities and Stockholders’ Equity Current liabilities Notes payable ...................................................... Accounts payable................................................ Dividends payable............................................... Income taxes payable ......................................... Total current liabilities ................................. Long-term liabilities Bonds payable, 10% due 2028............................ Less: Discount on bonds payable .................... Total long-term liabilities............................. Total liabilities ............................................................ Stockholders’ equity Paid-in capital Common stock, $5 par value, 500,000 shares authorized, 240,000 shares issued and outstanding ............................ Paid-in capital in excess of par value ......... Total paid-in capital .............................. Retained earnings ............................................... Total stockholders’ equity.................... Total liabilities and stockholders’ equity...........

70,000 150,000 50,000 70,000 $ 340,000 350,000 20,000 330,000 670,000

$1,200,000 464,000 1,664,000 310,000 1,974,000 $2,644,000

LO 3 BT: AP Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement & Reporting

APPENDIX I Payroll Accounting ASSIGNMENT CLASSIFICATION TABLE Learning Objectives

Questions

1. Record the payroll for a pay period.

1, 2, 3, 5, 6, 7, 8

2. Record employer payroll taxes. 3. Discuss the objectives of internal control for payroll.

Brief Exercises

Exercises

Problems

1, 2

1, 2, 3, 4

1, 2, 3

2, 3, 4, 8

3, 5

1, 2, 3

9, 10

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

I-1

Prepare payroll register and payroll entries.

Simple

30–40

I-2

Journalize payroll transactions and adjusting entries.

Moderate

30–40

I-3

Prepare entries for payroll and payroll taxes; prepare W-2 data.

Moderate

30–40

ANSWERS TO QUESTIONS 1.

Gross pay is the amount an employee actually earns. Net pay, the amount an employee is paid, is gross pay reduced by both mandatory and voluntary deductions, such as FICA taxes, union dues, federal income taxes, etc. Gross pay should be recorded as wages or salaries expense.

Both employees and employers are required to pay FICA taxes.

No. When an employer withholds federal or state income taxes from employee paychecks, the employer is merely acting as a collection agent for the taxing body. Since the employer holds employees’ funds, these withholdings are a liability for the employer until they are remitted to the government.

FICA stands for Federal Insurance Contribution Act; FUTA stands for Federal Unemployment Tax Act; and SUTA stands for State Unemployment Tax Act.

A W-4 statement shows the employee’s name, address, social security number, marital status and the number of allowances claimed for income tax withholding purposes. A W-2 statement contains the employee’s name, address, social security number, wages, tips, other compensation, social security taxes withheld, wages subject to social security taxes, and federal, state and local income taxes withheld.

Payroll deductions can be classified as either mandatory (required by law) or voluntary (not required by law). Mandatory deductions include FICA taxes and income taxes. Examples of voluntary deductions are health and life insurance premiums, pension contributions, union dues, and charitable contributions.

The employee earnings record is used in: (1) determining when an employee has earned the maximum earnings subject to FICA taxes, (2) filing state and federal tax returns, and (3) providing each employee with a statement of gross earnings and tax withholdings for the year.

(a) The three types of taxes are: (1) FICA, (2) federal unemployment, and (3) state unemployment. (b) The tax liability accounts are classified as current liabilities in the balance sheet. Payroll tax expense is classified under operating expenses in the income statement.

The main internal control objectives associated with payrolls are: (1) to safeguard company assets from unauthorized payments of payrolls and (2) to assure the accuracy and reliability of the accounting records pertaining to payrolls.

10.

The four functions associated with payroll are: (1) hiring employees, (2) timekeeping, (3) preparing the payroll, and (4) paying the payroll.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE I-1 Gross earnings: Regular pay (40 X $16)........................................... Overtime pay (5 X $24) .......................................... Gross earnings .............................................................. Less: FICA taxes payable ($760 X 7.65%)................... Federal income taxes payable........................... Net pay ...........................................................................

$640.00 120.00

$760.00 $760.00

$ 58.14 95.00

153.14 $606.86

BRIEF EXERCISE I-2 Jan. 15

Jan. 15

Salaries and Wages Expense ...................... FICA Taxes Payable ($760 X 7.65%) .... Federal Income Taxes Payable ............ Salaries and Wages Payable ................

760.00

Salaries and Wages Payable........................ Cash .......................................................

606.86

58.14 95.00 606.86 606.86

BRIEF EXERCISE I-3 Jan. 31

Payroll Tax Expense..................................... FICA Taxes Payable ($80,000 X 7.65%) Federal Unemployment Taxes Payable ($80,000 X .8%).................... State Unemployment Taxes Payable ($80,000 X 5.4%) ................................

11,080

BRIEF EXERCISE I-4 (a) Timekeeping (b) Hiring

6,120 640 4,320

SOLUTIONS TO EXERCISES EXERCISE I-1 (a) 1. Regular 40 X $16.00 = $640.00 Overtime 2 X $24.00 = 48.00 Gross earnings $688.00 2.

FICA taxes—$52.63 = ($688 X 7.65%).

Federal income taxes $30.

State income taxes $13.76 = ($688 X 2%).

Net pay $566.61 = ($688.00 – $52.63 – $33.00 – $13.76 – $25.00).

(b) Salaries and Wages Expense ................................... FICA Taxes Payable ........................................... Federal Income Taxes Payable ......................... State Income Taxes Payable ............................. Health Insurance Payable.................................. Salaries and Wages Payable .............................

688.00 52.63 30.00 13.76 25.00 566.61

EXERCISE I-2 J. Seligman

$4,500 X 7.65% = $344.25 Seligman’s total gross earnings for the year are $98,000 ($93,500 + $4,500), which is below the $117,000 maximum for FICA taxes.

R. Eby

($3,400 X 6.2%) + ($4,500 X 1.45%) = $276.05. Eby’s total gross earnings for the year are $113,600. Thus, only $3,400 of the gross earnings for this pay period are subject to Social Security taxes. In addition, $4,500 is subject to Medicare (1.45%) taxes.

L. Marshall

($1,900 X 6.2%) + ($4,500 X 1.45%) = $183.05. Marshall’s total gross earnings for the year are $115,100. Thus, only $1,900 of the gross earnings for this pay period are subject to Social Security taxes. In addition, $4,500 is subject to Medicare taxes.

EXERCISE I-2 (Continued) T. Olson

($4,500 X 1.45%) = $65.25 Olson’s gross earnings prior to this pay period exceed the maximum amount subject to Social Security taxes. However, all of the gross earnings in the December 31 pay period are subject to Medicare taxes.

EXERCISE I-3 (a) See next page. (b) Jan. 31

Salaries and Wages Expense............... FICA Taxes Payable ...................... Federal Income Taxes Payable..... Health Insurance Payable ............. Salaries and Wages Payable ........

1,880.00 143.82 129.00 60.00 1,547.18

EXERCISE I-3 (Continued) (b) Jan. 31

Payroll Tax Expense ................................ FICA Taxes Payable ......................... Federal Unemployment Taxes Payable ($1,880 X .8%) ................. State Unemployment Taxes Payable ($1,880 X 5.4%) ...............

260.38 143.82 15.04 101.52

EXERCISE I-4 (a) (1) (2) (3) (4) (5)

$900 [$10,000 see (2) below – $9,100]. $10,000 (FICA taxes $765 ÷ 7.65%). $400 ($10,000 X 4%). $2,405 ($10,000 – $7,595). $10,000

(b) Feb. 28

Salaries and Wages Expense ............ FICA Taxes Payable .................... Federal Income Taxes Payable .................................... State Income Taxes Payable ...... Union Dues Payable.................... Salaries and Wages Payable ......

10,000

Salaries and Wages Payable.............. Cash .............................................

7,595

765 1,140 400 100 7,595 7,595

EXERCISE I-5 (a) FICA tax ($770,000 X 6.2%) + ($850,000 X 1.45%) ... SUTA tax ($100,000 X 5.4%) ..................................... FUTA tax ($100,000 X 0.8%) ..................................... Total payroll tax................................................. (b) Payroll Tax Expense ................................................. FICA Taxes Payable .......................................... State Unemployment Taxes Payable ............... Federal Unemployment Taxes Payable ...........

$60,065 5,400 800 $66,265 66,265 60,065 5,400 800

PROBLEM I-1A (Continued) (b) Mar. 15

(d) Mar. 31

Salaries and Wages Expense............. 2,523.00 FICA Taxes Payable .................... Federal Income Taxes Payable..................................... State Income Taxes Payable....... United Fund Contributions Payable Salaries and Wages Payable ...... Payroll Tax Expense ........................... FICA Taxes Payable ($2,523 X 7.65%) ...................... Federal Unemployment Taxes Payable ($2,523 X .8%) ............ State Unemployment Taxes Payable ($2,523 X 5.4%) ..........

349.42

Salaries and Wages Payable .............. Cash .............................................

2,039.31

FICA Taxes Payable ($193.00 + $193.00).......................... Federal Income Taxes Payable .......... Cash .............................................

193.00 192.00 75.69 23.00 2,039.31

193.00 20.18 136.24

2,039.31

386.00 192.00 578.00

PROBLEM I-2A

(a)

Jan. 10 12

15 17 20

Union Dues Payable ...................... Cash ........................................

870.00

FICA Taxes Payable....................... Federal Income Taxes Payable ..... Cash ........................................

760.00 1,204.60

U.S. Savings Bonds Payable......... Cash ........................................

360.00

State Income Taxes Payable ......... Cash ........................................

108.95

Federal Unemployment Taxes Payable ....................................... State Unemployment Taxes Payable ....................................... Cash ........................................

870.00

1,964.60 360.00 108.95 288.95 1,954.40 2,243.35

Salaries and Wages Expense........ FICA Taxes Payable ............... Federal Income Taxes Payable ............................... State Income Taxes Payable ............................... Union Dues Payable............... United Fund Payable.............. Salaries and Wages Payable .

58,000.00

Salaries and Wages Payable......... Cash ........................................

48,663.00

4,437.00 2,158.00 454.00 400.00 1,888.00 48,663.00

48,663.00

PROBLEM I-2A (Continued) (b) Jan. 31

Payroll Tax Expense ........................... FICA Taxes Payable ($58,000* X 7.65%) ................. Federal Unemployment Taxes Payable ($58,000 X .8%) ........ State Unemployment Taxes Payable ($58,000 X 5.4%) ......

8,033.00

Vacation Benefits Expense ................ Vacation Benefits Payable ........

3,480.00

4,437.00 464.00 3,132.00

3,480.00

PROBLEM I-3A

(a) Salaries and Wages Expense ............................... FICA Taxes Payable ....................................... Federal Income Taxes Payable ..................... State Income Taxes Payable ......................... United Fund Payable...................................... Health Insurance Payable.............................. Salaries and Wages Payable .........................

570,000 38,645* 174,400 17,100 27,500 17,200 295,155

($490,000 X 6.2%) + ($570,000 X 1.45%) (b) Payroll Tax Expense .............................................. FICA Taxes Payable ....................................... Federal Unemployment Taxes Payable ($135,000 X .8%) ......................................... State Unemployment Taxes Payable ($135,000 X 2.5%) ....................................... (c) Employee Maria Sandoval Jennifer Mingenback (1) $59,000 X 3%. (2) $26,000 X 3%.

Federal Income Wages, Tips, Other Tax Compensation Withheld $59,000 26,000

$28,500 10,200

43,100 38,645 1,080 3,375

State Income Tax Withheld

FICA FICA Tax Wages Withheld

$1,770 (1) 780 (2)

$59,000 26,000

$4,514 1,989

APPENDIX J Subsidiary Ledgers and Special Journals ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Questions

Brief Exercises

Problems

Describe the nature and purpose of a subsidiary ledger.

1, 2, 5, 7,12

1, 2

1, 2, 3, 4, 5, 9, 11, 12, 13

1, 2, 3, 4, 5, 6

Record transactions in special journals.

3, 4, 6, 7, 8, 9, 10, 11, 13

3, 4, 5, 6, 7

1, 3, 4, 5, 6, 7, 8, 9, 10, 12, 13, 14

1, 2, 3, 4, 5, 6

Exercises

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Journalize transactions in cash receipts journal; post to control account and subsidiary ledger.

Simple

30–40

Journalize transactions in cash payments journal; post to control account and subsidiary ledgers.

Simple

30–40

Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers.

Moderate

40–50

Journalize transactions in special journals.

Moderate

50–60

Journalize in sales and cash receipts journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance.

Moderate

60–70

Journalize in special journals; post; prepare a trial balance.

Complex

60–70

ANSWERS TO QUESTIONS 1.

A subsidiary ledger is a group of accounts with a common characteristic. The accounts are assembled together to facilitate the accounting process by freeing the general ledger from details concerning individual balances. The advantages of using subsidiary ledgers are that they:

⯈ Permit transactions affecting a single customer or single creditor to be shown in a single account, thus providing necessary up-to-date information on specific account balances.

⯈ Free the general ledger of excessive details relating to accounts receivable and accounts payable. As a result, a trial balance of the general ledger does not contain potentially thousands and thousands of individual account balances. ⯈ Assist in locating errors in individual accounts by reducing the number of accounts in one ledger and by using control accounts. ⯈ Permit a division of labor in posting by having one employee post to the general ledger and (a) different employee(s) post to the subsidiary ledgers. 2.

(a) (1) Transactions to individual accounts are generally posted daily to the subsidiary ledger. (2) In contrast, postings to the control accounts are usually made in total at the end of the month. (b) A control account is a general ledger account that summarizes subsidiary ledger data. Subsidiary ledger accounts keep track of specific account activity (i.e., specific debtors or creditors). A subsidiary ledger is an addition to, and an expansion of, the general ledger.

Sales journal. Records entries for all sales of merchandise on account. Cash receipts journal. Records entries for all cash received by the business. Purchases journal. Records entries for all purchases of merchandise on account. Cash payments journal. Records entries for all cash paid. Some advantages of each journal are given below:

⯈

⯈ ⯈

Sales journal. (1) Since the sales journal employs only one line to record a Sales transaction, its use reduces recording time; (2) the column totals are only posted to the general ledger once an accounting period; and (3) the journal’s use separates responsibilities between employees. Cash receipts journal. (1) Its use aids in the posting process since the totals for Cash, Sales Discounts, Accounts Receivable, and Sales Revenue are all recorded in the general ledger only at the end of the month; and (2) it allows all accounts receivable credits to be posted to the appropriate subsidiary ledger accounts daily. Purchases journal. The advantages are similar to those of the sales journal except that items involved are Inventory debits and Accounts Payable credits. Cash payments journal. Similar advantages to cash receipts journal except the columns involved are different.

In general, special journals: (1) allow greater division of labor because various individuals can record entries in different journals at the same time; and (2) reduce posting time of journals. 4.

The entry for the sales return should be recorded in the general journal. Since Burguet Company has a single-column sales journal, only credit sales can be recorded there. A purchase by Burguet Company has not taken place, so the use of the purchases journal is inappropriate. Finally, no cash is received or paid, so neither the cash receipts or cash payments journal should be used.

Questions Appendix J(Continued) 5.

At the end of the month, after all postings to both the general ledger and the subsidiary accounts have been made, the total of the subsidiary account balances should equal the balance of the control account in the general ledger. In this case, the control account balance will be $450 larger than the total of the subsidiary accounts.

The purpose of special journals is to facilitate the recording process of the business entity. Therefore, the columns included in any special journal should correspond to the unique needs of the entity. In particular, one type of business which might not require an Accounts Receivable column would be grocery stores. These businesses rarely sell on credit to their customers. The minimum frequency of the transaction implies no need for an Accounts Receivable column in the cash receipts journal.

(a) No, the customers’ ledger will not agree with the Accounts Receivable control account. The customers’ ledger will be posted correctly, but the Accounts Receivable control account will be incorrect. (b) The trial balance will balance, although Cash will be $4,000 too high and Accounts Receivable $4,000 too low.

The special journal is the sales journal. The other account is Sales Revenue. (The cash receipts journal is an incorrect answer because there would be more than two month-end postings to general ledger accounts.)

(a) General journal. (b) General journal. (c) Cash receipts journal.

(d) Sales journal. (e) Cash receipts journal. (f) General journal.

10.

(a) Cash receipts journal. (b) Cash receipts journal. (c) General journal.

(d) Purchases journal. (e) General journal. (f) Cash payments journal.

11.

Typically included would be credit purchases of equipment, office supplies, and store supplies. However, any other item purchased on credit could also be included in a special column or the “other” column.

12.

One such example is a purchase return. Here the Accounts Payable control and subsidiary account must be debited for the same amount. The debit/ credit equality is unaffected since the balance sheet equation is computed using general ledger (control) accounts only. The subsidiary accounts should prove to the control account balance.

13.

The general journal may be used to record such transactions as the granting of credit to a customer for a sales return or allowance, the receipt of credit from a supplier for purchases returned, acceptance of a note receivable from a customer, or the purchase of a plant asset by issuing a note payable. In addition, all correcting, adjusting, and closing entries should be made in the general journal.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE J-1 Accounts Receivable Subsidiary Ledger

General Ledger

Adcock Co. Ref. Debit Credit 10,000 7,000

Accounts Receivable Ref. Debit Credit 26,000 22,000

Date Jan. 7 17

Balance Date 10,000 Jan. 31 3,000 31

Cruz Co. Date Jan. 15 24

Date Jan. 23 29

Ref.

Debit 7,000

Credit 6,000

Balance 7,000 1,000

Morissy Co. Ref. Debit Credit 9,000 9,000

Balance 9,000 0

BRIEF EXERCISE J-2 (a). General ledger (b). Subsidiary ledger

(c). General ledger (d). Subsidiary ledger

BRIEF EXERCISE J-3 (a). Cash Receipts Journal (b). Cash Payments Journal (c). Cash Payments Journal

(d). Sales Journal (e). Purchases Journal (f). Cash Receipts Journal

BRIEF EXERCISE J-4 (a). No (b). Yes

(c). Yes (d). No

Balance 26,000 4,000

BRIEF EXERCISE J-5 (a). General Journal (if a one-column Purchases Journal) Purchases Journal (if a multi-column Purchases Journal) (b). Purchases Journal (c). Cash Payments Journal (d). Sales Journal BRIEF EXERCISE J-6 (a). Cash Receipts Journal (b). Cash Receipts Journal (c). Cash Receipts Journal (d). Sales Journal and Cash Receipts Journal (e). Purchases Journal BRIEF EXERCISE J-7 (a). Both in total and daily (b). In total

(c). In total (d). Only daily

SOLUTIONS TO EXERCISES EXERCISE J-1 (a) $344,400. Beginning balance of $314,000 plus $161,400 debit from sales journal less $131,000 credit from cash receipts journal. (b) $83,600. Beginning balance of $77,000 plus $54,100 credit from purchases journal less $47,500 debit from cash payments journal. (c) The column total of $161,400 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger. (d) The accounts receivable column total of $131,000 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger. EXERCISE J-2 To:

Erica Grier, Chief Financial Officer

From:

Student

Subject:

Martha Nott account

The explanation of the three entries in the subsidiary ledger for the Martha Nott account is as follows: Sept. 2

This was a credit sale of merchandise to Nott. The entry was recorded on page 31 of the Sales Journal.

Sept. 9

This was a sales return or allowance granted to Nott. The entry was recorded on page 4 of the General Journal.

Sept. 27

This was a payment by Nott of the balance due. The entry was recorded on page 8 of the Cash Receipts Journal.

If I can be of further help, please let me know.

EXERCISE J-3 (a) & (b)

General Ledger

Accounts Receivable Date Sept. 1

Explanation Balance

Ref. � S CR G

Debit

Credit

4,650 7,030 185

Balance 10,960 15,610 8,580 8,395

Accounts Receivable Subsidiary Ledger Baez Date Sept. 1

Dey Date Sept. 1

Guy Date Sept. 1

Explanation Balance

Explanation

Ref. � S CR

Debit

Ref. � S CR G

Debit

Ref.

Debit

S CR

1,330

Ref. � CR

Debit

Credit

1,260 1,310

Credit

800 2,300 185

Credit

380

Balance 2,060 3,320 2,010

Balance 4,820 5,620 3,320 3,135

Balance 0 1,330 950

Milo Date Sept. 1

Explanation Balance

Credit 1,800

Balance 2,640 840

EXERCISE J-3 (Continued) Zeyen Date Sept. 1

Explanation Balance

(c)

Ref. � S CR

Debit

Credit

1,260 1,240

Balance 1,440 2,700 1,460

STARK COMPANY Schedule of Customers As of September 30, 2017 Baez ......................................................................................... Dey ......................................................................................... Guy ......................................................................................... Milo ......................................................................................... Zeyen ........................................................................................ Total ..................................................................................

$2,010 3,135 950 840 1,460 $8,395

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

$8,395

EXERCISE J-4 (a) $3,700 [$10,200 – ($4,000 + $2,500)]. (b) (c)

(d)

$12,000 [$10,200 + ($9,000 + $7,000 + $8,300) – ($8,000 + $2,500 + $9,000) – $3,000]. Connor ($4,000 + $9,000 – $8,000) $ 5,000 Uhlig ($2,500 + $7,000 – $2,500 – $3,000) 4,000 Matson ($3,700 + $8,300 – $9,000) 3,000 $12,000 The sales return ($3,000) would be recorded in the general journal.

EXERCISE J-5 (a) $3,375 [$8,250 – ($3,000 + $1,875)]. (b) (c)

(d)

$9,675 [$8,250 + ($6,750 + $5,250 + $6,375) – ($6,000 + $1,900 + $6,750) – $2,300]. Rye ($3,000 + $6,750 – $6,000) $3,750 Keyes ($1,875 + $5,250 – $1,900 – $2,300) 2,925 Colaw ($3,375 + $6,375 – $6,750) 3,000 $9,675 The purchase return ($2,300) would be recorded in the general journal.

EXERCISE J-6 (a) & (b)

Date

NORREN COMPANY Sales Journal Account Debited

Accounts Receivable Dr. Invoice Ref. Sales Revenue Cr. No.

2017 Sept. 2 J. Yancey 21 K. Pricer

101 102

S1 Cost of Goods Sold Dr. Inventory Cr.

780 800 1,580

420 480 900

NORREN COMPANY Purchases Journal Date

Account Credited

2017 Sept. 10 25

H. Heerey G. Jeanik

Terms

Ref.

P1 Inventory Dr. Accounts Payable Cr.

2/10, n/30 n/30

600 835 1,435

EXERCISE J-7 (a) & (b)

Date

MILNER CO. Cash Receipts Journal Account Credited

2017 May 1 Common Stock 2 22 N. Feeney

Ref.

Cash Dr. 48,000 6,340 9,000 63,340

Sales Sales Accounts Revenue Discounts Receivable Cr. Dr. Cr.

CR1 Other Accounts Cr.

Cost of Goods Sold Dr. Inventory Cr.

48,000 6,340 9,000 9,000

6,340

4,200 48,000

4,200

EXERCISE J-7 (Continued) MILNER CO. Cash Payments Journal Ck. No. Account Debited

Date 2015 May 3 101 Inventory 14 102 Salaries and Wages Expense

CP1

Other Accounts Accounts Payable Ref. Dr. Dr. 7,200 700 7,900

Cash Cr. 7,200 700 7,900

EXERCISE J-8 (a) Journal 1. Cash Payments 2. Cash Receipts 3. Cash Payments 4. Cash Payments 5. Cash Receipts 6. Cash Payments 7. Cash Payments 8. Cash Receipts 9. Cash Payments 10. Cash Receipts

(b) Columns in the journal Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales Discounts (Dr.), and Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Inventory (Cr.), and Accounts Payable (Dr.). Cash (Dr.), Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Other Accounts (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales Revenue (Cr.), Cost of Goods Sold (Dr.), and Inventory (Cr.).

EXERCISE J-9 (a) Mar. 2

(b) To:

Equipment..................................................... Accounts Payable—Brantly Company ...........................................

9,400

Accounts Payable—Dumont Company ................................................... Inventory................................................

9,400 410 410

Sales Returns and Allowances.................... Accounts Receivable—Horst Company ...........................................

390

Inventory ....................................................... Cost of Goods Sold ..............................

240

390 240

President Nolasco

From:

Chief Accountant

Subject:

Posting of Control and Subsidiary Accounts

The posting of these accounts varies with the journals used in recording the transactions. Sales and purchases journals—the total for the month is posted to the control accounts. The individual entries are posted daily to the subsidiary accounts. Columnar cash receipts and cash payments journals—the total of the control account column for the month is posted to the control account. The individual amounts in the column are posted daily to the subsidiary accounts. General journal—the individual entries are posted daily. Each entry that pertains to a control and a subsidiary account is dual posted. That is, it is posted to both the control account and the subsidiary account. I hope this memo answers your questions about posting.

EXERCISE J-10 1. 2. 3. 4. 5. 6. 7.

Cash Payments Journal General Journal Cash Receipts Journal Cash Receipts Journal Sales Journal Cash Receipts Journal General Journal

8. 9. 10. 11. 12. 13.

Cash Receipts Journal Cash Payments Journal Cash Payments Journal General Journal Cash Payments Journal Purchases Journal

EXERCISE J-11 (a) The debit posting reference on February 28 should be from the cash payments journal to record the payments made during the month. The general ledger debit amount should be $28,970 to balance. Robillard’s ending balance must be $3,100. (Accounts Payable control balance of $9,800 less Keyser, $4,600, and Stine, $2,100.) (b) Only the general journal amounts were dual posted. Thus, the amounts were $1,400 (Dr.), $195 (Cr.), and $550 (Cr.).

EXERCISE J-12 (a) Purchases Journal Date July 3 12 14 17 20 21 29

Account Credited Carolina Co. Nevada Co. Kentucky Co. Florida Corp. Carolina Co. Nevada Co. Florida Corp.

Ref. � � � � � � �

P1 Inventory Dr. Accounts Payable Cr. 2,400 500 1,300 1,400 700 600 1,600 8,500 120/201

EXERCISE J-12 (Continued) (b) Date July

General Journal Accounts and Explanations Equipment ........................................ Accounts Payable—Alaska Equipment Co......................

Ref. 153

Debit 3,900

201/�

Credit

3,900

Inventory........................................... 120 600 Accounts Payable— 600 Oklahama Inc....................... 201/� (This entry should have been recorded in the Purchases Journal.)

Accounts Payable—Florida Corp. ............................................. Inventory..................................

201/� 120

380

Accounts Payable—Kentucky Co. .. Inventory..................................

201/� 120

200

380 200

EXERCISE J-13 $985 ($280 + $240 + $145 + $190 + $130). All of the debit postings to the subsidiary ledger accounts should be from sales invoices. The total of all these debits should therefore be the total credit sales for the month, which would be the same amount as the end-of-month debit to Accounts Receivable.

EXERCISE J-14 (a) (b) (c) (d) (e)

$19,000 + $72,000 – $46,000 = $45,000 $22,000 + $100,000 – $48,000 = $74,000 $17,000 + $64,000 – $55,000 = $26,000 $13,500 + $72,000 – $1,000 – $63,600 = $20,900 $100,000 + $6,000 = $106,000

SOLUTIONS TO PROBLEMS PROBLEM J-1A

(a) Cash Receipts Journal Account Credited

Date

Apr. 1 Common Stock 4 Afzal 5 Hurt Co. 8 10 Park 11 Inventory 23 Hurt Co. 29 Kolten

Ref.

Cash Dr.

311 � �

7,200 1,764 990 7,845 � 600 120 680 � 1,500 � 1,200 21,779 (101)

(b)

Sales Sales Accounts Revenue Discounts Receivable Cr. Dr. Cr.

CR1 Other Accounts Cr.

Cost of Goods Sold Dr. Inventory Cr.

7,200 36

1,800 990 7,845

4,347

600 680

36 (414)

1,500 1,200 6,090 (112)

7,845 (401)

7,880 (X)

4,347 (505)(120)

General Ledger

Accounts Receivable Date Explanation Apr. 1 Balance 30

Ref. � CR1

Debit

Credit 6,090

No. 112 Balance 7,450 1,360

Accounts Receivable Subsidiary Ledger Park Date Apr.

1 10

Explanation Balance

Ref. � CR1

Debit

Credit 600

Balance 1,550 950

PROBLEM J-1 (Continued) Kolten Date Apr. 1 29

Explanation Balance

Ref. � CR1

Debit

Ref. � CR1 CR1

Debit

Ref. � CR1

Debit

Credit 1,200

Balance 1,200 0

Hurt Co. Date Apr.

1 5 23

Afzal Date Apr. 1 4

Explanation Balance

Credit 990 1,500

Credit 1,800

$1,360

Subsidiary account balances: Park Hurt Co. Total

$ 950 410 $1,360

Balance 2,900 1,910 410

Balance 1,800 0

PROBLEM J-2

(a) Cash Payments Journal Date

Ck. No. Account Debited

Oct. 1 3 5 10 15 16 19 29

63 64 65 66 67 68 69 70

Inventory Equipment Coulsen Company Inventory Noy Co. Cash Dividends Flynn Co. Trent Company

Other Accounts Accounts Payable Ref. Dr. Dr. 120 157

300 1,200

120

2,250

332

400

� �

Inventory Cr.

2,700

2,100

4,150 (X)

(b)

CP1

1,800 2,500 9,100 (201)

36 90 (120)

300 1,200 2,646 2,250 2,100 400 1,764 2,500 13,160 (101)

General Ledger

Accounts Payable Date Oct.

Cash Cr.

1 31

No. 201

Explanation Balance

Ref. � CP1

Debit

Credit

9,100

Balance 11,000 1,900

Accounts Payable Subsidiary Ledger Coulsen Company Date Oct.

1 5

Explanation Balance

Ref. � CP1

Debit 2,700

Credit

Balance 2,700 0

PROBLEM J-2 (Continued) Flynn Co. Date Explanation Oct. 1 Balance 19

Ref. � CP1

Debit

Noy Co. Date Oct. 1 15

Ref. � CP1

Debit

Ref. � CP1

Debit

Explanation Balance

Credit

Balance 2,500 700

Credit

Balance 2,100 0

Credit

Balance 3,700 1,200

1,800

2,100

Trent Company Date Oct.

1 29

Explanation Balance

2,500

$1,900 $ 700 1,200 $1,900

PROBLEM J-3

(a) Purchases Journal

Date

Account Credited (Debited)

Ref.

July 1 2 5 13

Dent Company Rensing Shipping Langer Company Abel Supply (Supplies) Dent Company Goran Company Wei Advertisements (Advertising Expense) Langer Company Abel Supply (Equipment) Rensing Shipping

� � �

15 15 18 24 26 28

Accounts Payable Cr.

Inventory Dr.

7,600 400 3,200 910

7,600 400 3,200

3,600 3,300 600

3,600 3,300

3,000 900

3,000

380 23,890 (201)

380 21,480 (120)

126/�

� �

610/�

�

157/�

�

P1 Other Accounts Dr.

910

600

900

Sales Journal Date

Account Debited

Ref.

July 3 3 16 16 21 21 30

Dayley Company Orsen Bros. Gentry Company Orsen Bros. Dayley Company Musky Company Gentry Company

� � � � � � �

2,410 (X)

Accounts Receivable Dr. Sales Revenue Cr.

Cost of Goods Sold Dr. Inventory Cr.

1,300 2,000 3,450 1,570 310 2,800 5,600 17,030 (112)(401)

910 1,400 2,415 1,099 217 1,960 3,920 11,921 (505)(120)

PROBLEM J-3 (Continued) General Journal Date July

Accounts and Explanations Accounts Payable—Langer Company ...................................... Inventory.................................. Sales Returns and Allowances Accounts Receivable— Dayley Company .................

(b) Accounts Receivable Date July 31 22

Explanation

G1 Ref.

Debit

201/� 120

300

412

300

112/�

General Ledger No. 112 Ref. S1 G1

Debit 17,030

Credit 65

Inventory Date July 31 8 31

Balance 17,030 16,965

No. 120 Explanation

Ref. P1 G1 S1

Debit 21,480

Credit 300 11,921

Supplies Date July 13

Credit

Balance 21,480 21,180 9,259

No. 126 Explanation

Ref. P1

Debit 910

Credit

Balance 910

PROBLEM J-3 (Continued) Equipment Date Explanation July 26

Ref. P1

Debit 900

Credit

Accounts Payable Date July 31 8

Explanation

Sales Revenue Date Explanation July 31

Sales Returns and Allowances Date Explanation July 22

No. 201 Ref. P1 G1

Ref. S1

Ref. G1

Debit

Credit 23,890

300

Debit

Debit 65

Credit 17,030

Credit

Cost of Goods Sold Date July 31

Explanation

Advertising Expense Date Explanation July 18

No. 157 Balance 900

Balance 23,890 23,590

No. 401 Balance 17,030

No. 412 Balance 65

No. 505 Ref. S1

Ref. P1

Debit 11,921

Debit 600

Credit

Balance 11,921

No. 610 Balance 600

PROBLEM J-3 (Continued) Accounts Receivable Subsidiary Ledger Orsen Bros. Date July

Explanation 3 16

Ref. S1 S1

Debit 2,000 1,570

Credit

Balance 2,000 3,570

Ref. S1 S1 G1

Debit 1,300 310

Credit

Balance 1,300 1,610 1,545

Ref. S1 S1

Debit 3,450 5,600

Credit

Balance 3,450 9,050

Ref. S1

Debit 2,800

Credit

Balance 2,800

Dayley Company Date July

Explanation 3 21 22

Gentry Company Date July 16 30

Explanation

Musky Company Date July 21

Explanation

Accounts Payable Subsidiary Ledger Abel Supply Date July 13 26

Explanation

Ref. P1 P1

Debit

Credit 910 900

Balance 910 1,810

PROBLEM J-3 (Continued) Rensing Shipping Date Explanation July 2 28

Ref. P1 P1

Debit

Credit 400 380

Balance 400 780

Ref. P1 P1

Debit

Credit 7,600 3,600

Balance 7,600 11,200

Ref. P1 G1 P1

Debit

Credit 3,200 3,000

Balance 3,200 2,900 5,900

Ref. P1

Debit

Credit 600

Balance 600

Ref. P1

Debit

Credit 3,300

Balance 3,300

Dent Company Date July

Explanation 1 15

Langer Company Date July

Explanation 5 8 24

300

Wei Advertisements Date July 18

Explanation

Goran Company Date Explanation July 15

PROBLEM J-3 (Continued) (c)

Accounts receivable balance................................. Subsidiary account balances Orsen Bros. ..................................................... Dayley Company ............................................. Gentry Company ............................................. Musky Company.............................................. Total..........................................................

$16,965 $ 3,570 1,545 9,050 2,800 $16,965

Accounts payable balance..................................... Subsidiary account balances Abel Supply ..................................................... Rensing Shipping............................................ Dent Company................................................. Langer Company............................................. Wei Advertisements ........................................ Goran Company .............................................. Total..........................................................

$23,590 $ 1,810 780 11,200 5,900 600 3,300 $23,590

PROBLEM J-4

(a), (b) & (c) Sales Journal Account Debited

Date

Jan. 4 Gant 9 Notson Corp. 17 Loeb Co. 31 Gant

Invoice Accounts Receivable Dr. No. Ref. Sales Revenue Cr. 371 372 373 374

� � � �

Cost of Goods Sold Dr. Inventory Cr.

5,600 6,400 1,200 9,330 22,530 (112)(401)

3,360 3,840 720 5,598 13,518 (505)(120)

Purchases Journal Date Jan. 3 8 11 23 24

Account Credited Quayle Co. Eubank Co. Akers Co. Quayle Co. Fifer Corp.

Ref. � � � � �

P1 Inventory Dr. Accounts Payable Cr. 10,000 4,500 3,700 7,800 5,100 31,100 (120)(201)

General Journal Date Jan. 5

Accounts and Explanations Accounts Payable—Quayle Co. ........... Inventory ...................................

Ref. 201/� 120

Debit 300

Equipment.......................................... Accounts Payable—Barb Corp. ......................................

157 201/�

5,500

Credit 300

5,500

PROBLEM J-4 (Continued) Cash Receipts Journal Account Credited

Date

Jan. 6 13 15 Notson Corp. 17 Gant 20 27 30 Loeb Co.

Ref.

� � �

Sales Accounts Sales Discounts Receivable Revenue Dr. Cr. Cr.

Cash Dr. 3,750 6,260 6,336 5,600 3,200 4,230 1,200 30,576 (101)

64 (414)

CR1 Other Accounts Cr.

Cost of Goods Sold Dr. Inventory Cr.

3,750 6,260

2,250 3,756

3,200 4,230

1,920 2,538

6,400 5,600

1,200 13,200 (112)

17,440 (401)

10,464 (505)(120)

0 (X)

Cash Payments Journal

Date

Account Debited

Ref.

Other Accounts Dr.

Jan. 4 13 15

Supplies Quayle Co. Salaries and Wages Expense Eubank Co. Salaries and Wages Expense

126

20 31

�

726

Accounts Payable Dr.

Inventory Cr.

Cash Cr.

9,700

194

80 9,506 14,300

4,500

4,410

284 (120)

14,300 42,596 (101)

14,300

� 726

CP1

14,300 28,680 (X)

14,200 (201)

PROBLEM J-5

(a), (d) & (g) Cash Date July 31 31

Explanation

Accounts Receivable Date Explanation July 31 31

Inventory Date Explanation July 31 29 31 31 31

Supplies Date Explanation July 4 31 Adjusting entry

Prepaid Rent Date Explanation July 11 31 Adjusting entry

General Ledger

Ref. CR1 CP1

Ref. S1 CR1

Ref. P1 CR1 CP1 S1 CR1

Ref. CP1 G1

Debit 101,765

Credit 38,766

Debit 20,100

Credit 15,100

Debit 43,720

Credit 450 234 13,065 4,095

Debit 600

Credit 430

Debit 6,000

Credit 500

No. 101 Balance 101,765 62,999

No. 112 Balance 20,100 5,000

No. 120 Balance 43,720 43,270 43,036 29,971 25,876

No. 127 Balance 600 170

No. 131 Balance 6,000 5,500

PROBLEM J-5 (Continued) Accounts Payable Date July 31 31

Explanation

No. 201 Ref. P1 CP1

Debit

Credit 43,720

29,900

Common Stock Date July

Explanation 1

No. 311 Ref. CR1

Debit

Credit 80,000

Cash Dividends Date July 19

Explanation

Sales Discounts Date Explanation July 31

Ref. CP1

Debit 2,500

Credit

Explanation

Balance 2,500

No. 401 Ref. S1 CR1

Ref. CR1

Debit

Debit 85

Credit 20,100 6,300

Balance 20,100 26,400

Credit

No. 414 Balance 85

Cost of Goods Sold Date July 31 31

Balance 80,000

No. 332

Sales Revenue Date July 31 31

Balance 43,720 13,820

No. 505 Ref. S1 CR1

Debit 13,065 4,095

Credit

Balance 13,065 17,160

PROBLEM J-5 (Continued) Supplies Expense Date July 31

No. 631

Explanation Adjusting entry

Ref. G1

Rent Expense Date Explanation July 31 Adjusting entry

Ref. G1

Debit 430

Debit 500

Credit

Balance 430

No. 729 Balance 500

(b) Sales Journal Date

Account Debited

Ref.

July 6 8 10 21

Edwards Co. Carmoni L. Nunez M.Putzi

� � � �

Accounts Receivable Dr. Sales Revenue Cr.

Cost of Goods Sold Dr. Inventory Cr.

6,600 3,600 4,900 5,000 20,100 (112)(401)

4,290 2,340 3,185 3,250 13,065 (505)(120)

Cash Receipts Journal Account Credited

Date July 1 7 13 16 20 29

Common Stock Carmoni L. Nunez Edwards Co. Inventory

Ref.

Cash Dr.

80,000 6,300 � 3,564 � 4,851 � 6,600 120 450 101,765 (101)

CR1

Sales Accounts Sales Other Discounts Receivable Revenue Accounts Dr. Cr. Cr. Cr.

311

Cost of Goods Sold Dr. Inventory Cr.

80,000 6,300 36 49

3,600 4,900 6,600

85 (414)

15,100 (112)

6,300 (401)

4,095

450 80,450 (X)

4,095 (505)(120)

PROBLEM J-5 (Continued) (c)

Accounts Receivable Subsidiary Ledger

Edwards Co. Date July

Explanation

Ref. S1 CR1

Debit 6,600

Explanation

Ref. S1

Debit 5,000

Credit

Balance 5,000

Explanation

Ref. S1 CR1

Debit 4,900

Credit

Balance 4,900 0

Ref. S1 CR1

Debit 3,600

6 20

M. Putzi Date July 21

Credit 6,600

Balance 6,600 0

L. Nunez Date July 10 16

4,900

Carmoni Date July

Explanation 8 13

Credit 3,600

Balance 3,600 0

Accounts Payable Subsidiary Ledger D. Sampson Date July 13 21

Explanation

K. Farmer Date Explanation July 5 10

Ref. P1 CP1

Debit

Credit 15,300

Balance 15,300 0

Credit 8,100

Balance 8,100 0

15,300

Debit 8,100

PROBLEM J-5 (Continued) G. Young Date Explanation July 20

Ref. P1

Debit

Credit 7,900

Balance 7,900

T. Donley Date Explanation July 4 15

Ref. P1 CP1

Debit

Credit 6,500

Balance 6,500 0

M. Huang Date Explanation July 11

Ref. P1

Debit

Credit 5,920

Balance 5,920

Debit $ 62,999 5,000 25,876 600 6,000

Credit

(e)

6,500

RAMIREZ CO. Trial Balance July 31, 2017 Cash................................................................ Accounts Receivable..................................... Inventory ........................................................ Supplies.......................................................... Prepaid Rent .................................................. Accounts Payable.......................................... Common Stock .............................................. Cash Dividends.............................................. Sales Revenue ............................................... Sales Discounts ............................................. Cost of Goods Sold .......................................

$ 13,820 80,000 2,500 26,400 85 17,160 $120,220

$120,220

PROBLEM J-5 (Continued) (f)

Accounts receivable balance.................................................

$ 5,000

Subsidiary accounts balance M. Putzi ............................................................................

$ 5,000

Accounts payable balance.....................................................

$13,820

Subsidiary accounts balance G. Young .......................................................................... M. Huang..........................................................................

$ 7,900 5,920 $13,820

(g) Date July 31 31

General Journal Accounts and Explanations Supplies Expense ............................ Supplies...................................

Ref. 631 127

Debit 430

Rent Expense ................................... Prepaid Rent............................

729 131

500

G1 Credit 430 500

PROBLEM J-5 (Continued) (h)

RAMIREZ CO. Adjusted Trial Balance July 31, 2017 Cash ................................................................ Accounts Receivable ..................................... Inventory......................................................... Supplies.......................................................... Prepaid Rent................................................... Accounts Payable .......................................... Common Stock............................................... Cash Dividends .............................................. Sales Revenue................................................ Sales Discounts ............................................. Cost of Goods Sold........................................ Supplies Expense .......................................... Rent Expense .................................................

Debit $ 62,999 5,000 25,876 170 5,500

Credit

$ 13,820 80,000 2,500 26,400 85 17,160 430 500 $120,220

$120,220

PROBLEM J-6

(b) & (c) Cash Receipts Journal

Date

Account Credited

Ref.

Jan. 7 13 23 29

E. Divine T. Raynor

� �

Notes Receivable

115

Cash Dr. 3,500 4,508 9,100 37,000 54,108 (101)

Sales Discounts Dr.

Accounts Receivable Cr.

3,500 4,600

CR1

Sales Revenue Cr.

Other Accounts Cr.

Cost of Goods Sold Dr. Inventory Cr.

9,100 92 (414)

8,100 (112)

9,100 (401)

5,460 37,000 37,000 (X)

5,460 (505)(120)

Cash Payments Journal Date

Account Debited

Ref.

Jan. 11 12 15 18

Inventory Rent Expense A. Pele Salaries and Wages Expense P. Weng

120 729 � 726

CP1

Other Accounts Accounts Payable Dr. Dr.

Inventory Cr.

300 1,000 15,000

150

950 15,950 (201)

150 (120)

4,500

� 5,800 (X)

Sales Journal Date

Account Debited

Jan. 3 T. Raynor 24 J. Deitz

Accounts Receivable Dr. Ref. Sales Revenue Cr. � �

4,600 7,400 12,000 (112)(401)

Cash Cr. 300 1,000 14,850 4,500 950 21,600 (101)

S1 Cost of Goods Sold Dr. Inventory Cr. 2,760 4,440 7,200 (505)(120)

PROBLEM J-6 (Continued) Purchases Journal Date Jan. 5 17

Account Credited P. Weng E. Nanco

P1 Inventory Dr. Accounts Payable Cr. 2,800 1,600 4,400 (120)(201)

Ref. � �

General Journal Date Jan. 14

20 30

Accounts and Explanations Ref. Sales Returns and Allowances ....... 412 Accounts Receivable— M. Cedeno ................................ �/112 Inventory ($300 X .60) ...................... 120 Cost of Goods Sold................. 505

Debit 300

Accounts Payable—L. Gold ................. �/201 Notes Payable.......................... 200

18,000

Accounts Payable—E. Nanco .............. �/201 Inventory.................................. 120

300

Credit

300 180 180 18,000 300

(a) & (c) General Ledger Cash Date Jan. 1 31 31

Explanation Balance

Ref. � CR1 CP1

Debit

Credit

54,108 21,600

No. 101 Balance 41,500 95,608 74,008

PROBLEM J-6 (Continued) Accounts Receivable Date Explanation Jan. 1 Balance 14 31 31

Ref. � G1 CR1 S1

Debit

Credit 300 8,100

12,000

Notes Receivable Date Jan.

1 29

Explanation Balance

Inventory Date Explanation Jan. 1 Balance 11 14 30 31 31 31 31

No. 115 Ref. � CR1

Ref. � CP1 G1 G1 P1 CP1 CR1 S1

Debit

Credit 37,000

Debit

Credit

300 180 300 4,400 150 5,460 7,200

Equipment Date Jan.

Explanation Balance

Balance 45,000 8,000

No. 120 Balance 20,000 20,300 20,480 20,180 24,580 24,430 18,970 11,770

No. 157 Ref. �

Debit

Credit

Accumulated Depreciation—Equipment Date Jan.

No. 112 Balance 15,000 14,700 6,600 18,600

Ref. �

Balance 7,500

No. 158 Debit

Credit

Balance 1,500

PROBLEM J-6 (Continued) Notes Payable Date Jan. 20

Explanation

No. 200 Ref. G1

Debit

Credit 18,000

Accounts Payable Date Jan.

1 20 30 31 31

Explanation Balance

No. 201 Ref. � G1 G1 P1 CP1

Debit

Credit

18,000 300 4,400 15,950

Common Stock Date Jan.

Explanation Balance

Explanation

Ref. �

Debit

Credit

Explanation

Sales Discounts Date Explanation Jan. 31

Balance 84,500

No. 401 Ref. CR1 S1

Debit

Credit 9,100 12,000

Sales Returns and Allowances Date Jan. 14

Balance 43,000 25,000 24,700 29,100 13,150

No. 311

Sales Revenue Date Jan. 31 31

Balance 18,000

Balance 9,100 21,100

No. 412 Ref. G1

Ref. CR1

Debit 300

Debit 92

Credit

Balance 300

No. 414 Balance 92

PROBLEM J-6 (Continued) Cost of Goods Sold Date Explanation Jan. 31 31 14

Ref. CR1 S1 G1

Debit 5,460 7,200

Credit

180

Salaries and Wages Expense Date Jan. 18

Explanation

No. 726 Ref. CP1

Debit 4,500

Credit

Rent Expense Date Jan. 12

No. 505 Balance 5,460 12,660 12,480

Balance 4,500

No. 729

Explanation

Ref. CP1

Debit 1,000

Credit

Balance 1,000

Accounts Receivable Subsidiary Ledger M. Cedeno Date Jan.

1 14

Explanation Balance

Ref. � G1

Debit

Ref. � S1

Debit

Credit 300

Balance 2,500 2,200

J. Deitz Date Jan.

1 24

Explanation Balance

7,400

Credit

Balance 7,500 14,900

PROBLEM J-6 (Continued) E. Divine Date Explanation Jan. 1 Balance 7

Ref. � CR1

Debit

Ref. S1 CR1

Debit 4,600

Credit 3,500

Balance 5,000 1,500

T. Raynor Date Jan.

Explanation 3 13

Credit 4,600

Balance 4,600 0

Accounts Payable Subsidiary Ledger E. Nanco Date Jan. 17 30

Explanation

Ref. P1 G1

Debit

B. Forrest Date Explanation Jan. 1 Balance

Ref. �

L. Gold Date Jan. 1 20

Explanation Balance

Ref. � G1

A. Pele Date Jan. 1 15

Explanation Balance

Ref. � CP1

Credit 1,600

Balance 1,600 1,300

Debit

Credit

Balance 10,000

Debit

Credit

Balance 18,000 0

Credit

Balance 15,000 0

300

18,000

Debit 15,000

PROBLEM J-6 (Continued) P. Weng Date Jan. 5 27

(d)

Explanation

Ref. P1 CP1

Debit

Credit 2,800

Balance 2,800 1,850

Debit $ 74,008 18,600 8,000 11,770 7,500

Credit

950

BENSEN CO. Trial Balance January 31, 2017 Cash ................................................................ Accounts Receivable...................................... Notes Receivable............................................ Inventory ......................................................... Equipment....................................................... Accumulated Depreciation—Equipment....... Notes Payable ................................................. Accounts Payable........................................... Common Stock ............................................... Sales Revenue ................................................ Sales Returns and Allowances...................... Sales Discounts.............................................. Cost of Goods Sold ........................................ Salaries and Wages Expense ........................ Rent Expense..................................................

300 92 12,480 4,500 1,000 $138,250

(e) Accounts Receivable Subsidiary Ledger M. Cedeno........................................................................ J. Deitz ............................................................................. E. Divine...........................................................................

Accounts Receivable Control ................................................

1,500 18,000 13,150 84,500 21,100

$138,250

$ 2,200 14,900 1,500 $18,600 $18,600

PROBLEM J-6 (Continued) Accounts Payable Subsidiary Ledger E. Nanco........................................................................... B. Forrest ......................................................................... P. Weng............................................................................ Accounts Payable Control .....................................................

$ 1,300 10,000 1,850 $13,150 $13,150

COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 6 AND APPENDIX j

Note: If the working papers that accompany this text are not used in solving this problem, account numbers may differ from those presented in this solution. (a) Sales Journal Date Jan. 3 3 11 11 22 22 25 25

Date Jan. 5 5 16 16 16 27 27 27

Account Debited W. Rayms M. Fischer G. Dukes L. Longhini W. Rayms G. Dukes M. Hall M. Fischer

Account Credited K. Zapfel J. Liotta L. Quinn O. Kitson K. Zapfel L. Quinn J. Liotta K. Zapfel

Ref. � � � � � � � �

S1 Accounts Receivable Dr. Sales Cr. 3,600 1,800 1,900 900 3,700 800 3,500 6,100 22,300 (112)(401)

Purchases Journal

Invoice No. 510 511 512 513 514 515 516 517

Terms

Ref. � � � � � � � �

Purchases Dr. Accounts Payable Cr. 3,000 2,400 15,000 13,900 1,500 12,500 1,200 2,800 52,300 (510)(201)

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.

COMPREHENSIVE PROBLEM (Continued) Cash Receipts Journal Date Jan. 7 7 10 13 13 20 21 31

Account Credited

Ref.

L. Longhini M. Hall

� �

4,000 2,000 15,500 3,600 1,560 17,750 900 22,920 68,230 (101)

� �

W. Rayms M. Fischer

�

L. Longhini

Accounts Receivable Cr.

Cash Dr.

CR1 Sales Cr.

4,000 2,000 15,500 3,600 1,560 17,750 900 12,060 (112)

22,920 56,170 (401)

Cash Payments Journal Date Jan. 8 9 9 12 15 17 23 23 28 31

Ref.

Other Accounts Dr.

Freight-In O. Kitson L. Quinn Rent Expense Cash Dividends

516

180

L. Quinn O. Kitson

� �

Account Debited

Salaries and Wages Expense

� �

729 332

627

Other Accounts Cr.

Accounts Payable Dr.

CP1 Supplies Dr.

200

180 9,000 11,000 1,000 650 400 15,000 13,700 200

600 (125)

7,400 58,530 (101)

9,000 11,000 1,000 650 400 15,000 13,700

7,400 9,230 (X)

48,700 (201)

Cash Cr.

COMPREHENSIVE PROBLEM (Continued) (a) & (e) General Journal Date Jan.

Account Titles and Explanations Sales Returns and Allowances ................................... Accounts Receivable— M. Fischer ............................ (Issued credit for merchandise returned) Accounts Payable—O. Kitson......... Purchase Returns and Allowances .......................... (Received credit for returned goods) Accounts Payable— D. Markoff ..................................... Notes Payable ......................... (Issued note for balance due)

G1 Ref.

Debit

412

240

112/�

201/�

Credit

240

200

512

200

201/� 200

15,000

728 125

1,020

15,000

Adjusting Entries 31

Supplies Expense ............................ Supplies...................................

1,020 31

Insurance Expense (1/10 X $2,000) .............................. Prepaid Insurance ................... Depreciation Expense (1/12 X $1,500) .............................. Accumulated Depreciation— Equipment ........................... Interest Expense .............................. Interest Payable ......................

722 130

200

711

125

158 718 230

200

125 30 30

COMPREHENSIVE PROBLEM (Continued)

Date Jan. 31

31 31

General Journal Account Titles and Explanations Inventory (Jan. 31) ........................... Sales Revenue.................................. Purchase Returns and Allowances ................................... Income Summary .................... Income Summary ............................. Inventory (Jan. 1) ................................. Sales Returns and Allowances .......................... Purchases................................ Freight In.................................. Rent Expense .......................... Salaries and Wages Expense ............................... Supplies Expense ................... Insurance Expense ................. Depreciation Expense............. Interest Expense .....................

Debit 12,600 78,470

512 350

200

350

82,495

91,270

120

20,000

412 510 516 729

240 52,300 180 1,000

627 728 722 711 718

7,400 1,020 200 125 30

Income Summary ............................. Retained Earnings...................

350 320

8,775

Retained Earnings............................ Cash Dividends .......................

320 332

650

(b) & (e) Cash Date Jan. 1 31 31

Ref. 120 401

G1 Credit

8,775 650

General Ledger

Explanation Balance

Ref. � CR1 CP1

Debit

Credit

68,230 58,530

No. 101 Balance 32,750 100,980 42,450

COMPREHENSIVE PROBLEM (Continued) Accounts Receivable Date Jan.

1 31 31 9

Explanation Balance

No. 112 Ref. � S1 CR1 G1

Debit

Credit

22,300 12,060 240

Notes Receivable Date Jan.

Explanation Balance

Inventory Date Explanation Jan. 1 Balance 31 31

Supplies Date Explanation Jan. 1 Balance 31 31

No. 115 Ref. �

Ref. � G1 G1

Ref. � CP1 G1

Debit

Credit

12,600 20,000

Debit

Credit

600 1,020

Prepaid Insurance Date Jan.

1 31

Explanation Balance

Explanation 1

Balance 42,000

No. 120 Balance 20,000 32,600 12,600

No. 125 Balance 1,000 1,600 580

No. 130 Ref. � G1

Debit

Credit 200

Equipment Date Jan.

Balance 13,000 35,300 23,240 23,000

Balance 2,000 1,800

No. 157 Ref. �

Debit

Credit

Balance 6,450

COMPREHENSIVE PROBLEM (Continued) Accumulated Depreciation—Equipment Date Explanation Ref. Jan. 1 Balance � 31 G1 Notes Payable Date Explanation Jan. 21 Balance Accounts Payable Date Explanation Jan. 1 Balance 31 31 18 21 Interest Payable Date Explanation Jan. 31 Common Stock Date Explanation Jan. 1 Retained Earnings Date Explanation Jan. 1 Balance 31 31 Cash Dividends Date Explanation Jan. 15 31

Ref. G1

Ref. � P1 CP1 G1 G1

Ref. G1

Ref. �

Ref. � G1 G1

Ref. CP1 G1

Debit

125

No. 158 Balance 1,500 1,625

Credit 15,000

No. 200 Balance 15,000

Credit

Credit 52,300

48,700 200 15,000

Debit

Credit 30

Credit

Credit 8,775

650

Debit 650

Credit 650

No. 201 Balance 35,000 87,300 38,600 38,400 23,400 No. 230 Balance 30 No. 311 Balance 70,000 No. 320 Balance 10,700 19,475 18,825 No. 332 Balance 650 0

COMPREHENSIVE PROBLEM (Continued) Income Summary Date Jan. 31 31 31

Explanation

Sales Revenue Date Explanation Jan. 31 31 31

No. 350 Ref. G1 G1 G1

Ref. S1 CR1 G1

Debit

Credit 91,270

82,495 8,775

Debit

Credit 22,300 56,170

78,470

Sales Returns and Allowances Date Jan.

Explanation 9 31

Purchases Date Explanation Jan. 31 31 Purchase Returns and Allowances Date Explanation Jan. 18 31

Ref. G1 G1

Ref. P1 G1

Ref. G1 G1

Debit 240

Credit 240

Debit 52,300

Credit 52,300

Debit

Credit 200

200

Balance 240 0 No. 510 Balance 52,300 0 No. 512 Balance 200 0 No. 516

Explanation 8 31

No. 401 Balance 22,300 78,470 0 No. 412

Freight-In Date Jan.

Balance 91,270 8,775 0

Ref. CP1 G1

Debit 180

Credit 180

Balance 180 0

COMPREHENSIVE PROBLEM (Continued) Salaries and Wages Expense Date Explanation Jan. 31 31

Ref. CP1 G1

Debit 7,400

Credit 7,400

Depreciation Expense Date Jan. 31 31

Explanation

No. 711 Ref. G1 G1

Debit 125

Credit 125

Interest Expense Date Jan. 31 31

Explanation

Ref. G1 G1

Debit 30

Credit 30

Explanation

Balance 30 0

No. 722 Ref. G1 G1

Debit 200

Credit 200

Supplies Expense Date Jan. 31 31

Balance 125 0

No. 718

Insurance Expense Date Jan. 31 31

No. 627 Balance 7,400 0

Balance 200 0

No. 728 Ref. G1 G1

Debit 1,020

Credit 1,020

Balance 1,020 0

COMPREHENSIVE PROBLEM (Continued) Rent Expense Date Jan. 12 31

No. 729

Explanation

Ref. CP1 G1

Debit 1,000

Credit 1,000

Balance 1,000 0

Accounts Receivable Subsidiary Ledger G. Dukes Date Jan.

1 11 22

Explanation Balance

Ref. � S1 S1

Debit

Ref. S1 G1 CR1 S1

Debit 1,800

Ref. � CR1 S1

Debit

Ref. � CR1 S1 CR1

Debit

Credit

Balance 1,800 3,700 4,500

Credit

Balance 1,800 1,560 0 6,100

1,900 800

M. Fischer Date Jan.

Explanation 3 9 13 25

240 1,560 6,100

M. Hall Date Jan.

1 7 25

Explanation Balance

Credit 2,000

3,500

Balance 7,200 5,200 8,700

L. Longhini Date Jan.

1 7 11 21

Explanation Balance

Credit 4,000

900 900

Balance 4,000 0 900 0

COMPREHENSIVE PROBLEM (Continued) W. Rayms Date Explanation Jan. 3 13 22

Ref. S1 CR1 S1

Debit 3,600

Credit 3,600

3,700

Balance 3,600 0 3,700

Accounts Payable Subsidiary Ledger J. Liotta Date Jan.

Explanation

Ref. P1 P1

Debit

Credit 2,400 1,200

Balance 2,400 3,600

Explanation Balance

Ref. � CP1 P1 G1 CP1

Debit

Credit

Balance 9,000 0 13,900 13,700 0

5 27

O. Kitson Date Jan.

1 9 16 18 23

9,000 13,900 200 13,700

D. Markoff Date Jan.

1 21

Explanation Balance

Ref. � G1

Debit

Credit

Balance 15,000 0

Credit

Balance 11,000 0 15,000 0 12,500

15,000

L. Quinn Date Jan.

1 9 16 23 27

Explanation Balance

Ref. � CP1 P1 CP1 P1

Debit 11,000

15,000 15,000 12,500

COMPREHENSIVE PROBLEM (Continued) K. Zapfel Date Explanation Jan. 5 16 27

Ref. P1 P1 P1

Debit

Credit 3,000 1,500 2,800

Balance 3,000 4,500 7,300

(c)

ZWEIFEL COMPANY Worksheet For the Month Ended January 31, 2017

Kimmel, Accounting 6e, Solutions Manual (For Instructor Use Only)

Trial Balance

Adjustments

Adjusted Trial Balance

Account Titles

Dr.

Cash Accounts Receivable Notes Receivable Inventory Supplies Prepaid Insurance Equipment Accum. Depreciation—Equipment Notes Payable Accounts Payable Interest Payable Common Stock Retained Earnings Cash Dividends Sales Revenue Sales Returns and Allowances Purchases Purchase Returns and Allowances Freight In Salaries and Wages Expense Rent Expense Totals Supplies Expense Insurance Expense Depreciation Expense Interest Expense Totals Net Income Totals

42,450 23,000 42,000 20,000 1,600 2,000 6,450

Cr.

(1) 1,020 (2) 200 1,500 15,000 23,400

(3)

125

(4)

42,450 23,000 42,000 20,000 580 1,800 6,450

Cr.

20,000

12,600

650 78,470

78,470

240 52,300

240 52,300 200

180 7,400 1,000 199,270

Dr.

1,625 15,000 23,400 30 70,000 10,700

70,000 10,700 650

Cr.

Income Statement

78,470 240 52,300

200

180 7,400 1,000

1,020 200 125 30 199,425

1,020 200 125 30

199,270 (1) 1,020 (2) 200 (3) 125 (4) 30 1,375

1,375

199,425 82,495 8,775 91,270

91,270 91,270

COMPREHENSIVE PROBLEM (Continued) (d)

ZWEIFEL CO. Income Statement For the Month Ended January 31, 2017 Sales Sales revenue ................................ Less: Sales returns and allowances ...................... Net sales......................................... Cost of goods sold Inventory, 1/1/17 ............................ Purchases ...................................... Less: Purchase returns and allowances.......................... Net purchases................................ Add: Freight in ............................... Cost of goods available for sale ............................................. Less: Inventory, 1/31/17 ...................................... Cost of goods sold .................. Gross profit on sales..................... Operating expenses Salaries and wages expense ........ Rent expense ................................. Supplies expense .......................... Insurance expense ........................ Depreciation expense.................... Total oper. expenses ............... Income from operations ...................... Other expenses and losses Interest expense ............................ Net income ...........................................

$78,470 240 78,230 $20,000 $52,300 200 52,100 180

52,280 72,280 12,600 59,680 18,550

7,400 1,000 1,020 200 125 9,745 8,805 30 $ 8,775

COMPREHENSIVE PROBLEM (Continued) ZWEIFEL CO. Statement Retained Earnings For the Month Ended January 31, 2017 Retained earnings, January 1, 2017 ...................................... Add: Net income ................................................................... Less: Dividends ..................................................................... Retained earnings, January 31, 2017 ....................................

$ 10,700 8,775 19,475 650 $18,825

ZWEIFEL CO. Balance Sheet January 31, 2017 Assets Current assets Cash ............................................................ Notes receivable......................................... Accounts receivable .................................. Inventory ..................................................... Supplies ...................................................... Prepaid insurance ...................................... Total current assets............................

$42,450 42,000 23,000 12,600 580 1,800

Property, plant, and equipment Equipment................................................... Less: Accumulated depreciation ............. Total assets.........................................

6,450 1,625

$122,430

4,825 $127,255

Liabilities and Stockholders’ Equity Current liabilities Notes payable............................................. Accounts payable....................................... Interest payable .......................................... Total liabilities..................................... Stockholders’ equity Common stock ........................................... Retained earnings ...................................... Total stockholders’ equity ................. Total liabilities and stockholders’ equity ...............................................

$15,000 23,400 30 $ 38,430 70,000 18,825 88,825 $127,255

COMPREHENSIVE PROBLEM (Continued) (f)

ZWEIFEL CO. Post-Closing Trial Balance January 31, 2017 Cash ................................................................ Notes Receivable............................................ Accounts Receivable...................................... Inventory ......................................................... Supplies .......................................................... Prepaid Insurance .......................................... Equipment....................................................... Accumulated Depreciation—Equipment....... Notes Payable ................................................. Accounts Payable........................................... Interest Payable .............................................. Common Stock ............................................... Retained Earnings ..........................................

Debit $ 42,450 42,000 23,000 12,600 580 1,800 6,450 $

$128,880

Accounts Receivable balance ............................. Subsidiary account balances G. Dukes ........................................................ M. Fischer ...................................................... M. Hall ............................................................ W. Rayms.......................................................

Credit

1,625 15,000 23,400 30 70,000 18,825 $128,880

$23,000 $ 4,500 6,100 8,700 3,700 $23,000

Accounts Payable balance................................... Subsidiary account balances J. Liotta .......................................................... L. Quin ........................................................... K. Zapfel.........................................................

$23,400 $ 3,600 12,500 7,300 $23,400

Appendix K Accounting for Partnerships ASSIGNMENT CLASSIFICATION TABLE

Learning Objectives

Brief Exercises

Questions

Exercises

Problems

Discuss and account for the formation of a partnership.

1, 2, 3, 4, 5, 17

1, 2

1, 2, 3

Explain how to account for net income or net loss of a partnership.

6, 7, 8, 9, 10, 11

3, 4, 5

4, 5, 6, 7

1, 2

Explain how to account for the liquidation of a partnership.

12, 13, 14, 15, 16

8, 9, 10

Prepare journal entries when a new partner is either admitted or withdraws.

18, 19, 20, 21, 22, 23, 24

7, 8, 9, 10

11, 12, 13, 14, 15

4, 5

K-1

KIMMEL, Accounting 6e, Solutions Manual

(For Instructor Use Only

ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description

Difficulty Level

Time Allotted (min.)

Prepare entries for formation of a partnership and a balance sheet.

Simple

20–30

Journalize divisions of net income and prepare a partners’ capital statement.

Moderate

30–40

Prepare entries with a capital deficiency in liquidation of a partnership

Moderate

30–40

Journalize admission of a partner under different assumptions.

Moderate

30–40

Journalize withdrawal of a partner under different assumptions.

Moderate

30–40

KIMMEL, Accounting 6e, Solutions Manual

(For Instructor Use Only

K-3

Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises an Learning Objective

Knowledge

Comprehension

Application

1. Discuss and account for the formation of a partnership.

QK-1 QK-2 QK-3 QK-4

QK-17 QK-5 DK12-1 BEK-1 EK-1 BEK-2 EK-2

2. Explain how to account for net income or net loss of a partnership.

QK-6 QK-7 QK-9 QK-11

QK-8 QK-10 BEK-3 BEK-4 BEK-5

Analysis

Synthesis

EK-3 PK-1

EK-5 EI12-6 EI12-7 PK-1A PK-2

EK-4 3. Explain how to account for the liquidation of a partnership.

QK-12 QK-13 QK-14

QK-15 QK-16 BEK-6

EK-8 EK-9 EK-10 PK-3

4. Prepare journal entries when a new partner is either admitted or withdraws.

QK-18 QK-19 QK-23 QK-24

QK-20 QK-21 QK-22 BEK-7 BEK-8 BEK-9 BEK-10 EK-11

EK-12 EK-13 EK-14 EK-15 PK-4 PK-5

Broadening Your Perspective

Real-World Focus Decision Making Across the Organization

KIMMEL, Accounting 6e, Solutions Manual

Communicatio All About You

(For Instructor Use Only

K-6

ANSWERS TO QUESTIONS 1.

(a) Association of individuals. A partnership is a voluntary association of two or more individuals based on as simple an act as a handshake. Preferably, however, the agreement should be in writing. A partnership is both a legal entity and an accounting entity, but it is not a taxable entity. (b) Limited life. A partnership does not have unlimited life. A partnership may be ended voluntarily or involuntarily. Thus, the life of a partnership is indefinite. Any change in the members of a partnership results in the dissolution of the partnership. (c) Co-ownership of property. Partnership assets are co-owned by all the partners. If the partnership is terminated, the assets do not legally revert to the original contributor. Each partner has a claim on total assets equal to his or her capital balance. This claim does not attach to specific assets the individual partner contributed to the firm.

(a) Mutual agency. This characteristic means that the act of any partner is binding on all other partners when engaging in partnership business. This is true even when the partners act beyond the scope of their authority, so long as the act appears to be appropriate for the partnership. (b) Unlimited liability. Each partner is personally and individually liable for all partnership liabilities. Creditors’ claims attach first to partnership assets and then to personal resources of any partner, irrespective of that partner’s equity in the partnership.

The advantages of a partnership are: (1) combining skills and resources of two or more individuals, (2) ease of formation, (3) freedom from governmental regulations and restrictions, and (4) ease of decision making. Disadvantages are: (1) mutual agency, (2) limited life, and (3) unlimited liability.

A limited partnership is used when a general partner(s) wish to raise cash without involving outside investors in management of the business. Limited partners in this case have limited personal liability for business debts as long as they don’t participate in management.

Newland capital account balance should be $97,000, comprised of land $60,000, and equipment $57,000, less debt $20,000.

When the partnership agreement does not specify the division of net income or net loss, net income and net loss should be divided equally.

Factors to be considered in determining how income and loss should be divided are: (1) a fixed ratio is easy to apply and it may be an equitable basis in some circumstances; (2) capital balance ratios, when the funds invested in the partnership are considered the most critical factor; and (3) salary allowance and/or interest allowance coupled with a fixed ratio. This last approach gives specific recognition to differences that may exist among partners by providing salary allowances for time worked and interest allowances for capital invested.

The net income of $42,000 should be divided equally—$21,000 to M. Elston and $21,000 to R. Ogle

(a) Account debited: Income Summary; accounts credited: S. Pletcher, Capital and F. Holt, Capital. (b) Account debited: S. Pletcher, Drawings; account credited: Cash.

Questions Appendix K (Continued)

10.

Division of Net Income

Salary Allowance ............................................ Deficiency: ($15,000) ($40,000 – $55,000) T. Greer (60% X $15,000) ................... R. Parks (40% X $15,000) ................... Total division..............................

T. Greer

R. Parks

Total

$30,000

$25,000

$55,000

(6,000) $19,000

(9,000) (6,000) $40,000

(9,000) $21,000

11. The financial statements of a partnership are similar to those of a proprietorship. The differences are due to the number of partners involved. The income statement for a partnership is identical to the income statement for a proprietorship except for the detailed information concerning the division of net income. The owners’ equity statement is called the partners’ capital statement. This statement shows the changes in each partner’s capital account and in total partnership capital during the year. On the balance sheet each partner’s capital balance is reported in the owners’ equity section. 12. Liquidation of a partnership ends both the legal and economic life of the entity. Partnership dissolution occurs whenever a partner withdraws or a new partner is admitted. Dissolution does not necessarily mean that the business ends. If the continuing partners agree, operations can continue without interruption by forming a new partnership. 13. No, Roger is not correct. All gains and losses on liquidation should be allocated to the partners on the basis of their income ratio. However, final cash distributions should be based on their capital balances. 14. Yes, Mike is correct. Capital balances are used because they represent the individual partner’s equity in the partnership. The objective of the distribution is to eliminate the balance in each partner’s capital account. 15. Total cash after paying liabilities .............................................................................. Total capital balances ($34,000 + $31,000 + $28,000) ............................................ Excess (gain on sale of noncash assets) .................................................................

$103,000 93,000 $ 10,000

Allocated to Madson ($10,000 X 3/10) .....................................................................

3,000

Cash to Madson ($31,000 + $3,000)........................................................................

$ 34,000

16. Capital deficiency, M. Luthi ......................................................................................

4,000

Loss allocated to: L. Seastrom, capital ($4,000 X 3/8) ............................................

1,500

Cash to L. Seastrom ($12,000 – $1,500) .................................................................

10,500

17. A partnership is an association of two or more persons to carry on as co-owners of a business for profit. Apple is a corporation since its has thousands of owners (called stockholders).

Questions Appendix K (Continued)

18.

This transaction represents the purchase of an existing partner’s interest. It is a personal transaction that has no effect on partnership net assets.

19.

Partnership net assets increase $25,000. No, Jerry Park does not necessarily acquire a 1/6 income ratio. Unless stated otherwise, net income or net loss is divided evenly among all partners.

20.

Jamar, Capital ......................................................................................... Parsons, Capital ..............................................................................

68,000

Jaime Keller, Capital................................................................................ Sam Parmenter, Capital...................................................................

41,000

21.

22.

Pester’s share of the $4,000 bonus is computed as follows: Partnership assets ........................................................................... Capital credit, Riley .......................................................................... Bonus to retiring partner................................................................... Allocated to: Jaggard:$4,000 X 5/8 = ........................................................... Pester: $4,000 X 3/8 = ...........................................................

68,000

41,000

$85,000 81,000 4,000 $2,500 1,500

4,000 $ 0

23.

Recording the revaluations violates the cost principle, which requires that assets be stated at original cost. It is also a departure from the going-concern assumption, which assumes the entity will continue indefinitely.

24.

When a partner dies, it is usually necessary to determine the partner’s equity at the date of death by: (1) determining the net income or loss for the year to date, (2) closing the books, and (3) preparing financial statements. The partnership agreement may also require an audit of the financial statements by independent auditors and a revaluation of assets by an appraisal firm.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE K-1 Cash ................................................................................ Equipment....................................................................... Fred Nichols, Capital ..............................................

10,000 4,000 14,000

BRIEF EXERCISE K-2 Accounts Receivable ..................................................... Less: Allowance for doubtful accounts........................ Equipment.......................................................................

$16,000 1,500

$14,500 11,000

Accumulated depreciation should not be shown because a new company cannot have any accumulated depreciation. BRIEF EXERCISE K-3 The division is: Rod $45,000 ($75,000 X 60%) and Dall $30,000 ($75,000 X 40%). The entry is: Income Summary.................................................... 75,000 Rod, Capital ..................................................... 45,000 Dall, Capital ..................................................... 30,000 BRIEF EXERCISE K-4 Division of Net Income

Salary allowance ....................... Remaining income, $20,000: ($45,000 – $25,000) P ($20,000 X 50%)............ F ($20,000 X 30%)............ W ($20,000 X 20%)............ Total remainder........ Total division of net income .....

Pitts $15,000

Filbert $ 5,000

Witten $ 5,000

Total $25,000

10,000 6,000 4,000 $25,000

$11,000

$9,000

20,000 $45,000

BRIEF EXERCISE K-5 Division of Net Income

Salary allowance ....................................... Interest allowance ..................................... Remaining deficiency, ($6,000): [$31,000 – ($25,000 + $12,000)] Nabb ($6,000 X 50%).......................... Fry ($6,000 X 50%) ............................. Total remainder .......................... Total division of net income.....................

Nabb $15,000 7,000

Fry $10,000 5,000

Total $25,000 12,000

(3,000) (3,000) $19,000

$12,000

(6,000) $31,000

BRIEF EXERCISE K-6 A, Capital ........................................................................... B, Capital ........................................................................... C, Capital ........................................................................... Cash............................................................................

8,000 9,000 4,000 21,000

BRIEF EXERCISE K-7 Eubank, Capital ................................................................. Tovar, Capital.............................................................

11,000 11,000

BRIEF EXERCISE K-8 Cash ................................................................................... Irey, Capital (50% X $8,600*)............................................. Pedigo, Capital (50% X $8,600)......................................... Vernon, Capital (45% X $148,000)............................. *[($40,000 + $50,000 + $58,000) X 45%] – $58,000 = $8,600.

58,000 4,300 4,300 66,600

BRIEF EXERCISE K-9 Fernetti, Capital ................................................................. Lango, Capital............................................................ Oslo, Capital...............................................................

20,000 10,000 10,000

BRIEF EXERCISE K-10 Fernetti, Capital ................................................................. Lango, Capital (50% X $4,000) .......................................... Oslo, Capital (50% X $4,000)............................................. Cash............................................................................

20,000 2,000 2,000 24,000

SOLUTIONS TO EXERCISES EXERCISE K-1 1. 2. 3. 4. 5. 6. 7. 8. 9.

False. A partnership is an association of two or more persons to carry on as co-owners of a business for profit. False. Partnerships are fairly easy to form; they can be formed simply by a verbal agreement. False. A partnership is an entity for financial reporting purposes. False. The net income of a partnership is not taxed as a separate entity. True. True. False. When a partnership is dissolved, the assets do not revert to the original contributor. True. False. Mutual agency is a disadvantage of the partnership form of business.

EXERCISE K-2 (a) Cash............................................................................ Decker, Capital ...................................................

50,000

Land............................................................................ Buildings .................................................................... Rosen, Capital ...................................................

15,000 80,000

50,000

95,000

Cash........................................................................... Accounts Receivable................................................ Equipment ................................................................. Allowance for Doubtful Accounts .................... Toso, Capital .....................................................

9,000 32,000 39,000 3,000 77,000

(b) $50,000 + $95,000 + $77,000 = $222,000 EXERCISE K-3 Jan. 1

Cash ................................................................... Accounts Receivable ........................................ Equipment........................................................... Allowance for Doubtful Accounts.............. Suzy Vopat, Capital.....................................

12,000 14,000 23,500 3,000 46,500

EXERCISE K-4 (a) (1)

DIVISION OF NET INCOME

Salary allowance ............................... Interest allowance McGill ($50,000 X 10%) .............. Smyth ($40,000 X 10%) .............. Total interest ........................ Total salaries and interest ............... Remaining income, $6,000 ($50,000 – $44,000) McGill ($6,000 X 60%) ................ Smyth ($6,000 X 40%) ................ Total remainder.................... Total division of net income ............

(2)

Smyth $13,000

Total $35,000

5,000 4,000 27,000

17,000

9,000 44,000

3,600 2,400 $30,600

$19,400

6,000 $50,000

Smyth $13,000 4,000 17,000

Total $35,000 9,000 44,000

DIVISION OF NET INCOME

Salary allowance ............................... Interest allowance............................. Total salaries and interest ............... Remaining deficiency, ($8,000) ($36,000 – $44,000) McGill ($8,000 X 60%) ................ Smyth ($8,000 X 40%) ................ Total remainder.................... Total division of net income ............

(b) (1)

McGill $22,000

McGill $22,000 5,000 27,000

(4,800) (3,200) $22,200

$13,800

Income Summary ............................................... McGill, Capital ............................................. Smyth, Capital .............................................

50,000

Income Summary ............................................... McGill, Capital ............................................. Smyth, Capital .............................................

36,000

(8,000) $36,000

30,600 19,400 22,200 13,800

EXERCISE K-5 (a) Income Summary...................................................... Coburn, Capital ($80,000 X 45%)...................... Webb, Capital ($80,000 X 55%).........................

80,000

(b) Income Summary...................................................... Coburn, Capital [$30,000 + ($25,000 X 45%)] ......................... Webb, Capital [$25,000 + ($25,000 X 55%)] .........................

80,000

(c) Income Summary....................................................... Coburn, Capital .................................................. Webb, Capital .....................................................

80,000

36,000 44,000

41,250 38,750 41,000 39,000

Coburn: [$40,000 + $6,000 – ($10,000 X 50%)] Webb: [$35,000 + $9,000 – ($10,000 X 50%)] (d) Coburn: $60,000 + $41,000 – $18,000 = $83,000 Webb: $90,000 + $39,000 – $24,000 = $105,000

EXERCISE K-6 (a)

NATIONAL CO. Partners’ Capital Statement For the Year Ended December 31, 2017

Capital, January 1 ................... Add: Net income .................... Less: Drawings ...................... Capital, December 31..............

N. Payne $20,000 20,000 40,000 8,000 $32,000

A. Dody $18,000 20,000 38,000 5,000 $33,000

Total $38,000 40,000 78,000 13,000 $65,000

EXERCISE K-6 (Continued) (b)

NATIONAL CO. Partial Balance Sheet December 31, 2017 Owners’ equity N. Payne, Capital ............................................ A. Dody, Capital.............................................. Total owners’ equity ................................

$32,000 33,000 $65,000

EXERCISE K-7 THE DOCTOR PARTNERSHIP Balance Sheet December 31, 2017 Assets Current Assets Cash ($30,000 + $7,000) .............................. Accounts Receivable .................................. Less: Allowance for Doubtful Accounts....... Supplies ....................................................... Total current assets................................

$37,000 $36,000 4,000 32,000 3,000

Property, Plant and Equipment Land.............................................................. Buildings...................................................... Equipment ($25,000 + $27,000)................... Total property, plant, and equipment....... Total assets ........................................................

$ 72,000 28,000 75,000 52,000 155,000 $227,000

Liabilities and Owners’ Equity Long-term Liabilities Mortgage Payable........................................ Owners’ Equity Terry, Capital ($30,000 + $25,000) .............. Nick, Capital ($28,000 + $75,000 – $20,000) Frank, Capital............................................... Total owners’ equity ............................... Total liabilities and owners’ equity ................... *$7,000 + $36,000 + $3,000 + $27,000 – $4,000

$ 20,000 $55,000 83,000 69,000* 207,000 $227,000

EXERCISE K-8 SEDGWICK COMPANY Schedule of Cash Payments Item Cash Balances before liquidation $ 20,000 Sale of noncash assets and allocation of gain 105,000 New balances 125,000 Pay liabilities (55,000) New balances 70,000 Cash distribution (70,000) to partners Final balances $ 0

Noncash Floyd, DeWitt, + Assets =Liabilities + Capital + Capital $100,000 (100,000) 0

$55,000

55,000 (55,000) 0

$45,000

$20,000

3,000 48,000

2,000 22,000

48,000

22,000

(48,000) $ 0

(22,000) $ 0

EXERCISE K-9 (a) Cash......................................................................... Noncash Assets .............................................. Gain on Realization .........................................

105,000

(b) Gain on Realization ................................................ Floyd, Capital ($5,000 X 60%) ......................... DeWitt, Capital ($5,000 X 40%) .......................

5,000

(c) Liabilities ................................................................. Cash .................................................................

55,000

(d) Floyd, Capital .......................................................... DeWitt, Capital ........................................................ Cash .................................................................

48,000 22,000

100,000 5,000

3,000 2,000

55,000

70,000

EXERCISE K-10 (a) (1) (2)

(b) (1)

(2)

Cash .................................................................... Pena, Capital...............................................

8,000

Vogel, Capital ..................................................... Utech, Capital ..................................................... Cash ............................................................

17,000 15,000

Vogel, Capital ($8,000 X 5/8) .............................. Utech, Capital ($8,000 X 3/8).............................. Pena, Capital...............................................

5,000 3,000

Vogel, Capital ($17,000 – $5,000) ...................... Utech, Capital ($15,000 – $3,000) ...................... Cash ............................................................

12,000 12,000

8,000

32,000

8,000

24,000

EXERCISE K-11 (a) K. Kolmer, Capital ($34,000 X 50%) .......................... D. Jernigan, Capital............................................

17,000

(b) C. Eidman, Capital ($26,000 X 50%).......................... D. Jernigan, Capital............................................

13,000

(c) C. Ryno, Capital ($21,000 X 33 1/3%)........................ D. Jernigan, Capital............................................

7,000

17,000 13,000 7,000

EXERCISE K-12 (a) Cash............................................................................ S. Pagon, Capital (6/10 X $15,000) .................... T. Tabor, Capital (4/10 X $15,000)...................... W. Wolford, Capital ............................................ Total capital of existing partnership ..... Investment by new partner, Wolford ..... Total capital of new partnership ............

$160,000 90,000 $250,000

Wolford’s capital credit (30% X $250,000) ............................

$ 75,000

90,000 9,000 6,000 75,000

EXERCISE K-12 (Continued) Investment by new partner, Wolford .... Wolford’s capital credit ......................... Bonus to old partners ...........................

$ 90,000 75,000 $ 15,000

(b) Cash............................................................................ S. Pagan, Capital (6/10 X $13,000) ............................ T. Tabor, Capital (4/10 X $13,000) ............................. W. Wolford, Capital ............................................ Total capital of existing partnership .... Investment by new partner, Wolford .... Total capital of new partnership ...........

$160,000 50,000 $210,000

Wolford’s capital credit (30% X $210,000)..............................

$ 63,000

Investment by new partner, Wolford .... Wolford’s capital credit ......................... Bonus to new partner ............................

$ 50,000 63,000 $ 13,000

50,000 7,800 5,200 63,000

EXERCISE K-13 1.

C. Heganbart, Capital ................................................ N. Essex, Capital ................................................ C. Gilmore, Capital .............................................

30,000

C. Heganbart, Capital ................................................ C. Gilmore, Capital .............................................

30,000

C. Heganbart, Capital ................................................ N. Essex, Capital ................................................

30,000

15,000 15,000

30,000

EXERCISE K-14 1.

N. Rice, Capital .......................................................... B. Higgins, Capital ..................................................... J. Mayo, Capital ......................................................... Cash .................................................................... Capital balance of withdrawing partner ................................................. Payment to withdrawing partner ........... Bonus to retiring partner........................

$60,000 64,000 $ 4,000

Allocation of bonus Higgins, Capital ($4,000 X 5/8)................... $2,500 Mayo, Capital ($4,000 X 3/8) ................ 1,500

$ 4,000

N. Rice, Capital .......................................................... B. Higgins, Capital ............................................. J. Mayo, Capital .................................................. Cash .................................................................... Capital balance of withdrawing partner ................................................. Payment to withdrawing partner ........... Bonus to remaining partners .................

$60,000 52,000 $ 8,000

Allocation of bonus Higgins, Capital ($8,000 X 5/8)..................... $5,000 Mayo, Capital ($8,000 X 3/8) ................ 3,000

$ 8,000

60,000 2,500 1,500 64,000

60,000 5,000 3,000 52,000

EXERCISE K-15 (a) Cash...................................................................... Garrett, Capital ($288,000a X 25%) .............. Foss, Capital ($16,000 X 50%) ..................... Albertson, Capital ($16,000 X 30%) ............. Espinosa, Capital ($16,000 X 20%).............. a

88,000 72,000 8,000 4,800 3,200

$100,000 + $60,000 + $40,000 + $88,000

(b) Foss, Capital ........................................................ Albertson, Capital ($10,000 X 3/5)....................... Espinosa, Capital ($10,000 X 2/5) ....................... Cash ..............................................................

100,000 6,000 4,000 110,000

SOLUTIONS TO PROBLEMS PROBLEM K-1

(a) Jan. 1

(b) Jan. 1

Cash ............................................................ Accounts Receivable ................................. Inventory ..................................................... Equipment................................................... Allowance for Doubtful Accounts ......................................... Notes Payable ..................................... Accounts Payable ............................... Sorensen, Capital................................

14,000 17,500 28,000 25,000

12,000 26,000 20,000 15,000

Cash ............................................................ Sorensen, Capital................................

5,000

Cash ............................................................ Lucas, Capital......................................

19,000

4,500 18,000 22,000 40,000

4,000 15,000 31,000 23,000

5,000 19,000

PROBLEM K-1 (Continued) (c)

SOLU COMPANY Balance Sheet January 1, 2017 Assets Current assets Cash ($14,000 + $12,000 + $5,000 + $19,000) .... Accounts receivable ($17,500 + $26,000).................................... Less: Allowance for doubtful accounts ($4,500 + $4,000) .............................. Inventory ($28,000 + $20,000)..................... Total current assets ............................ Property, plant, and equipment Equipment ($25,000 + $15,000) .................. Total assets.........................................................

$ 50,000 $43,500 8,500

35,000 48,000 133,000 40,000 $173,000

Liabilities and Owners’ Equity Current liabilities Notes payable ($18,000 + $15,000)............. Accounts payable ($22,000 + $31,000) ...... Total current liabilities ........................ Owners’ equity Sorensen, capital ($40,000 + $5,000) ......... Lucas, capital ($23,000 + $19,000) ............. Total owners’ equity ............................ Total liabilities and owners’ equity....................

$ 33,000 53,000 86,000 $45,000 42,000 87,000 $173,000

PROBLEM K-2

(a) (1)

(2)

Income Summary .................................................. A. Niensted, Capital ($30,000 X 60%) ........... G. Bolen, Capital ($30,000 X 30%) ................ K. Sayler, Capital ($30,000 X 10%) ...............

30,000

Income Summary .................................................. A. Niensted, Capital ($15,000 + $5,000)........ G. Bolen, Capital ($10,000 + $5,000)............. K. Sayler, Capital ($0 + $5,000).....................

40,000

Net income............................ Salary allowance Niensted ........................... Bolen ................................. Remainder......................... To each partner ($15,000 X 1/3) ..................

18,000 9,000 3,000

$40,000 (15,000) (10,000) $15,000 $ 5,000

(3) Income Summary ......................................................19,000 A. Niensted, Capital ($4,800 + $15,000 – $2,100) ...................... G. Bolen, Capital ($3,000 – $2,100)............... K. Sayler, Capital ($2,500 – $2,100) .............. Net income............................ Interest allowance Niensted ($48,000 X 10%). Bolen ($30,000 X 10%)...... Sayler ($25,000 X 10%)..... Balance ................................. Salary allowance Niensted ........................... Remainder......................... To each partner ($6,300 X 1/3) ....................

20,000 15,000 5,000

$19,000 (4,800) (3,000) (2,500) 8,700 (15,000) $ (6,300) $ (2,100)

17,700 900 400

PROBLEM K-2 (Continued) (b)

DIVISION OF NET INCOME Art Niensted Salary allowance ........................ Interest allowance on capital A. Niensted ($48,000 X 10%)................. G. Bolen ($30,000 X 10%)................. K. Sayler ($25,000 X 10%)................. Total interest ................. Total salaries and interest......... Remaining deficiency, ($6,300) A. Niensted ($6,300 X 1/3)..................... G. Bolen ($6,300 X 1/3)..................... K. Sayler ($6,300 X 1/3)..................... Total remainder ............. Total division of net income......

(c)

Greg Bolen

Krista Sayler

$15,000

Total $15,000

4,800 $3,000 $2,500 19,800

3,000

2,500

10,300 25,300

(2,100) (2,100) (2,100) $17,700

$ 900

$ 400

(6,300) $19,000

NBS COMPANY Partners’ Capital Statement For the Year Ended December 31, 2017

Capital, January 1 ............. Add: Net income ............. Less: Drawings................. Capital, December 31........

Art Niensted

Greg Bolen

Krista Sayler

Total

$48,000 17,700 65,700 23,000 $42,700

$30,000 900 30,900 14,000 $16,900

$25,000 400 25,400 10,000 $15,400

$103,000 19,000 122,000 47,000 $ 75,000

PROBLEM K-3

(a)

(1) Cash........................................................................... Allowance for Doubtful Accounts ........................... Accumulated Depreciation—Equipment................. Loss on Realization .................................................. Accounts Receivable ........................................ Inventory............................................................ Equipment ......................................................... Noncash assets (net) ................. Sale proceeds............................. Loss on sale of noncash assets......................................

51,000 1,000 5,500 23,000 25,000 34,500 21,000

$74,000 51,000 $23,000

(2) A. Jamison, Capital ($23,000 X 5/10) ........................ S. Moyer, Capital ($23,000 X 3/10) ............................ P. Roper, Capital ($23,000 X 2/10)............................. Loss on Realization ...........................................

11,500 6,900 4,600

(3) Notes Payable ........................................................... Accounts Payable..................................................... Salaries and Wages Payable.................................... Cash ...................................................................

13,500 27,000 4,000

(4) Cash........................................................................... P. Roper, Capital ($4,600 – $3,000) ..................

1,600

(5) A. Jamison, Capital ($33,000 – $11,500).................. S. Moyer, Capital ($21,000 – $6,900) ........................ Cash ...................................................................

21,500 14,100

23,000

44,500

1,600

35,600

PROBLEM K-3 (Continued) (b) Bal. (1) (4) Bal.

(2) (5)

Cash 27,500 (3) 51,000 (5) 1,600 –0–

44,500 35,600

S. Moyer, Capital 6,900 Bal. 21,000 14,100 Bal. –0–

(2) (5)

A. Jamision, Capital 11,500 Bal. 33,000 21,500 Bal.

(2)

P. Roper, Capital 4,600 Bal. (4) Bal.

(c) (1) A. Jamison, Capital ($1,600 X 5/8).................... S. Moyer, Capital ($1,600 X 3/8)........................ P. Roper, Capital........................................

1,000 600

(2) A. Jamison, Capital ($21,500 – $1,000) ............ S. Moyer, Capital ($14,100 – $600) ................... Cash ($35,600 – $1,600).............................

20,500 13,500

–0–

3,000 1,600 –0–

1,600

34,000

*PROBLEM K-4

(a) (1)

(2)

(3)

J. Pinkston, Capital ............................................ J. Terrell, Capital.........................................

9,000

C. Lamar, Capital................................................ J. Terrell, Capital.........................................

16,000

Cash .................................................................... G. Donley, Capital (50% X $8,000) ............. C. Lamar, Capital (40% X $8,000)............... J. Pinkston, Capital (10% X $8,000) ........... J. Terrell, Capital.........................................

62,000

Total capital of existing partnership..................... Investment by Terrell......... Total capital of new partnership..................... Terrell’s capital credit ($180,000 X 30%)............

9,000

16,000

4,000 3,200 800 54,000

$118,000 62,000 $180,000 $ 54,000

Investment by new partner, Terrell .............. $ 62,000 Terrell’s capital credit....... 54,000 Bonus to old partners ...... $ 8,000 (4) Cash .................................................................... G. Donley, Capital ($6,000 X 50%)..................... C. Lamar, Capital ($6,000 X 40%) ...................... J. Pinkston, Capital ($6,000 X 10%) .................. J. Terrell, Capital......................................... Total capital of existing partnership.................... Investment by Terrell........ Total capital of new partnership....................

$118,000 42,000 $160,000

42,000 3,000 2,400 600 48,000

*PROBLEM K-4 (Continued) Terrell’s capital credit ($160,000 X 30%)..............

$48,000

Investment by new partner .............................. Terrell’s capital credit.......... Bonus to new partner..........

$42,000 48,000 $ 6,000

(b) (1) Total capital after admission ($32,000 ÷ 20%) .............. Total capital before admission...................................... Cash investment by Terrell ...........................................

$160,000 118,000 $ 42,000

(2) Decrease in Lamar’s equity ($48,000 – $32,000) ............

$ 16,000

Lamar’s income ratio ..................................................... Bonus to new partner ($16,000 ÷ 40%) .........................

40% $ 40,000

*PROBLEM K-5

(a) (1)

(2)

(3)

Posada, Capital ................................................... Trayer, Capital ............................................. Emig, Capital ...............................................

30,000

Posada, Capital ................................................... Emig, Capital ...............................................

30,000

Posada, Capital ................................................... Trayer, Capital ($4,000 X 5/8) ............................. Emig, Capital ($4,000 X 3/8)................................ Cash .............................................................

30,000 2,500 1,500

Posada’s capital balance .... Payment to Posada ............. Bonus to Posada .................

30,000

34,000

$30,000 34,000 $ 4,000

(4) Posada, Capital ................................................... Trayer, Capital ($8,000 X 5/8) ...................... Emig, Capital ($8,000 X 3/8) ........................ Cash ............................................................. Posada’s capital balance .... Payment to Posada ............. Bonus to old partners .........

15,000 15,000

30,000 5,000 3,000 22,000

$30,000 22,000 $ 8,000

(b) (1) Emig’s capital after withdrawal ...................................... Emig’s capital before withdrawal................................... Bonus to Emig................................................................. Emig’s income ratio with Trayer .................................... Total bonus ($3,600 ÷ 3/8) .......................................

$43,600 40,000 3,600 3/8 $ 9,600

(2) Posada’s capital balance................................................ Total bonus to other partners ........................................ Cash paid to Posada ...............................................

$30,000 (9,600) $20,400

APPENDIX L Accounting for Sole Proprietorships ASSIGNMENT CLASSIFICATION TABLE Learning Objectives

Questions

Identify the differences in equity accounts between a corporation and a sole proprietorship.

1, 2

2. Understand what account transactions increase and decrease owner’s equity.

3, 4

Describe the differences between a retained earnings statement and an owner’s equity statement.

Explain the process of closing the books for a sole proprietorship.

Brief Exercises

Exercises

Problems

1, 2, 3

1, 3

1, 2, 3

2, 3

1, 2, 3

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Prepare income statement, owner’s equity statement, and balance sheet.

Moderate

15–20

Prepare financial statements, closing entries, and post-closing trial balance.

Moderate

15–20

Prepare financial statements, closing entries, and post-closing trial balance.

Moderate

15–20

ANSWERS TO QUESTIONS 1.

The accounting equation for a sole proprietorship is Assets = Liabilities + Owner’s Equity (rather than Stockholders’ Equity).

A corporation has two separate equity accounts – Common Stock and Retained Earnings. A sole proprietorship has a single equity account – Owner’s Capital.

Owner’s equity is increased by revenues and investments by the owner and it is decreased by expenses and withdrawals (drawings) by the owner.

It is correct that the company’s cash increased. However, investments of cash into the company by the owner are not revenue. Instead, they increase the Owner’s Capital account directly.

An owner’s equity statement begins with the beginning balance in the owner’s capital account. Then it adds any investments made by the owner during that period as well as net income for the period. It then subtracts any withdrawals (drawings) by the owner during that period, as well as a net loss.

Assuming that the company had net income, the entries to close the accounts would be: i. Debit each revenue account for its balance, and credit Income Summary for total revenues. ii. Debit Income Summary for total expenses, and credit each expense account for its balance. iii. Debit Income Summary and credit Owner’s Capital for the amount of net income. (The reverse is true for a loss). iv. Debit Owner’s Capital for the balance in the Owner’s Drawing account, and credit Owner’s Drawing for the same amount.

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE L-1 Assets + – NE

(a) (b) (c)

Liabilities NE NE NE

Owner’s Equity + – NE

BRIEF EXERCISE L-2 R NOE E

Received cash for services performed. Paid cash to purchase equipment. Paid employee salaries.

BRIEF EXERCISE L-3

1. 2. 3. 4. 5. 6.

Accounts Payable Advertising Expense Service Revenue Accounts Receivable A. L. Brislin, Capital A. L. Brislin, Drawing

(a) Debit Effect Decrease Increase Decrease Increase Decrease Increase

(b) Credit Effect Increase Decrease Increase Decrease Increase Decrease

SOLUTIONS TO EXERCISES EXERCISE L-1 (a) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Owner invested $12,000 cash in the business. Purchased equipment for $5,000, paying $2,000 in cash and the balance of $3,000 on account. Paid $750 cash for supplies. Earned $6,300 in service revenue, receiving $2,600 cash and $3,700 on account. Paid $1,500 cash on accounts payable. Owner withdrew $2,000 cash for personal use. Paid $650 cash for rent. Collected $450 cash from customers on account. Paid salaries and wages of $2,900. Incurred $500 of utilities expense on account.

(b) Investment............................................................................... Service revenue ...................................................................... Drawings ................................................................................. Rent expense .......................................................................... Salaries and wages expense ................................................. Utilities expense ..................................................................... Increase in owner’s equity .....................................................

$12,000 6,300 (2,000) (650) (2,900) (500) $12,250

(c) Service revenue ...................................................................... Rent expense .......................................................................... Salaries and wages expense ................................................. Utilities expense ..................................................................... Net income ..............................................................................

$ 6,300 (650) (2,900) (500) $ 2,250

EXERCISE L-2 KURT COOPER, ATTORNEY Owner’s Equity Statement For the Year Ended December 31, 2017 Kurt Cooper, Capital, January 1 ............................................ Add: Net income................................................................... Less: Drawings...................................................................... Kurt Cooper, Capital, December 31.......................................

$ 23,000 (a) 149,000 (b) 172,000 74,000 $ 98,000 (c)

Supporting Computations (a) Assets, January 1, 2017 $ 85,000 Liabilities, January 1, 2017 ....................................................... (62,000) Capital, January 1, 2017 ........................................................ $ 23,000 (b) Legal service revenue ................................................................ $360,000 Total expenses .......................................................................... (211,000) Net income ............................................................................. $149,000 (c) Assets, December 31, 2017 ................................................... $168,000 Liabilities, December 31, 2017 .................................................. (70,000) Capital, December 31, 2017................................................... $ 98,000 EXERCISE L-3 (a)

LORENZ COMPANY Income Statement For the Year Ended July 31, 2017 Revenues Service revenue.......................................... Rent revenue .............................................. Total revenues .................................... Expenses Salaries and wages expense ..................... Utilities expense ......................................... Depreciation expense ................................ Total expenses.................................... Net loss...............................................................

$65,100 6,500 $71,600 55,700 14,900 4,000 74,600 ($ 3,000)

EXERCISE L-3 (Continued) LORENZ COMPANY Owner’s Equity Statement For the Year Ended July 31, 2017 J. D. Lorenz, Capital, August 1, 2013 ................ Less: Net loss .................................................... Drawings .................................................. J. D. Lorenz, Capital, July 31, 2014.................... (b)

$45,200 $ 3,000 14,000

17,000 $28,200

LORENZ COMPANY Balance Sheet July 31, 2017 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Total current assets .............................. Property, plant, and equipment Equipment ..................................................... Less: Accumulated depreciation ................ Total assets............................................

$14,940 8,780 $23,720 15,900 5,400

10,500 $34,220

Liabilities and Owner’s Equity Current liabilities Accounts payable ......................................... Unearned rent revenue ................................. Total current liabilities .......................... Owner’s equity J. D. Lorenz, Capital ...................................... Total liabilities and owner’s equity ......

$ 4,220 1,800 $ 6,020 28,200 $34,220

SOLUTIONS TO PROBLEMS PROBLEM L-1

(a)

SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2017 Revenues Service revenue........................................... Expenses Gasoline expense........................................ Rent expense............................................... Advertising expense ................................... Insurance expense ...................................... Maintenance and repairs expense ............. Total expenses..................................... Net income ..........................................................

$8,600 $2,500 1,200 500 400 400 5,000 $3,600

SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2017 Steven Ramfond Capital, May 1 ......................... Add: Investments.............................................. Net income ...............................................

$ $45,000 3,600

Less: Drawings .................................................. Steven Ramfond Capital, May 31 .......................

48,600 48,600 1,700 $46,900

SKYLINE FLYING SCHOOL Balance Sheet May 31, 2017 Assets Cash......................................................................................... Accounts receivable ............................................................... Equipment ............................................................................... Total assets .....................................................................

$ 6,500 7,200 64,000 $77,700

PROBLEM L-1 (Continued) SKYLINE FLYING SCHOOL Balance Sheet (Continued) May 31, 2017 Liabilities and Owner’s Equity Liabilities Notes payable.................................................................. Accounts payable ........................................................... Total liabilities.......................................................... Owner’s equity Steven Ramfond, Capital ................................................ Total liabilities and owner’s equity ........................

(b)

$30,000 800 30,800 46,900 $77,700

SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2017 Revenues Service revenue ($8,600 + $900) ................. Expenses Gasoline expense ($2,500 + $3,300)............ Rent expense................................................ Advertising expense .................................... Insurance expense....................................... Maintenance and repairs expense .............. Total expenses...................................... Net income ...........................................................

$9,500 $5,800 1,200 500 400 400 8,300 $1,200

SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2017 Steven Ramfond, Capital, May 1......................... Add: Investments .............................................. Net income ................................................ Less: Drawings ................................................... Steven Ramfond, Capital, May 31.......................

$ $45,000 1,200

46,200 46,200 1,700 $44,500

PROBLEM L-2

(a)

WHITMORE COMPANY Income Statement For the Year Ended December 31, 2017 Revenues Service revenue............................................. Expenses Salaries and wages expense ........................ Advertising expense ..................................... Depreciation expense ................................... Insurance expense ........................................ Supplies expense .......................................... Interest expense ............................................ Total expenses....................................... Net income ............................................................

$79,000 $39,000 12,000 6,000 4,000 3,700 1,000 65,700 $13,300

WHITMORE COMPANY Owner’s Equity Statement For the Year Ended December 31, 2017 B. Whitmore Capital, January 1 ............................................. Add: Net income ................................................................... Less: Drawing ........................................................................ B. Whitmore Capital, December 31........................................

$36,000 13,300 49,300 12,000 $37,300

PROBLEM L-2 (Continued) WHITMORE COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash ............................................................... $20,800 Accounts receivable ..................................... 15,400 Supplies ......................................................... 2,300 Prepaid insurance ......................................... 4,800 Total current assets .............................. Property, plant, and equipment Equipment ..................................................... 44,000 Less: Accumulated depreciation ................ 18,000 Total assets............................................

$43,300 26,000 $69,300

Liabilities and Owner’s Equity Current liabilities Notes payable................................................ Accounts payable ......................................... Salaries and wages payable......................... Interest payable............................................. Total current liabilities .......................... Long-term liabilities Notes payable................................................ Total liabilities........................................ Owner’s equity B. Whitmore, Capital ..................................... Total liabilities and owner’s equity ......

$10,000 8,000 3,000 1,000 $22,000 10,000 32,000 37,300 $69,300

PROBLEM L-2 (Continued) (b) Date Dec. 31 31

31 31

General Journal Account Titles and Explanation

Ref.

Debit

Service Revenue Income Summary

400 350

79,000

Income Summary Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries and Wages Expense Interest Expense

350 610 631 711 722 726 905

65,700

Income Summary B. Whitmore, Capital

350 301

13,300

B. Whitmore, Capital B. Whitmore, Drawing

301 306

12,000

J14 Credit 79,000 12,000 3,700 6,000 4,000 39,000 1,000

13,300 12,000

(c)

Date Jan. 1 Dec. 31 31

Explanation Balance Closing entry Closing entry

Whitmore Capital Ref. Debit  J14 J14 12,000

Credit 13,300

Whitmore Drawing Date Dec. 31 31

Explanation Balance Closing entry

Ref.  J14

Debit 12,000

No. 301 Balance 36,000 49,300 37,300 No. 306

Credit 12,000

Balance 12,000 0

PROBLEM L-2 (Continued)

Date Dec. 31 31 31

Explanation Closing entry Closing entry Closing entry

Income Summary Ref. Debit J14 J14 65,700 J14 13,300

Credit 79,000

Service Revenue Date Dec. 31 31

Date Dec. 31 31

Debit

No. 400

Explanation Balance Closing entry

Ref.  J14

Credit 79,000

79,000

Balance 79,000 0

Explanation Balance Closing entry

Advertising Expense Ref. Debit  12,000 J14

No. 610 Balance 12,000 0

Explanation Balance Closing entry

Supplies Expense Ref. Debit  3,700 J14

Credit 12,000

Credit 3,700

Depreciation Expense Date Dec. 31 31

Date Dec. 31 31

No. 350 Balance 79,000 13,300 0

Explanation Balance Closing entry

Ref.  J14

Debit 6,000

Explanation Balance Closing entry

Insurance Expense Ref. Debit  4,000 J14

No. 631 Balance 3,700 0

No. 711 Credit 6,000

Credit 4,000

Balance 6,000 0

No. 722 Balance 4,000 0

PROBLEM L-2 (Continued) Salaries and Wages Expense Date Dec. 31 31

Date Dec. 31 31

(d)

Explanation Balance Closing entry

Ref.  J14

Debit 39,000

Explanation Balance Closing entry

Interest Expense Ref. Debit 1,000  J14

No. 726 Credit 39,000

Balance 39,000 0

1,000

No. 905 Balance 1,000 0

Debit

Credit

WHITMORE COMPANY Post-Closing Trial Balance December 31, 2017

Cash.................................................................... Accounts Receivable......................................... Supplies.............................................................. Prepaid Insurance.............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Notes Payable .................................................... Accounts Payable .............................................. Salaries and Wages Payable............................. Interest Payable ................................................. B. Whitmore, Capital..........................................

$20,800 15,400 2,300 4,800 44,000

$87,300

$18,000 20,000 8,000 3,000 1,000 37,300 $87,300

PROBLEM L-3

(a)

RICK POOL COMPANY Income Statement For the Year Ended December 31, 2017 Revenues Service revenue............................................. Expenses Salaries and wages expense........................ Advertising expense ..................................... Supplies expense.......................................... Insurance expense........................................ Depreciation expense ................................... Interest expense............................................ Total expenses....................................... Net income ............................................................

$88,000 $42,000 12,000 5,700 5,000 4,000 500 69,200 $18,800

RICK POOL COMPANY Owner’s Equity Statement For the Year Ended December 31, 2017 Rick Pool Capital, January 1 .................................................. Add: Net income ................................................................... Less: Drawings ...................................................................... Rick Pool Capital, December 31 ............................................

$25,000 18,800 43,800 10,000 $33,800

PROBLEM L-3 (Continued) RICK POOL COMPANY Balance Sheet December 31, 2017 Assets Current assets Cash ............................................................... $13,600 Accounts receivable ..................................... 15,400 Supplies ......................................................... 1,500 Prepaid insurance ......................................... 2,800 Total current assets............................... Property, plant, and equipment Equipment...................................................... 34,000 Less: Accumulated depreciation ................ 8,000 Total assets............................................

$33,300 26,000 $59,300

Liabilities and Owner’s Equity Current liabilities Notes payable – (Current portion)................ Accounts payable.......................................... Salaries and wages payable ......................... Interest payable ............................................. Total current liabilities........................... Long-term liabilities Notes payable................................................ Total liabilities........................................ Owner’s equity Rick Pool, Capital .......................................... Total liabilities and owner’s equity.......

$10,000 6,000 3,000 500 $19,500 6,000 25,500 33,800 $59,300

PROBLEM L-3 (Continued) (b) Date Dec. 31 31

31 31

General Journal Account Titles and Explanation

Ref.

Debit

Service Revenue Income Summary

400 350

88,000

Income Summary Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries and Wages Expense Interest Expense

350 610 631 711 722 726 905

69,200

Income Summary Rick Pool, Capital

350 301

18,800

Rick pool, Capital Rick pool, Drawing

301 306

10,000

J14 Credit 88,000 12,000 5,700 4,000 5,000 42,000 500

18,800 10,000

(c)

Date Jan. 1 Dec. 31 31

Explanation Balance Closing entry Closing entry

Rick Pool, Capital Ref. Debit  J14 J14 10,000

Credit 18,800

Rick Pool, Drawing Date Dec. 31 31

Explanation Balance Closing entry

Ref.  J14

Debit 10,000

No. 301 Balance 25,000 43,800 33,800 No. 306

Credit 10,000

Balance 10,000 0

PROBLEM L-3 (Continued)

Date Dec. 31 31 31

Explanation Closing entry Closing entry Closing entry

Income Summary Ref. Debit J14 J14 69,200 J14 18,800

Credit 88,000

Service Revenue Date Dec. 31 31

Date Dec. 31 31

No. 400

Explanation Balance Closing entry

Ref.  J14

Debit

Credit 88,000

88,000

Balance 88,000 0

Explanation Balance Closing entry

Advertising Expense Ref. Debit  12,000 J14

No. 610 Balance 12,000 0

Explanation Balance Closing entry

Supplies Expense Ref. Debit  5,700 J14

Credit 12,000

Credit 5,700

Depreciation Expense Date Dec. 31 31

Date Dec. 31 31

No. 350 Balance 88,000 18,800 0

Explanation Balance Closing entry

Ref.  J14

Debit 4,000

Explanation Balance Closing entry

Insurance Expense Ref. Debit  5,000 J14

No. 631 Balance 5,700 0

No. 711 Credit 4,000

Credit 5,000

Balance 4,000 0

No. 722 Balance 5,000 0

PROBLEM L-3 (Continued) Salaries and Wages Expense Date Dec. 31 31

Date Dec. 31 31

(d)

Explanation Balance Closing entry

Ref.  J14

Debit 42,000

Explanation Balance Closing entry

Interest Expense Ref. Debit  500 J14

No. 726 Credit 42,000

Balance 42,000 0

500

No. 905 Balance 500 0

Debit

Credit

RICK POOL COMPANY Post-Closing Trial Balance December 31, 2017

Cash..................................................................... Accounts Receivable.......................................... Supplies .............................................................. Prepaid Insurance............................................... Equipment ........................................................... Accumulated Depreciation—Equipment........... Notes Payable ..................................................... Accounts Payable............................................... Salaries and Wages Payable.............................. Interest Payable .................................................. Rick Pool, Capital ............................................... Totals

$13,600 15,400 1,500 2,800 34,000

$67,300

$ 8,000 16,000 6,000 3,000 500 33,800 $67,300

Appendix M Pricing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises

Learning Objectives

Questions

Exercises

Problems

1. Compute a target cost when the market determines a product price.

1, 2

1, 2, 3

2. Compute a target selling price using cost-plus pricing.

3, 4, 5, 6, 7, 8

2, 3, 4, 5

3, 4, 5, 6, 7

1, 2

3. Use time-and-material pricing to determine the cost of services provided.

9, 10

8, 9, 10

4. Determine a transfer price using the negotiated, costbased, and market-based approaches.

11, 12, 13, 14, 15, 16, 17

7, 8, 9

11, 12, 13, 14, 15, 16, 17

4, 5, 6

5. Determine prices using absorption-cost pricing and variable-cost pricing.

18, 19

10, 11

18, 19, 20

7, 8

ASSIGNMENT CHARACTERISTICS TABLE Problem Number

Description

Difficulty Level

Time Allotted (min.)

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use cost-plus pricing to determine various amounts.

Simple

20–30

Use time-and-material pricing to determine bill.

Simple

20–30

Determine minimum transfer price with no excess capacity and with excess capacity.

Moderate

20–30

Determine minimum transfer price with no excess capacity.

Moderate

20–30

Determine minimum transfer price under different situations.

Moderate

20–30

Compute the target price using absorption-cost pricing and variable-cost pricing.

Moderate

30–40

Compute various amounts using absorption-cost pricing and variable-cost pricing.

Complex

40–50

ANSWERS TO QUESTIONS 1.

The first type of pricing environment is where the company is a price taker; that is, the company does not set the price, but instead the price is set by a competitive market. In the second type of situation, the company sets the price. This happens most often when the product is specially made for a customer or there are few or no other producers capable of manufacturing a similar item.

A company focuses on target cost when it cannot influence the market price. The target cost is determined by subtracting the desired profit per unit from the market-determined selling price.

The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost)

The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost) $23.40 = $18 + (30% X $18)

The basic formula to compute the markup percentage is: Markup percentage =

Desired ROI per unit Total unit cost

Some of the factors that affect a company’s desired ROI are competitive and market conditions, political and legal issues, and other relevant risk factors.

Total cost base per unit, excluding selling and administrative expenses ......................... $60 Selling and administrative expenses per unit .................................................................. 15 Total unit cost ................................................................................................................. $75 The markup percentage is computed as follows: $6 = 8% $75

Variable cost per unit ...................................................................................................... Fixed cost per unit .......................................................................................................... Desired ROI per unit ....................................................................................................... Target selling price ......................................................................................................... The markup percentage is:

$16 9 6 $31

= 24%

$25 9.

Time-and-material pricing is most often used in service industries. It involves two pricing rates, one for the labor used on a job, while the other involves the materials used. Each typically has a profit rate factored into it.

10.

The material loading charge is a fee added to each bill to cover the costs of purchasing, receiving, handling, and storing materials, plus any desired profit margin on the materials themselves. The material loading charge is expressed as a percentage of the total estimated costs of parts and materials for the year.

Questions Appendix M (Continued) 11.

A transfer price is the price used to record the transfer of goods or services between two divisions in the same company. Setting a fair transfer price is important because an improper price will benefit one division while hurting the other.

12.

The objective of an appropriate transfer price is to maximize the return to the whole company and not cause divisional performance to decline.

13.

The three approaches for determining transfer prices are: (1) Negotiated transfer prices (2) Cost-based transfer prices (3) Market-based transfer prices

14.

When a cost-based transfer price is used, the exchange of goods between divisions is recorded by using the costs incurred by the selling division. This may either be the variable costs or the variable costs with an additional markup to cover fixed costs. The primary advantage of this approach is that it is relatively simple to use. The disadvantage is that it understates the selling division’s contribution to the company’s total contribution margin. Finally, it reduces the selling division’s incentive to control cost.

15.

The general formula for determining the minimum transfer price that the selling division should be willing to accept is: Minimum transfer price = Variable cost + Opportunity cost

16.

When determining the minimum transfer price, the opportunity cost is the contribution margin that would be received if the goods were sold externally.

17.

A company is likely to use a negotiated transfer price rather than a market-based price when the selling division has excess capacity, and is therefore eager to expand production, or when a market price does not exist (e.g., for a special order).

18.

The absorption-cost approach defines the cost base as manufacturing cost. Therefore, it excludes variable and fixed selling and administrative costs.

19.

The markup percentage using variable-cost pricing would be: $3 + $9 = 75% $16

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE M-1 In order to obtain a profit of $10 per drive, Ortega must set its target cost at $35 per drive ($45 – $10). It will then need to form a design team that will design a product that will meet quality specifications without exceeding the target cost.

BRIEF EXERCISE M-2 Direct materials ....................................................................................... Direct labor .............................................................................................. Variable manufacturing overhead .......................................................... Fixed manufacturing overhead .............................................................. Variable selling and administrative expenses....................................... Fixed selling and administrative expenses ........................................... Total unit cost ..................................................................................

$12 8 6 14 4 12 $56

Total unit cost + (Markup percentage X Total unit cost) = Target selling price $56 + (30% X $56) = $72.80

BRIEF EXERCISE M-3 ROI per unit = (Total investment X Desired ROI percentage) Number of units = ($10,000,000 X 12%) 50,000

= $24

BRIEF EXERCISE M-4 The markup percentage would be: $30 $36 + $24 + $18 + $40 + $14 + $28

18.75%

BRIEF EXERCISE M-5 The markup percentage is equal to Desired ROI per unit divided by total unit cost. The desired ROI per unit is computed as follows: Desired ROI per unit =

$1,500,000 X 20%

= $30

10,000 units The total unit cost is computed as follows: Total unit cost = $1,100,000 + $100,000 = $120 10,000 units The markup percentage is computed as follows: Desired ROI per unit = Total unit cost

$30 = 25% $120

BRIEF EXERCISE M-6 Rooney’s total bill would equal: (10.5 hours X $42) + $700 + ($700 X 40%) = $1,421 BRIEF EXERCISE M-7 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. The opportunity cost is equal to its contribution margin on goods sold to external parties. Thus, the minimum transfer price in this case is: Minimum transfer price = $25 + ($45 – $25) = $45. BRIEF EXERCISE M-8 If the division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is: Minimum transfer price = $25 + $0 = $25.

BRIEF EXERCISE M-9 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. In this case the minimum transfer price is: Minimum transfer price = $27 + ($45 – $25) = $47.

BRIEF EXERCISE M-10 The markup percentage using the absorption-cost approach is calculated by including only manufacturing costs in the cost base. Therefore, all costs related to selling and administration are excluded from the cost base and added back in the numerator. $30 + ($14 + $28)

Markup percentage =

= 61.02%

$36 + $24 + $18 + $40 BRIEF EXERCISE M-11 The markup percentage using variable-cost pricing is calculated by including only variable costs in the cost base. Therefore, all fixed costs are excluded from the cost base and added back in the numerator. Markup percentage =

$30 + ($40 + $28)

= 106.52%

$36 + $24 + $18 + $14 5 ($8 – $3)

SOLUTIONS TO EXERCISES EXERCISE M-1 (a)

The target cost formula is: Target cost = Market price – Desired profit. In this case, the market price is $20 and the desired profit is $8 (40% X $20). Therefore the target cost is $12 ($20 – $8).

(b)

Target costing is particularly helpful when a company faces a competitive market. In this case, the price is affected by supply and demand, so no company in the industry can affect price. Therefore to earn a profit, companies must focus on controlling costs.

EXERCISE M-2 The following formula may be used to determine return on investment Investment $8,000,000

X X

ROI percentage 20%

= Return on investment = $1,600,000

Return on investment per unit is then $16 ($1,600,000 ÷ 100,000) The target cost is therefore $74 computed as follows: Target cost $74

= Market price – Desired profit = $90 – $16

EXERCISE M-3 (a)

(1) In this case the selling price would be $125 ($100 + [$100 X 25%]). The problem with the $125 is that it is unlikely that Leno will be able to sell any All-Body suits at that price. Market research seems to indicate that it will sell for only $100. (2) One way that Leno might consider manufacturing the All-Body swimsuit is if it has excess capacity and therefore manufacturing the All-Body will not affect fixed costs. Thus if the company can cover its variable costs, it might want to sell at the $100 level.

(b)

In this case, the amount would be the selling price of $100.

EXERCISE M-3 (Continued) (c)

The highest acceptable cost would be the target cost. The target cost is $75 as shown below: Target cost = Market price – Desired profit $75 = $100 – $25

EXERCISE M-4 (a) Total cost per unit: Direct materials.......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ($300,000/30,000).................................................................... Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ($150,000/30,000)....................................................................

Per Unit $17 8 11 10 4 5 $55

(b) Target selling price = $55 + (40% X $55) = $77 EXERCISE M-5 (a) Total cost per unit: Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ($3,000,000/500,000)............................................................... Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ($1,500,000/500,000)............................................................... (b) Desired ROI per unit = (25% X $28,000,000)/500,000 = $14

Per Unit $ 7 11 15 6 14 3 $56

EXERCISE M-5 (Continued) (c) Markup percentage using total cost per unit: $14 $56

25%

(d) Target selling price = $56 + ($56 X 25%) = $70 EXERCISE M-6 (a)

Total cost per session: Direct materials ................................................. Direct labor ........................................................ Variable overhead ............................................. Fixed overhead ($950,000 ÷ 1,000) ................... Variable selling & administrative expenses .... Fixed selling & administrative expenses ($500,000 ÷ 1,000) .......................................... Total cost per session ..............................

Per Session $ 20 400 50 950 40 500 $1,960

(b)

Desired ROI per session = (20% X $2,352,000) ÷ 1,000 = $470.40

(c)

Mark-up percentage on total cost per session = $470.40 ÷ $1,960 = 24%

(d)

Target price per session = $1,960 + ($1,960 X 24%) = $2,430.40

EXERCISE M-7 (a) Fixed manufacturing overhead per unit = $1,500,000 = $500 per unit 3,000 Fixed selling and administrative = $324,000 = $108 per unit expenses per unit 3,000 (b) Desired ROI per unit = 20% X $54,000,000 = $3,600 per unit 3,000

EXERCISE M-7 (Continued) (c) Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ................................................. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses.............................. Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price ....................................................................

Per Unit $ 380 290 72 500 55 108 1,405 3,600 $5,005

EXERCISE M-8 (a)

Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead

Total Per Hour ÷ Hours = Charge

$228,000

7,600

$30

38,000 15,200 $281,200

÷ ÷ ÷

7,600 7,600 7,600

= = =

5 2 37 30 $67

Profit margin Rate charged per hour of labor

(b)

Total Invoice Cost, Material Material Loading Loading Parts and Charges ÷ Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Profit margin Material loading percentage

$42,500 9,000 51,500 24,000 $75,500

÷ ÷ ÷

$400,000 $400,000 $400,000

= = =

12.875% 6.000% 18.875% 20.000% 38.875%

EXERCISE M-8 (Continued) (c) Job: Pace Corporation—Rebuild spot welder Labor charges 40 hours @ $67 ............................................ Material charges Cost of parts and materials......................... Material loading charge (38.875% X $2,000)....................................

$2,680.00 $2,000.00 777.50

2,777.50

Total price of labor and material ..........

$5,457.50

EXERCISE M-9 (a)

Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead

Total Per Hour ÷ Hours = Charge

$150,000

6,250

$24.00

30,000 15,000 $195,000

÷ ÷ ÷

6,250 6,250 6,250

= = =

4.80 2.40 31.20 38.00 $69.20

Profit margin Rate charged per hour of labor

(b)

Total Material Invoice Cost, Material Loading Loading Parts and Charges ÷ Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Profit margin Material loading percentage

$34,000 15,000 49,000

$700,000

7.00%

42,000 $91,000

÷ ÷

$700,000 $700,000

6.00% 13.00% 80.00% 93.00%

EXERCISE M-9 (Continued) (c) Job: Buil Builders Labor charges 80 hours @ $69.20 ............................... Material charges Cost of parts and materials................. Material loading charge (93% X $40,000) ................................ Total price of labor and material...

$ 5,536 $40,000 37,200

77,200 $82,736

EXERCISE M-10 (a)

Total Cost Hourly labor rate: Restorers’ wages and fringes Overhead costs: Administrative salaries & fringes Other overhead costs Total hourly cost

Total Hours ÷

Hourly = Charge

$270,000 ÷

12,000 =

$22.50

54,000 ÷

12,000 =

4.50

24,000 ÷ $348,000 ÷

12,000 = 12,000 =

2.00 $29.00

Profit margin = Hourly rate – total hourly cost = $70.00 – $29.00 = $41.00

EXERCISE M-10 (Continued) (b) Material Loading Charges Overhead costs: Purchasing agent’s salary and fringes Administrative salaries and fringes Other overhead costs Total

Total Invoice Cost, Parts & Materials ÷

Material Loading = Percentage

$ 67,500 21,960 89,460 ÷

$1,260,000

7.10%

77,490 ÷ $166,950 ÷

$1,260,000 $1,260,000

= =

6.15% 13.25%

Material loading charge (with profit) Material loading charge (without profit) Profit margin on materials (c) Labor charges: 150 hours @ $70 Material charges: Cost of parts & materials Material loading charge ($60,000 X 83.25%) Total price of labor and materials

83.25% 13.25% 70.00%

$ 10,500 $60,000 49,950

109,950 $120,450

EXERCISE M-11 (a)

The minimum transfer price is: Minimum transfer price = Variable cost + opportunity cost Given that the Small Motor Division has excess capacity, the minimum transfer price is the variable cost of $11 per unit.

(b)

Given no excess capacity, the minimum transfer price is $35, which is its variable cost plus the lost contribution margin.

EXERCISE M-11 (Continued) (c)

The level of capacity plays a significant role in determining the appropriate transfer price. If a division has no excess capacity, why should it sell its product below a selling price it can obtain in an outside market? Conversely, if it has excess capacity, as long as it receives more than its variable cost, it has a net gain.

EXERCISE M-12 (a) As indicated, FrameBody has excess capacity and therefore should be willing to accept any price that equals or exceeds its variable cost. 1.

The effect on Cycle Division is as follows:

Selling price Variable cost of goods sold Body frame Other variable costs Contribution margin

Purchase from FrameBody $2,200

Present Situation $2,200 $300 900

1,200 $1,000

$280 900

1,180 $1,020

In this case, Cycle Division makes $20 ($1,020 – $1,000) more per cycle sold and therefore if it sells 1,000 cycles, it makes an additional $20,000. 2.

The effect on FrameBody is that it makes $10 on each frame sold as shown below: Selling price to Cycle Division Variable cost

$280 270 $ 10

Thus the FrameBody Division gains $10,000 ($10 X 1,000). 3.

As a result, the overall income for Ayala increases $30,000 ($20,000 from Cycle Division and $10,000 from FrameBody).

EXERCISE M-12 (Continued) (b) 1.

The answer would not change from (a)(1). Cycle Division would gain $20,000 if it purchased the frames from FrameBody.

However, FrameBody would incur a loss of $70,000 as computed below: Selling price to outside buyer Selling price to Cycle Division Lost contribution margin per cycle Number of cycles Lost contribution margin

350 280 $ 70 X 1,000 $70,000

The effect on the overall income to Ayala is a net loss of $50,000 as shown below: Cycle Division gain Frame Body loss Overall loss

$20,000 (70,000) ($50,000)

EXERCISE M-13 (a) The minimum transfer price that Benson should accept is: Minimum transfer price = ($37 – $3) + ($86 – $37) = $83 (b) The lost contribution margin per unit to the company is: Contribution margin lost by Benson [($86 – $37) – ($35 – $34)] .................................................... $48 Increased contribution margin to vehicle division ($80 – $35) ................................................. 45 Net loss in contribution margin............................................... $ 3 Total lost contribution margin is $3 X 200,000 units = $600,000 (c) If management insists that it wants Benson to provide the stereo units, and Benson is operating at full capacity, then it must be willing to pay the minimum transfer price for those units. Otherwise it will be penalizing the managers of Benson by not giving them adequate credit for their contribution to the corporation’s contribution margin.

EXERCISE M-14 The minimum transfer price on this special order would be: Minimum transfer price = ($140 – $6) + ($50 – $29) = $155. Since the $160 price offered by the Bathtub Division exceeds this minimum price, the offer should probably be accepted. However, given that the division is operating at full capacity, it should give some consideration to the chance that it may anger existing customers if it has to turn away business. EXERCISE M-15 (a) Minimum transfer price = ($130 – $8) + $0 = $122 (b) Minimum transfer price = ($130 – $8) + ($160 – $130) = $152 (c) No. By forcing the Appraisal Department to accept the $150 per appraisal price, management is penalizing the Appraisal department. If the department was allowed to sell its services to outside customers, it could earn $30 ($160 – $130) in contribution margin per appraisal. Forcing them to sell their services internally would allow them to earn only $28 ($150 – $122) in contribution margin. A loss of $2 per appraisal or a total of $2,400 (1,200 X $2) would result. EXERCISE M-16 (a) The minimum transfer price for Division B would be variable costs, which are $6 per unit ($7, variable cost – $1, variable selling expense). The maximum price would be the external price paid by Division A, which is $10 per unit. (b) Minimum transfer price = variable costs + opportunity cost Variable costs = $6 (as in (a)) Opportunity cost = (($7 – $5) X 15,000) ÷ 10,000 = $3 Therefore the minimum transfer price should be $9 ($6 + $3) The maximum price would still be the external price paid by Division A, which is $10 per unit.

EXERCISE M-16 (Continued) (c) Minimum transfer price = variable costs + opportunity cost Variable costs = $6.00 (as in (a)) Opportunity cost = (($12 – $7) X 5,000) ÷ 15,000 = $1.67 Therefore the minimum transfer price should be $7.67 ($6 + $1.67) The maximum price would still be the external price paid by Division A, which is $10 per unit. EXERCISE M-17 (a) Sales Less: Costs Variable costs Transfer costs Total costs Contribution to income

Division A $1,500

Division B $2,400

Total Company $3,900

$1,100 0 $1,100 $ 400

$1,200 1,500 $2,700 $ (300)

$2,300 1,500 $3,800 $ 100

(b) The opportunity cost is the market price. Transfers should be made at market prices less any avoidable costs. In the current situation, it would appear that no transfers would be made. (c) (i) (ii)

Maintain price, no transfers (500 X $1,500) – (500 X $1,100) = $200,000 Cut price, no transfers (1,000 X $1,200) – (1,000 X $1,100) = $100,000

(iii) Maintain price and transfers (500 X $2,400) + (500 X $1,500) – $1,700,000* = $250,000 *(500 X $2,300) + (500 X $1,100) The firm is better off by maintaining the current market price for Division A’s product and transferring 500 units to Division B. A transfer price within the range of $1,100 to $1,200 would be needed to motivate both divisional managers to engage in the transfers. An optimal transfer price cannot be determined from the information given (even with full information, the best transfer price in the range may not be determinable).

EXERCISE M-18 (a) Cost per unit: Direct materials.......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ($3,000,000/500,000) .............. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ($1,500,000/500,000) ..............................................................

Per Unit $ 7 11 15 6 14 3 $56

(b) Desired ROI per unit = (25% X $28,000,000)/500,000 = $14 (c) Absorption-cost pricing markup percentage (d) Variable-cost pricing markup percentage

$14 + ($14 + $3) = 79.49% ($7 + $11 + $15 + $6)

$14 + ($6 + $3) = 48.94% ($7 + $11 + $15 + $14)

EXERCISE M-19 (a) The cost base of absorption-cost pricing includes only manufacturing costs. All selling and administrative costs are excluded from the cost base and are added back in the numerator of the markup percentage. Absorption-cost pricing markup percentage

$24 + ($9 + $11) = 55% ($20 + $25 + $14 + $21)

(b) The cost base of variable-cost pricing includes only variable costs. All fixed costs are excluded from the cost base and are added back in the numerator of the markup percentage. Variable-cost pricing markup percentage

$24 + ($21 + $11) = 82.35% ($20 + $25 + $14 + $9)

EXERCISE M-20 (a) Fixed manufacturing = $1,500,000 = $500 per unit overhead per unit 3,000 Fixed selling and administrative = $324,000 = $108 per unit expenses per unit 3,000 (b) Desired ROI per unit = 20% X $54,000,000 = $3,600 per unit 3,000 (c)

$3,600 + ($55 + $108) Absorption-cost pricing = = 302.979% markup percentage $380 + $290 + $72 + $500 Target selling price = $1,242 + ($1,242 X 302.979%) = $5,005

(d) Variable-cost pricing markup percentage

$3,600 + ($500 + $108) = 527.980% $380 + $290 + $72 + $55

Target selling price = $797 + ($797 X 527.980%) = $5,005

SOLUTIONS TO PROBLEMS PROBLEM M-1A

(a) Direct materials.......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Variable selling and administrative expenses ......................... Variable cost per unit ................................................................

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$25 40 10 5 $80

Total Budgeted Cost Costs ÷ Volume = Per Unit $1,440,000 ÷ 80,000 = $18 960,000 ÷ $2,400,000 ÷

80,000 80,000

Variable cost per unit ................................................................ Fixed cost per unit..................................................................... Total cost per unit......................................................................

= =

12 $30 $ $

80 30 110

(b) Total cost per unit...................................................................... Markup........................................................................................ Desired ROI per unit ..................................................................

$ 110 X 40% $ 44

(c) Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price....................................................................

$110 44 $154

(d) Variable cost per unit ......... Fixed cost per unit.............. Total cost per unit...............

$ 80 40 $120

(same as above) ($1,440,000 + $960,000) ÷ 60,000

PROBLEM M-2A

(a) Direct materials ......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Variable cost per unit ...............................................................

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$ 50 26 20 19 $115

Total Budgeted Cost Costs ÷ Volume = Per Unit $ 600,000 ÷ 50,000 = $12 400,000 ÷ $1,000,000 ÷

50,000 50,000

= =

Variable cost per unit ............................................................... Fixed cost per unit .................................................................... Total cost per unit.....................................................................

8 $20 $115 20 $135

Desired ROI per unit = 25% X $1,000,000 = $5 50,000 Markup percentage =

= 3.70%

$135 Total cost per unit..................................................................... Desired ROI per unit ................................................................. Target selling price ................................................................... (b) Variable cost per unit .............................................

Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit

$135 5 $140

$115 (same as (a))

Total Budgeted Cost ÷ Volume = Per Unit Costs $ 600,000 ÷ 40,000 = $15 400,000 ÷ $1,000,000 ÷

40,000 40,000

10 $25

PROBLEM M-2A (Continued) Variable cost per unit ................................................................ Fixed cost per unit..................................................................... Total cost per unit...................................................................... Desired ROI per unit =

25% X $1,000,000

$115 25 $140

= $6.25

40,000 Markup percentage = $6.25 = 4.46% $140 Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price....................................................................

$140.00 6.25 $146.25

PROBLEM M-3A

(a) Computation of time charge rate Total Cost Hourly labor rate for repairs Shop employees’ wages and benefits Overhead costs Office employee’s salary and benefits Other overhead Total Profit margin Rate charged per hour of labor

Total Per Hour ÷ Hours = Charge

$108,000 ÷ 5,000 =

$21.60

23,500 ÷ 5,000 = 26,000 ÷ 5,000 = $157,500 ÷ 5,000 =

4.70 5.20 31.50 10.00 $41.50

(b) Computation of material loading charge Material Material Loading Total Invoice Cost, Loading Charges ÷ Parts and Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Total Profit margin Material loading percentage

$25,400 13,600 39,000 ÷ 16,000 ÷ $55,000 ÷

$100,000 100,000 100,000

= = =

39% 16% 55% 25% 80%

PROBLEM M-3A (Continued) (c) Price quotation for time and material SUTTON’S ELECTRONIC REPAIR SHOP Time and Material Price Quotation January 5, 2017 Job: Fix big screen TV set Labor charges: 4 hours @ $41.50.................... Material charges Cost of parts and materials......................... Material loading charge (80% X $200) ........ Total price of labor and material.......................

$166 $200 160

360 $526

PROBLEM M-4A

(a) Assuming no available capacity, the printing operation’s variable cost is $0.004 per page and its opportunity cost is $0.006 ($0.01 – $0.004) per page. The minimum transfer price would be $0.01 ($0.004 + $0.006). Therefore, the printing operation would not accept the internal transfer price of $0.007. (b) Assuming that the printing operation has available capacity, the printing operation’s variable cost is $0.004 and its opportunity cost is $0. The minimum transfer price would be $0.004 ($0.004 + $0). Therefore, in this case, the printing operation should accept the offer to print internally. The $0.007 transfer price would provide a contribution margin of $0.003 ($0.007 – $0.004) per page. Depending on its bargaining strength, the printing operation might want to ask for a transfer price higher than $0.007, since the company is saving money at any price below the $0.009 price that the line pays to outside printers. (c) The advantages of having all of the company’s printing done internally include: (1) ensuring that the company’s quality expectations are met, (2) ensuring that all projects are completed on a timely basis, and (3) ensuring that jobs are scheduled in a manner consistent with the company’s priorities. The primary disadvantages of forcing the printing operation to print internal work when it doesn’t feel it is in its best interest are: (1) the division manager loses control over the division’s performance, resulting in a loss of morale, and (2) the profitability of the division, as well as the company as a whole, will decline. (d) The printing operation would lose: ($0.01 – $0.007) X 500 pages X 1,500 copies

= ($2,250)

Business Books would save: ($0.009 – $0.007) X 500 pages X 1,500 copies = Overall loss to the company as a whole

1,500

= ($ 750)

PROBLEM M-5A

(a) The minimum transfer price is based on the variable cost of units transferred internally, plus the opportunity cost of units sold externally. The variable cost of internal sales would be $10 ($14.50 – $4.50). The opportunity cost would be $8 ($22.50 – $14.50). Therefore, the minimum transfer price would be $18 ($10 + $8). Since the $20 transfer price offered by the Board Division exceeds this minimum transfer price, the Chip Division should sell the chip internally. Since it is already at capacity, it probably needs to consider the implications to its existing customers. (b) If the Chip Division rejects the offer, each division will suffer a loss of contribution margin, as well as the company as a whole. The amount of this loss is calculated as: Lost contribution margin by Board Division: Cost of buying externally, per chip Cost of buying internally, per chip Increased cost, resulting in lower unit contribution margin Number of units purchased Total lost contribution margin Lost contribution margin by Chip Division: Unit contribution margin on internal sales ($21 – $10) Unit contribution margin on external sales ($22.50 – $14.50) Lost unit contribution margin Number of units sold Total lost contribution margin Overall lost contribution margin for the company

$22 21 1 X 40,000 $ 40,000

$11 8 3 X 40,000 120,000 $160,000

PROBLEM M-6A

(a) Assuming no available capacity, and that the number of new units produced would be equal to the number of standard units forgone, variable cost of the special pager would be $80 ($50 + $30) and the opportunity cost would be $45 ($95 – $50). Therefore, the minimum transfer price would be $125 ($80 + $45). Since this is higher than the $105 transfer price, the CD Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 12,000 special pagers, 16,000 standard pagers would be forgone, the minimum variable cost would be ($50 + $30) or $80 and the opportunity cost would be: Total contribution margin on standard pagers = ($95 – $50) X 16,000 Number of special pagers 12,000

= $60

Therefore, the minimum transfer price would be $140 [($50 + $30) + $60]. Since the $150 transfer price being offered exceeds the minimum transfer price of $140, the CD Division should accept the offer. (c) Assuming that the CD Division has available capacity, variable cost would be $80 ($50 + $30) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $80 ($80 + $0). Since the $100 transfer price being offered exceeds the $80 minimum transfer price, the offer should be accepted.

PROBLEM M-7A

(a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($1,600,000 ÷ 80,000) ............ Unit manufacturing cost ................................................... Markup: 50% X $90 .................................................................. Target selling price...................................................................

$ 20 40 10 20 90 45 $135

The markup of $45 per unit must cover selling and administrative expenses (variable and fixed) plus provide a desired return on investment. (b) Variable-cost pricing: Computation of total variable cost and target selling price Direct materials......................................................................... Direct labor................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Unit total variable cost...................................................... Markup: 80% X $75 .................................................................. Target selling price...................................................................

$ 20 40 10 5 75 60 $135

The markup of $60 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.

PROBLEM M-8A

Absorption-cost pricing (a) Step one—Computation of unit manufacturing cost: Direct materials ........................................................................ Direct labor............................................................................... Variable manufacturing overhead .......................................... Fixed manufacturing overhead ($120,000 ÷ 4,000) ................ Total manufacturing cost.................................................

Per Unit $100 70 20 30 $220

Step two—Computation of markup percentage to provide a 25% ROI: Markup = [(25% X $1,016,000) ÷ 4,000] + [$10 + ($102,000 ÷ 4,000)] = $99 = 45% Percentage $220 $220

(b) Step three—Computation of target price: Target price: $220 + [45% X $220) = $319 Proof of 25% ROI under absorption-cost pricing: ANDERSON WINDOWS INC. Budgeted Absorption-Cost Income Statement (Tinted Window) Revenues (4,000 units X $319) ........................................ Cost of goods sold (4,000 units X $220)......................... Gross profit ...................................................................... Selling and administrative expenses [(4,000 units X $10) + $102,000] .................................. Net income ....................................................................... Desired ROI =

$254,000

= 25%

$1,016,000 Markup percentage = $254,000 + $142,000 = 45% $880,000* *$220 X 4,000

$1,276,000 880,000 396,000 142,000 $ 254,000

PROBLEM M-8A (Continued) Variable-cost pricing (c) Step one—Computation of unit variable cost: Direct materials...................................................................... Direct labor............................................................................. Variable manufacturing overhead ........................................ Variable selling and administrative expenses ............................................................................ Total variable cost..........................................................

Per Unit $100 70 20 10 $200

Step two—Computation of markup percentage to provide a 25% ROI: Markup = [(25% X $1,016,000) ÷ 4,000] + [($120,000 + $102,000) ÷ 4,000] = $119 = 59.50% Percentage $200 $200

(d) Step three—Computation of target price: Target price: $200 + (59.5% X $200) = $319 Proof of 25% ROI under variable-cost pricing: ANDERSON WINDOWS INC. Budgeted Variable-Cost Income Statement (Tinted Window) Revenue (4,000 units X $319)............................ Variable costs (4,000 units X $200) .................. Contribution margin .......................................... Fixed costs Fixed manufacturing overhead costs........... Fixed selling and administrative expenses.... Net income ......................................................... Desired ROI =

$254,000

$1,276,000 800,000 476,000 $120,000 102,000

= 25%

$1,016,000 Markup percentage =

$222,000 + $254,000 $800,000

= 59.5%

222,000 $ 254,000

PROBLEM M-8A (Continued) (e) Both absorption-cost pricing and variable-cost pricing are used because they have differing merits. Absorption-cost pricing, especially when it includes full or all costs, is preferred by some because in the long-run all costs plus a normal profit margin must be covered. Using only variable costs, as the variable-cost pricing does, is thought to encourage decision makers to set too low a price in order to boost sales. Also, absorption-cost pricing is preferred because of its convenience. Absorption-cost data is more readily provided by most companies’ financial and cost accounting systems. The accounts and numbers used to prepare financial reports can be used for absorption-cost pricing. Variable-cost pricing is preferred by some, even though the basic accounting data is less accessible, because it is more consistent with cost-volume-profit analysis. In addition, it can be used in pricing special orders since it shows the incremental cost of one more unit or one more order. Variable-cost pricing also avoids arbitrary allocation of common fixed costs to individual product lines.

CDM

CURRENT DESIGNS

Repair-technician’s wages Fringe benefits Overhead

Total Cost $30,000 10,000 10,000 $50,000

Total Hours 2,000 2,000 2,000 2,000

Profit margin Rate charged per hour of labor Job: Composite kayak repair Labor charges: 3 hours @ $45 Materials charges Cost of parts and materials Materials loading charge (50% X $100) Total price of labor and material

$135 $100 50

150 $285

Per Hour Charge $15 5 5 25 20 $45

If this link does not work with a click, then copy the complete Download link and paste link in internet explorer/firefox/google chrome and get all files download successfully.