Introduction to Financial Accounting, 11th edition By Charles Horngren
Email: richard@qwconsultancy.com
Introduction to Financial Accounting, 11e (Horngren) Chapter 1 Accounting: The Language of Business Learning Objective 1.1 Questions 1) The primary purpose of financial accounting is to A) supply information for external users' decision making. B) provide data for internal users' decision making. C) produce data for income taxes. D) create an audit report. E) organize the data for management. Answer: A Diff: 1 Objective: L.O. 1-1
2) Footnotes are A) included in the audit report. B) an integral part of financial statement information. C) an appendix to the letter from corporate management. D) at the bottom of the report of the independent auditors. E) explanatory information in the statement of management's responsibility for preparation of financial statements. Answer: B Diff: 2 Objective: L.O. 1-1
3) Accountants analyze and record A) economic events. B) costs. C) revenues. D) financial statements. E) creditor statements. Answer: A Diff: 1 Objective: L.O. 1-1
4) Annual reports include all, but which of the following? A) A letter from corporate management B) Footnotes that explain many elements of the financial statements in more detail C) The report of the independent registered public accounting firm (auditors) D) Statements by both management and auditors on the company's internal controls E) The company's handbook for new employees Answer: E Diff: 2 Objective: L.O. 1-1
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5) The accountant at Forgum Corporation is asked to prepare the financial statements for the month of July. Which financial statement will he NOT prepare? A) Balance sheet B) Income statement C) Statement of earnings and taxation D) Statement of cash flows E) Statement of stockholders' equity Answer: C Diff: 1 Objective: L.O. 1-1
6) Which of the following would be classified as external users of financial statements? A) Creditors of the organization and the Internal Revenue Service B) Stockholders and the CFO of the organization C) Management of the organization and the audit firm D) Management of the organization and SEC E) Stockholders and middle managers of the organization Answer: A Diff: 2 Objective: L.O. 1-1
7) Which of the following individuals are most interested in management accounting information for Dotty Industries? A) Bankers who loan money to Dotty Industries B) The IRS, who Dotty Industries pays taxes to C) Stockholders who buy stock in Dotty Industries D) Management who work for Dotty Industries E) Suppliers who sell goods to Dotty Industries Answer: D Diff: 2 Objective: L.O. 1-1
8) The governmental agency that regulates the stock market and the financial reporting of firms that trade in the market is the A) Financial Accounting Standards Board. B) Internal Revenue Service. C) Public Company Accounting Oversight Board. D) Securities and Exchange Commission. E) Generally Accepted Accounting Board. Answer: D Diff: 1 Objective: L.O. 1-1
9) Accounting does not provide information that is useful in making decisions that have economic consequences. Answer: FALSE Diff: 2 Objective: L.O. 1-1
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10) Because officials in federal, state, and local governments are not in the business of making a profit, they do not need an understanding of accounting. Answer: FALSE Diff: 2 Objective: L.O. 1-1
11) Financial accounting serves external decision makers, such as suppliers, banks, government agencies, and stockholders. Answer: TRUE Diff: 1 Objective: L.O. 1-1
12) Management accounting serves internal decision makers, such as top executives and department heads. Answer: TRUE Diff: 1 Objective: L.O. 1-1
13) Managerial accounting serves external users while financial accounting serves internal users. Answer: FALSE Diff: 2 Objective: L.O. 1-1
14) The annual report is a document prepared by the board of directors and distributed to current and potential investors. Answer: FALSE Diff: 1 Objective: L.O. 1-1
15) It is against SEC regulations to promote the corporation in the annual report. Answer: FALSE Diff: 1 Objective: L.O. 1-1
16) Describe the differences between financial accounting and management accounting. Answer: Financial accounting focuses on the specific needs of decision makers external to the organization such as stockholders, suppliers, banks, and government agencies. Management accounting serves internal decision makers, such as top executives, department heads, college deans, hospital administrators, and people at other management levels within an organization. The two fields of accounting share many of the same procedures for analyzing and recording the effects of individual transactions. Diff: 2 Objective: L.O. 1-1
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Learning Objective 1.2 Questions 1) A liability that results from a purchase of goods or services on open account is referred to as a(n) A) accounts receivable. B) notes payable. C) accounts payable. D) notes receivable. E) capital stock. Answer: C Diff: 1 Objective: L.O. 1-2
2) Which of the following statements is true? A) Owners' equities are economic sacrifices after deducting liabilities. B) Assets are expected to benefit no one. C) Liabilities are future cash inflows. D) Assets are always the sum of liabilities and owners' equities. E) Owners' equities have priority over liabilities for assets upon liquidation. Answer: D Diff: 1 Objective: L.O. 1-2
3) The accounting equation can be stated as which of the following? A) Assets - liabilities = owners' equity B) Assets + liabilities = owners' equity C) Liabilities + assets = owners' equity D) Owners' equity + assets = liabilities E) Liabilities - owners' equity = assets Answer: A Diff: 2 Objective: L.O. 1-2
4) Which of the following describes a liability? A) Future economic benefit B) Economic obligations to creditors C) Paid-in capital D) Investment by owners E) Present value of customer future payments Answer: B Diff: 2 Objective: L.O. 1-2
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5) Notes Payable are classified as A) equity. B) assets. C) owner investments. D) liabilities. E) expenses. Answer: D Diff: 2 Objective: L.O. 1-2
6) Income taxes owed to the federal government would be classified as a(n) A) liability on the balance sheet. B) asset on the balance sheet. C) liability on the statement of cash flows. D) equity on the balance sheet. E) They would not appear on a financial statement. Answer: A Diff: 2 Objective: L.O. 1-2
7) An example of stockholders' equity is A) accounts payable. B) accounts receivable. C) capital stock. D) marketable securities. E) cash and cash equivalents. Answer: C Diff: 1 Objective: L.O. 1-2
8) Statement of financial position is another name for the balance sheet. Answer: TRUE Diff: 1 Objective: L.O. 1-2
9) Assets and owners' equity are presented on the right side of the balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 1-2
10) The balance sheet equation is assets = liabilities - owner's equity. Answer: FALSE Diff: 1 Objective: L.O. 1-2
11) Liabilities are economic obligations of the organization to outsiders, or claims against its assets by outsiders. Answer: TRUE Diff: 2 Objective: L.O. 1-2
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12) Accountants use the terms notes payable or notes receivable to describe the existence of promissory notes. Answer: TRUE Diff: 1 Objective: L.O. 1-2
13) Examples of assets include cash, inventory, and capital stock. Answer: FALSE Diff: 1 Objective: L.O. 1-2
14) Inventory is goods held by a company for the purpose of sale to customers, and is considered a liability on the balance sheet. Answer: FALSE Diff: 2 Objective: L.O. 1-2
15) A balance sheet is dated for a period of time, such as "for the year ended December 31, 20X2." Answer: FALSE Diff: 1 Objective: L.O. 1-2
16) Owners' equity is the residual interest in the organization's assets after deducting liabilities. Answer: TRUE Diff: 1 Objective: L.O. 1-2
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17) Long-term debt Cash Total stockholders' equity Total liabilities Accounts receivable Common stock Inventory Accounts payable Property, plant, and equipment Additional stockholders' equity Other assets Other liabilities Total assets
$ 190 (1) (2) (3) 450 75 375 575 525 650 200 (4) 2,000
Using the balance sheet equation as a starting point, determine the missing amounts: (1), (2), (3), and (4) above. Answer: (1) $2,000 - $450 - $375 - $525 - $200 = $450 (2) $75 + $650 = $725 (3) $2,000 - $725 = $1275 (4) $1,275 - $575 - $190 = $510 Diff: 2 Objective: L.O. 1-2
18) What is the purpose of a balance sheet? Answer: A balance sheet shows the financial position of an entity at a point in time. The accounting equation is represented in the balance sheet. The balance sheet reports a company's assets, liabilities and owners' equity. Diff: 2 Objective: L.O. 1-2
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Learning Objective 1.3 Questions 1) An entity A) is a separate economic unit. B) allows a section of an organization to be a separate economic unit. C) helps accountants relate events to a defined area of accounting. D) All of the above E) None of the above Answer: D Diff: 2 Objective: L.O. 1-3
2) If liabilities increase by $10,000 during a given period and stockholders' equity decreases by $6,000 during the same period, assets must have A) increased by $16,000. B) increased by $4,000. C) decreased by $4,000. D) decreased by $16,000. E) This cannot be determined with the given information. Answer: B Diff: 3 Objective: L.O. 1-3
3) A transaction A) affects the financial position of an entity. B) maintains the equality of the balance sheet equation. C) affects the cash position of an entity. D) will always change values on the income statement. E) both A and B Answer: E Diff: 2 Objective: L.O. 1-3
4) Surround Sound, LLC owned land originally costing $33,000. A real estate agent appraised the land and stated that it is now worth $38,000. Surround Sound, LLC should A) increase the land account by $5,000 and increase the capital stock account by $5,000. B) increase the land account by $5,000 and increase the cash account by $5,000. C) increase the land account by $5,000 and increase the paid-in capital in excess of par account by $5,000. D) There is no effect from the increase in the value of the land on the accounts of Surround Sound, LLC. E) increase the land account and the investment account. Answer: D Diff: 2 Objective: L.O. 1-3
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5) Which of the following statements is false? A) If you increase an asset account, you may increase a liability account. B) If you increase an asset account, you may decrease an asset account. C) If you decrease an asset account, you may increase an owners' equity account. D) If you decrease an asset account, you may decrease an owners' equity account. E) If you increase an asset account, you may increase an owners' equity account. Answer: C Diff: 2 Objective: L.O. 1-3
6) Mexland Company, acquired land costing $25,000. Mexland Company paid $10,000 in cash and issued a short-term note for the balance. The effect of this transaction on Mexland Company, would be to A) increase the land account by $25,000, decrease the cash account by $10,000, and decrease the balance in the notes payable account by $15,000. B) increase the land account by $25,000, decrease the cash account by $10,000, and decrease the balance in the notes receivable account by $15,000. C) increase the land account by $25,000, decrease the cash account by $10,000, and increase the balance in the notes receivable account by $15,000. D) increase the land account by $10,000 and decrease the cash account by $10,000. E) increase the land account by $25,000, decrease the cash account by $10,000, and increase the balance in the notes payable account by $15,000. Answer: E Diff: 2 Objective: L.O. 1-3
7) Assets amount to $35,000 at the beginning of the period and $40,000 at the end of the period. Liabilities amount to $10,000 at the beginning of the period and $20,000 at the end of the period. What is the amount of the change and the direction of the change in owners' equity for the period? A) Increase of $15,000 B) Decrease of $10,000 C) Increase of $5,000 D) Increase of $10,000 E) Decrease of $5,000 Answer: E Diff: 2 Objective: L.O. 1-3
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8) Smith's Medical Supplies sold unused land at cost, which was $15,000. The buyer paid $6,000 in cash, with the balance to be paid on a note due in 6 months. The effect on Smith's Medical Supplies is to A) decrease the land account by $15,000, increase the cash account by $6,000, and increase the balance in the notes payable account by $9,000. B) decrease the land account by $15,000, increase the cash account by $6,000, and increase the balance in the notes receivable account by $9,000. C) decrease the land account by $15,000, increase the cash account by $6,000, and decrease the balance in the notes receivable by $9,000. D) decrease the land account by $6,000 and increase the cash account by $6,000. E) decrease the land account by $15,000, increase the cash account by $6,000, and decrease the balance in the notes payable account by $9,000. Answer: B Diff: 2 Objective: L.O. 1-3
9) Mailers Manufacturing, acquired equipment for $19,000. Mailers Manufacturing, paid $6,000 in cash, with the balance due on a note. The effect of this transaction on Mailers Manufacturing, would be to A) increase the equipment account by $19,000, decrease the cash account by $6,000 and increase the notes payable account by $13,000. B) increase the equipment account by $19,000, decrease the cash account by $6,000, and decrease the notes receivable by $13,000. C) increase the equipment account by $6,000, and decrease the cash account by $6,000. D) increase the equipment account by $6,000, decrease the cash account by $6,000, and increase the notes payable account by $13,000. E) increase the equipment account by $19,000, and increase the notes payable account by $6,000. Answer: A Diff: 2 Objective: L.O. 1-3
10) Zeus Greek Foods purchased a $21,000 van for use in the business. The company made a $15,000 cash down payment, and signed a note for the balance. The effect of this transaction on Zeus Greek Foods would be to A) increase the van account by $21,000, decrease the cash account by $15,000, and decrease the notes receivable account by $6,000. B) increase the van account by $21,000, decrease the cash account by $15,000, and decrease the notes payable account by $6,000. C) increase the van account by $15,000 and decrease the cash account by $15,000. D) increase the van account by $21,000, decrease the cash account by $15,000, and increase the notes payable account by $6,000. E) decrease the van account by $15,000 and increase the cash account by $15,000. Answer: D Diff: 2 Objective: L.O. 1-3
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11) Payton Corporation, acquired some office equipment, including a desk costing $900. The owner of the business next door said that he had been searching for a desk just like that one, so Payton Corporation, sold the desk to its business neighbor at cost, receiving $400 in cash, with the remainder to be paid in 30 days. The effect of this transaction on Payton Corporation, would be to A) increase the cash account by $400, increase the capital account by $500, and decrease the equipment account by $900. B) increase the cash account by $400, increase the accounts payable account by $500, and decrease the equipment account by $900. C) increase the cash account by $400, decrease the accounts payable account by $500, and decrease the equipment account by $900. D) increase the cash account by $400, increase the accounts receivable account by $500, and decrease the equipment account by $900. E) increase the cash account by $400, decrease the accounts receivable account by $500, and decrease the equipment account by $900. Answer: D Diff: 2 Objective: L.O. 1-3
12) Home Theater Advantage sells audio equipment. Home Theater Advantage acquired 50 speakers from a manufacturer at a cost of $200 per speaker and purchased the speakers on account. The effect of this transaction on Home Theater Advantage would be to A) increase inventory by $10,000 and increase capital by $10,000. B) increase inventory by $10,000 and decrease capital by $10,000. C) increase inventory by $10,000 and decrease cash by $10,000. D) increase inventory by $10,000 and increase accounts payable by $10,000. E) increase inventory by $10,000 and decrease accounts payable by $10,000. Answer: D Diff: 2 Objective: L.O. 1-3
13) Iacofano Pizza Place acquired equipment costing $11,000 on account. The effect of this transaction on Iacofano Pizza Place would be to A) increase equipment by $11,000 and decrease capital by $11,000. B) increase equipment by $11,000 and increase capital by $11,000. C) increase equipment by $11,000 and increase accounts payable by $11,000. D) increase equipment by $11,000 and decrease accounts payable by $11,000. E) No transaction is recorded since no cash has been paid. Answer: C Diff: 2 Objective: L.O. 1-3
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14) Manziel Inc. is a sole proprietorship owned by Chris Herold. Chris acquired $9,000 worth of equipment for use in his store. He will pay for the equipment in 30 days. The effect of this transaction on Manziel would be to A) increase the equipment account by $9,000 and increase the accounts payable account by $9,000. B) increase the equipment account by $9,000 and decrease the accounts payable account by $9,000. C) increase the equipment account by $9,000 and increase the capital account by $9,000. D) This would not change any account because the equipment has not been paid for. E) This would not change any account because this transaction does not affect Manziel Inc. Answer: A Diff: 2 Objective: L.O. 1-3
15) Jakey Technologies has 1,000 folders in inventory that cost $2.00 each. The company's supplier announced that, effective immediately, all future folders will cost $2.20 each. Jakey Technologies should A) increase the inventory account by $200 and increase the capital account by $200. B) increase the inventory account by $200 and decrease the capital account by $200. C) increase the inventory account by $200 and increase the accounts payable account by $200. D) increase the inventory account by $200 and decrease the accounts payable account by $200. E) There is no effect from the price change on the accounts of Jakey Technologies. Answer: E Diff: 2 Objective: L.O. 1-3
16) Sounds Good Entertainment acquired office equipment valued at $4,000 and office supplies valued at $600 by paying cash of $1,300 with the balance on account. The effect of this transaction on Sounds Good Entertainment would be to A) increase the cash account by $1,300, increase the accounts payable account by $3,300, and increase the office equipment account by $4,600. B) increase the office equipment account by $4,600, decrease the cash account by $1,300, and decrease the accounts payable account by $3,300. C) decrease the cash account by $1,300, increase the accounts payable account by $3,300, increase the office equipment account by $4,000, and increase the office supplies by $600. D) increase the cash account by $1,300, increase the capital account by $3,300, decrease the equipment account by $4,000, and increase the office supplies account by $600. E) increase the office supplies account by $600, decrease the office equipment account by $4,000, increase the accounts payable account by $4,000, and decrease the cash account by $600. Answer: C Diff: 2 Objective: L.O. 1-3
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17) Kitty Clips acquired $2,800 worth of merchandise inventory on account. Upon inspection, the company discovered that $400 worth of the merchandise inventory was defective. Kitty Clips returned the defective merchandise inventory and received full credit. The effect of the return transaction on Kitty Clips would be to A) decrease the merchandise inventory account by $400 and increase the accounts payable account by $400. B) decrease the merchandise inventory account by $400 and decrease the accounts payable account by $400. C) decrease the merchandise inventory account by $400 and increase the accounts receivable account by $400. D) decrease the merchandise inventory account by $400 and decrease the accounts receivable account by $400. E) Because the merchandise inventory was never used, Kitty Clips would not record the return of the merchandise inventory. Answer: B Diff: 2 Objective: L.O. 1-3
18) Stockholders' equity at the beginning and end of the period amounts to $16,000 and $19,000, respectively. Assets at the beginning and end of the period amount to $26,000 and $21,000, respectively. Liabilities at the beginning of the period were $10,000. Liabilities at the end of the period amount to A) $8,000. B) $6,000. C) $2,000. D) $5,000. E) $3,000. Answer: C Diff: 2 Objective: L.O. 1-3
19) What effect does the purchase of store equipment on account have on the balance sheet equation? A) Assets increase and liabilities decrease B) Assets increase and liabilities increase C) Assets decrease and liabilities decrease D) Assets decrease and liabilities increase E) There is no effect on the accounting equation. Answer: B Diff: 2 Objective: L.O. 1-3
20) What accounts are affected by an initial investment of cash by an owner into his business? A) Cash and Owner payable B) Cash and Long-term debt payable C) Owner payable and Accounts payable D) Cash and Capital E) Cash and Retained earnings Answer: D Diff: 2 Objective: L.O. 1-3
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21) An owner's investment into a business will increase assets and decrease liabilities. Answer: FALSE Diff: 2 Objective: L.O. 1-3
22) An account is a summary record of the changes in a particular asset, liability, or owners' equity. Answer: TRUE Diff: 1 Objective: L.O. 1-3
23) A transaction affects the financial position of an entity and can be reliably recorded in terms of money. Answer: TRUE Diff: 2 Objective: L.O. 1-3
24) A transaction does not require counterbalancing entries so that the total assets are equal to the total liabilities plus owner's equity. Answer: FALSE Diff: 2 Objective: L.O. 1-3
25) A loan from a financial institution will increase assets and increase liabilities. Answer: TRUE Diff: 2 Objective: L.O. 1-3
26) The purchase of inventory on credit will increase liabilities and equity. Answer: FALSE Diff: 2 Objective: L.O. 1-3
27) Buying on credit creates an account receivable. Answer: FALSE Diff: 1 Objective: L.O. 1-3
28) A creditor is one to whom money is owed. Answer: TRUE Diff: 2 Objective: L.O. 1-3
29) A payment to a creditor will decrease assets and increase liabilities. Answer: FALSE Diff: 2 Objective: L.O. 1-3
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30) If assets increase $80,000 during a period and liabilities decrease $40,000, then owners' equity must have decreased $40,000. Answer: FALSE Diff: 2 Objective: L.O. 1-3
31) Analyze the following transactions in the balance sheet equation using the following worksheet. 1. Initial investment of $300,000 by the owner 2. Acquire equipment for $25,000 cash 3. Acquire inventory for $6,000 on credit 4. Obtain loan of $15,000 from the bank 5. Returned $600 of inventory to supplier 6. Payment to creditor for amount of inventory purchase less amount returned
Transaction 1 2 3 4 5 6
Cash
Inventory Equipment
Note Payable
Accounts Payable
Capital
Answer: Transaction 1 2 3 4 5 6
Note Accounts Cash Inventory Equipment Payable Payable Capital +300,00 +300,000 -25,000 +25,000 +6,000 +6,000 +15,000 +15,000 -600 -600 -5,400 -5,400
Diff: 3 Objective: L.O. 1-3
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32) Given below are the daily balances in the accounts of Travel Tips, Inc.. Assuming only one transaction occurred each day, explain the nature of each transaction from June 1 to June 10. Accounts Payable $4,000 4,700 4,700 3,900 3,900 5,200 4,700 4,700 4,700 4,700 4,700
Owner, Capital $20,000 20,000 20,000 20,000 21,100 21,100 21,100 21,100 19,000 19,000 20,700
Cash Receivable Inventory Equipment Bal. $6,000 $3,000 $8,000 $7,000 June 1 6,000 3,000 8,700 7,000 June 2 6,600 2,400 8,700 7,000 June 3 5,800 2,400 8,700 7,000 June 4 6,900 2,400 8,700 7,000 June 5 5,600 2,400 8,700 9,600 June 6 5,600 2,400 8,200 9,600 June 7 6,100 3,700 8,200 7,800 June 8 4,000 3,700 8,200 7,800 June 9 3,200 3,700 9,000 7,800 June 10 3,200 3,700 9,000 9,500 Answer: June 1: Acquired $700 of inventory on credit. June 2: Received $600 from credit customers. June 3: Paid $800 in accounts payable. June 4: Owners invested an additional $1,100 in cash. June 5: Acquired equipment costing $2,600, paying $1,300 in cash with the remaining $1,300 on account. June 6: Returned inventory costing $500 and received a reduction in its accounts payable. June 7: Sold equipment costing $1,800, receiving $500 in cash with the remaining $1,300 owed toTravel Tips June 8: Owners withdrew $2,100 from Travel Tips company. June 9: Bought $800 of inventory, paying cash. June 10: Owners invested equipment in the business valued at $1,700. Diff: 2 Objective: L.O. 1-3
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33) Use the following balance sheet equation format to show the effect of the following transactions. Write the signs (+, -) for increases and decreases in components of the equation for each transaction. Total assets
Total liabilities
Owners' equity
A B C D E F G A. The owner invests cash in the company. B. The company borrows money from a bank, issuing a promissory note payable. C. The company acquires equipment by paying cash for the total amount. D. The company acquires inventory from the manufacturer on credit. E. The company returns part of the inventory purchased in part D. F. The company sells equipment acquired in part C to a competitor on open account at cost. G. The company pays the amount due on the inventory purchase in part D. Answer: Total assets Total liabilities Owners' equity A + + B + + C +, D + + E F +, G Diff: 2 Objective: L.O. 1-3
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Learning Objective 1.4 Questions 1)
Twinkle Toes Dance Company December 31, 20X9 Cash $10,000 Accounts payable Accounts receivable 4,000 Notes payable Inventory 8,000 Common stock Equipment 14,800 Retained earnings Total Assets $36,800 Total liabilities and shareholders equity What is the name of the financial statement above? A) Income Statement B) Balance Sheet C) Statement of Cash Flows D) Statement of Changes in Shareholders Equity E) Statement of Retained Earnings Answer: B
$5,600 17,000 5,000 9,200 $36,800
Diff: 2 Objective: L.O. 1-4
2) Following is an alphabetical list of the assets, liabilities, and stock owners' equity accounts of Apex Marketing Solutions. Prepare a balance sheet dated December 31, 20X9. Accounts payable $ 2,000 Accounts receivable 31,400 Capital stock 25,500 Cash 18,000 Inventory 9,600 Notes payable 14,900 Paid-in capital in excess of par 16,600 Answer: Apex Marketing Solution Balance Sheet December 31, 20X9 Assets Liabilities and Owners' Equity Liabilities: Cash $18,000 Accounts payable $ 2,000 Accounts receivable 31,400 Notes payable 14,900 Inventory 9,600 Total liabilities Owners' equity: Capital stock 25,500 Paid-in capital in excess of par 16,600 Total owners' equity Total assets $59,000 Total liabilities and owners' equity Diff: 2 Objective: L.O. 1-4
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$16,900
42,100 $59,000
3) Presented below are the balances, listed in alphabetical order, of Ferb Products, at December 1, 20X9: Accounts Payable Accounts Receivable Cash Land Machinery Merchandise Inventory Long-term Debt Payable Note Payable Paid-in Capital
$ 8,100 4,000 7,300 15,300 31,600 12,200 20,700 2,200 39,400
Following are the transactions for Ferb Products for the month of December 20X9: a. Borrowed an additional $1,300 in notes payable. b. Collected $1,900 from credit customers. c. Paid $2,600 of the amount owed on account. d.The owners contributed $12,000 cash in exchange for capital. Required: 1. Prepare an analysis of the transactions on the balance sheet equation. 2. Prepare a balance sheet as of December 31, 20X9, considering the beginning balances and incorporating the effects of the December, 20X9 transactions. Answer: Cash
$7,300 +1,300 +1,900 -2,600 +12,000 $19,900
Accounts Receivable
Merch. Inventory Land
$4,000
$12,200
$15,300
Machinery
Accounts Notes Payable Payable
$31,600
$8,100
LT Debt Payable
Paid-in Capital
$2,200 +$1,300
$20,700
$39,400
$3,500
$20,700
+12,000 $51,400
-1,900 -2,600 $2,100
$12,200
$15,300
$31,600
$5,500
Ferb Products Balance Sheet December 31, 20X9 Assets Cash Accounts Receivable Merchandise Inventory Land Machinery Total Assets
$ 19,900 2,100 12,200 15,300 31,600 81,100
Liabilities and Owners' Equity Liabilities: Accounts Payable Notes Payable Long-term Debt Payable Total Liabilities Owners' Equity: Paid-in Capital Total Liab. and Owners' Equity
Diff: 3 Objective: L.O. 1-3, 1-4
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$ 5,500 3,500 20,700 29,700 51,400 $81,100
4) Shelly Wagner began a sole proprietorship named Wagner Company on June 1, 20X9. Following are the transactions, which occurred during the first 10 days of June, 20X9. June 1 Shelly invested $6,600 cash in Wagner Company June 2 Wagner Company acquired equipment costing $3,900. One-third of the balance was paid in cash with the balance as a note. June 4 Wagner Company acquired inventory costing $2,200, half of which was paid in cash. June 5 Wagner Company acquired $200 in supplies on open account. June 7 Shelly's daughter, Sydney, purchased $600 of equipment, at cost and on open account from Wagner Company June 9 Wagner Company returned $100 of defective inventory and received a full credit. June 10 Wagner Company received $200 from Sydney, Shelly's daughter, in partial settlement of her account. Required: 1. Prepare an analysis of the transactions on the balance sheet equation. 2. Prepare a balance sheet for Wagner Company as of June 10, 20X9. Answer: Cash
June 1 June 2 June 4 June 5 June 7 June 9 June 10
Accounts Receivable
Inventory
+$6,600 -1,300 -1,100
Supplies
Equipment
+3,900 +2,200 -600 -100 -200 $400
+$2,600 +1,100 +200
+200
$2,100
-100 $200
$3,300
$1,200
$2,600
Wagner Company Balance Sheet June 10, 20X9 Assets Cash Accounts Receivable Inventory Supplies Equipment Total Assets
Wagner, Capital
+$6,600
+600 +200 $4,400
Accounts Notes Payable Payable
$ 4,400 400 2,100 200 3,300 $10,400
Liabilities and Owner's Equity Liabilities: Accounts Payable Notes Payable Total Liabilities Owner's Equity: Shelly Wagner, Capital Total Liab. and Owner's Equity
Diff: 3 Objective: L.O. 1-3, 1-4
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$ 1,200 2,600 3,800 6,600 $10,400
$6,600
5) Abigail and Amanda started the ACL Partnership on September 1, 20X9. Given the following transactions, prepare a balance sheet for the partnership as of September 10, 20X9. Sept. 1 The ACL Partnership was formed as Abigail invested $9,000 in cash and Amanda invested $4,100 worth of supplies and $4,700 in cash. Sept. 2 ACL acquired $3,600 in inventory, paying cash. Sept. 4 ACL acquired equipment costing $23,900, making a $3,500 cash down payment, with the balance due on a note. Sept. 5 ACL returned $300 worth of defective inventory and received a refund. Sept. 7 ACL acquired inventory costing $800 on open account. Sept. 8 ACL sold equipment costing $1,700 at cost. A close friend, purchased the equipment on account. Sept. 9 ACL paid $400 associated with the inventory acquired on September 7. Sept. 10 ACL received $400 from the friend who acquired equipment on September 8. Required: 1. Prepare an analysis of the transactions on the balance sheet equation. 2. Prepare a balance sheet as of September 10, 20X9 for ACL Partnership. Answer:
Sept. 1 Sept. 2 Sept. 4 Sept. 5 Sept. 7 Sept. 8 Sept. 9 Sept 10
Cash +$9,000 +4,700 -3,600 -3,500 +300
Accts. Receiv Inventory Supplies +4,100 +3,600
+23,900 -300 +800
+20,400 +800
+1,700 -400 +400 $6,900
Accts. Notes Abigail, Amanda, Equip. Payable Payable Capital Capital +$9,000 +8,800
-1,700 -400
-400 $1,300
$4,100
$4,100
$22,200
$400
$20,400
$9,000
$8,800
The ACL Partnership Balance Sheet September 10, 20X9 Assets Cash Accounts Receivable Inventory Supplies Equipment
$ 6,900 1,300 4,100 4,100 22,200
Total Assets
$38,600
Liabilities and Owners' Equity Liabilities: Accounts Payable $ 400 Notes Payable 20,400 Total Liabilities Owners' Equity: Abigail, Capital 9,000 Amanda, Capital 8,800 Total Partners' Capital Total Liabilities and Owners' Equity
Diff: 3 Objective: L.O. 1-3, 1-4
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$20,800
17,800 $38,600
6) The accountant for Tibbo Industries is required to prepare monthly financial statements. Upon opening the file with the previous month's balance sheets, the accountant notices that they have been prepared incorrectly. Prepare a corrected November balance sheet based on the information below. Balance Sheet for Tibbo Industries Prepared on November 29, 2009 Assets Merchandise inventory Accounts payable Cash Owners' equity Property and equipment Answer: Assets Cash Merchandise Inventory Prepaid expenses Office supplies Property and equipment Total assets
Liabilities and Owners' Equity 8,000 4,500 9,000 50,500 50,500
Liabilities and Owners' Equity Liabilities: Accounts payable Long term debt Total Liabilities Owners' equity Total Liabilities and Owners' Equity
Office supplies Long term debt Owners equity Prepaid expenses
$ 9,000 8,000 5,000 500 50,500 $73,000
$ 4,500 18,000 22,500 50,500 $73,000
Diff: 3 Objective: L.O. 1-4
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500 18,000 50,500 5,000
Learning Objective 1.5 Questions 1) Which of the following statements is false? A) If a sole proprietorship fails, the creditors can obtain repayment from the personal assets of the single owner. B) If a partnership fails, the creditors can obtain repayment from the personal assets of the partners. C) If a corporation fails, the creditors can obtain repayment from the personal assets of the stockholders. D) A change in ownership among the partners results in the termination of the partnership. E) Income taxes are not levied against sole proprietorships and partnerships. Answer: C Diff: 2 Objective: L.O. 1-5
2) Which of the following statements is false? A) Most states require stock certificates to have some dollar amount printed on them. B) Additional paid-in capital is part of total liabilities on the balance sheet. C) The ultimate responsibility for management of a company is delegated by stockholders to professional managers. D) Typically, stock is sold for an amount above par value. E) An advantage of the corporate form of organization is the separation of ownership and management. Answer: B Diff: 2 Objective: L.O. 1-5
3) Which of the following forms of business organizations protect the personal assets of the owners from creditors of the business? A) Partnerships B) Corporations C) Proprietorships D) Partnerships and corporations E) Partnerships and proprietorships Answer: B Diff: 1 Objective: L.O. 1-5
4) Which of the following statements is false? A) Corporations are business organizations created under federal law. B) One of the most notable characteristics of a corporation is the limited liability of the owners. C) An advantage of corporations over other business entities is the ease of transfer of ownership. D) The laws governing corporations vary from state to state. E) Individuals can sell stock to each other without corporate involvement. Answer: A Diff: 2 Objective: L.O. 1-5
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5) A corporation is an organization A) with owners assuming personal liability for business losses. B) that joins two or more people together as co-owners. C) that is an "artificial being" created by individual state laws. D) that gives stockholders control of everyday management decisions. E) that does not sell stock to raise capital. Answer: C Diff: 1 Objective: L.O. 1-5
6) The form of organization that has limited liability for the owners is a(n) A) corporation. B) partnership. C) proprietorship. D) cartel. E) Sarbanes group. Answer: A Diff: 1 Objective: L.O. 1-5
7) Which is a disadvantage of a corporation? A) Limited liability for owners B) Easy transfer of ownership C) Ease in raising ownership capital from potential stockholders D) Management's consumption of perquisites E) Continuity of existence Answer: D Diff: 1 Objective: L.O. 1-5
8) A sole proprietorship is an accounting entity, even though it has only a single owner. Answer: TRUE Diff: 1 Objective: L.O. 1-5
9) The owners of a corporation have limited liability. Answer: TRUE Diff: 1 Objective: L.O. 1-5
10) Corporations are the most important form of business ownership because they conduct the vast majority of business. Answer: TRUE Diff: 2 Objective: L.O. 1-5
11) The effects of the form of ownership of a business entity on income taxes may vary significantly. Answer: TRUE Diff: 2 Objective: L.O. 1-5
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12) Privately held corporations can be owned by family members, but they still sell stock publicly. Answer: FALSE Diff: 2 Objective: L.O. 1-5
13) Describe the three forms of business entities and state how they differ. Answer: A proprietorship has a single owner whereas a partnership has two or more individuals together as co-owners. In both of these forms of organization, the owners are individually liable for the debts of the business. A corporation is a business owned by stockholders, who generally do not have a part in the day-to-day operations of the business. The stockholders of a corporation are not legally liable for the debts of the business and it is easier to sell out of a corporation than a proprietorship or partnership. Corporations can raise capital easier than proprietorships and partnerships. Corporations also have the advantage of continuity of existence. Diff: 2 Objective: L.O. 1-5
14) Match each of the following terms with the appropriate definition. Use each term only once. A. Sole proprietorship B. Partnership C. Corporation D. For-profit company E. Not-for-profit company ________ 1. A company with the goal of maximizing the owners' wealth ________ 2. An organization that exists to provide goods and services to a target group at a reduced cost or no cost ________ 3. A company owned by two or more individuals ________ 4. This type of organization is taxed twice; first as a business and second when shareholders receive dividends ________ 5. A company with one owner Answer: D, E, B, C, A Diff: 2 Objective: L.O. 1-5
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Learning Objective 1.6 Questions 1) Kristine Parsons owns 2,000 shares of $1.00 par value capital stock of Garments 4 You. Kristine sold 100 of these shares to Beverly Plito for $200. The effect of this transaction on the accounts of Garments 4 You would be to A) increase the capital stock account by $1,800 and increase the cash account by $1,800. B) increase the capital stock account by $200, increase the paid-in capital in excess of par account by $2,000, and increase the cash account by $1,800. C) decrease the capital stock account by $1,800 and increase the paid-in capital in excess of par account by $1,800. D) increase the capital stock account by $1,800 and decrease the paid-in capital in excess of par account by $1,800. E) There is no effect from this transaction on the accounts of Garments 4 You. Answer: E Diff: 2 Objective: L.O. 1-6
2) Wendy Walia owns 500 shares of Rhodes Water Company. The capital stock of Rhodes Water Company has a par value of $3 per share. Wendy Walia sells her 500 shares of Rhodes Water stock to Steve Matelski for $10 per share. The effect of this transaction on Rhodes Water Company would be to A) increase the cash account by $5,000 and increase the capital stock account by $5,000. B) increase the cash account by $5,000, increase the capital stock account by $1,500, and increase the paidin capital in excess of par account by $3,500. C) increase the cash account by $5,000 and decrease the capital stock account by $5,000. D) increase the cash account by $5,000, decrease the capital stock account by $1,500, and decrease the paid-in capital in excess of par account by $3,500. E) Rhodes Water Company would not record this transaction but would note the change in ownership. Answer: E Diff: 2 Objective: L.O. 1-6
3) Michael Hudson owns 400 shares of Surefoot Enterprises. The capital stock of Surefoot Enterprises has a par value of $8 per share. Michael Hudson sells his 400 shares of Surefoot Enterprises stock to Brian Haas for $15 per share. The effect of this transaction on Surefoot Enterprises, would be to A) increase the cash account by $6,000 and increase the capital stock account by $6,000. B) increase the cash account by $6,000 and decrease the capital stock account by $6,000. C) increase the cash account by $6,000, increase the capital stock account by $3,200, and increase the paidin capital in excess of par account by $2,800. D) Surefoot Enterprises would not record this transaction but would note the change in ownership. E) Surefoot Enterprises records this transaction but would not note the change in ownership. Answer: D Diff: 2 Objective: L.O. 1-6
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4) Firelog Company began business on July 1, 20X8, by selling 1,000 shares of $1 par value capital stock at $20 per share. The effect of this transaction on Firelog Company would be to A) increase the capital stock at par account by $20,000 and increase the cash account by $20,000. B) increase the capital stock at par by $20,000 and decrease the cash account by $20,000. C) decrease the capital stock at par by $20,000 and increase the cash account by $20,000. D) increase the capital stock at par by $1,000, increase the paid-in capital in excess of par account by $19,000, and increase the cash account by $20,000. E) decrease the capital stock at par by $1,000, decrease the paid-in capital in excess of par account by $19,000, and increase the cash account by $20,000. Answer: D Diff: 2 Objective: L.O. 1-6
5) Passport Global sold 250 shares of $4.00 par value capital stock in exchange for equipment worth $3,000. The effect of this transaction on Passport Global would be to A) increase the equipment account by $1,000 and increase the capital at par by $1,000. B) increase the equipment account by $3,000 and increase the capital at par by $3,000. C) increase the equipment account by $3,000, increase the capital stock at par by $1,000, and increase the paid-in capital in excess of par account by $2,000. D) increase the equipment account by $3,000 and decrease the capital stock at par by $3,000. E) increase the equipment account by $3,000, decrease the capital stock at par by $1,000, and decrease the paid-in capital in excess of par account by $2,000. Answer: C Diff: 2 Objective: L.O. 1-6
6) Halo Corporation repaid an $8,000 note payable by issuing 500 shares of its $4.00 par value capital stock. The effect of this transaction on Halo Corporation would be to A) increase the capital stock at par by $8,000 and decrease the notes payable account by $8,000. B) increase the capital stock at par by $2,000 and decrease the notes payable account by $2,000. C) increase the capital stock at par by $2,000, increase the paid-in capital in excess of par account by $6,000, and decrease the notes payable account by $8,000. D) increase the capital stock at par by $2,000, decrease the paid-in capital in excess of par account by $6,000, and decrease the notes payable account by $8,000. E) increase the capital stock at par by $2,000, decrease the cash account by $6,000, and decrease the notes payable account by $8,000. Answer: C Diff: 2 Objective: L.O. 1-6
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7) Pandey Company's capital stock is currently selling for $25 per share. Pandey Company has the following accounts included within the owners' equity section of the balance sheet: Capital stock, $1.00 par value, 10,000 shares issued Additional paid-in capital
$ 10,000 $ 60,000
Assuming that the only transaction affecting these accounts was the sale of the company's capital stock, Pandey Company originally sold its capital stock for A) $ 1.00 per share. B) $ 7.00 per share. C) $6.00 per share. D) $10.00 per share. E) The selling price of the capital stock cannot be determined from the information given. Answer: B Diff: 2 Objective: L.O. 1-6
8) Postal Manufacturing began business on July 1, 20X5, by selling 1,000 shares of $10 par value capital stock at $30 per share. The effect of this transaction on Postal Manufacturing would be to A) increase the capital stock at par by $10,000, increase the paid-in capital in excess of par account by $20,000, and increase the cash account by $30,000. B) decrease the capital stock at par by $30,000 and increase the cash account by $30,000. C) increase the capital stock at par by $30,000 and increase the cash account by $30,000. D) decrease the capital stock at par by $10,000, decrease the paid-in capital in excess of par account by $20,000, and increase the cash account by $30,000. E) increase paid-in capital in excess of par account by $30,000 and increase the cash account by $30,000. Answer: A Diff: 2 Objective: L.O. 1-6
9) When stock is sold, the difference between the total amount the company receives and the par value is called A) stated value. B) par value. C) additional paid-in capital. D) stockholders' equity value. E) common stock. Answer: C Diff: 2 Objective: L.O. 1-6
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10) The two equity accounts that Total Paid-in Capital is split between are A) capital stock at par and owners' equity. B) capital stock at par and paid-in capital in excess of par. C) capital stock at par and stockholders' equity. D) paid-in capital in excess of par and owners' equity. E) paid-in capital in excess of par and stockholders' equity. Answer: B Diff: 2 Objective: L.O. 1-6
11) Common stockholders A) upon dissolution are paid the same amount as all creditors. B) must purchase all shares directly from the issuing organization. C) purchase stock certificates at par value. D) have a claim on whatever is left over after all other claimants have been paid upon liquidation. E) are also members of the New York Stock Exchange after the purchase of the stock. Answer: D Diff: 2 Objective: L.O. 1-6
12) The board of directors' duty is to manage a company. Answer: FALSE Diff: 2 Objective: L.O. 1-6
13) Typically, a company sells its stock at par value. Answer: FALSE Diff: 2 Objective: L.O. 1-6
14) Regardless of the type of corporation, companies generally account for assets and liabilities similarly. Answer: TRUE Diff: 2 Objective: L.O. 1-6
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15) Below are owners' equity accounts for three different forms of business entities. Identify which form of business entity each set of owners' equity accounts represents and explain how you arrived at your decision. Business entity #1 Sara Kromar, capital Daniel Tondra, capital Ann Pamer, capital Kathy Brenan, capital Total capital
$100,000 15,000 90,000 110,000 $315,000
Business entity #2 Stockholders' equity: Paid-in capital: Capital stock, 25,000 shares issued at par value of $5 per share Paid-in capital in excess of par value Total paid-in capital
$125,000 250,000 $375,000
Business entity #3 Mary Housel, capital $100,000 Answer: Business entity #1 is a partnership since the capital accounts show straight forward records of the capital invested by each owner. These capital accounts are similar to a sole proprietorship except that a partnership has more than one owner account. Business entity #2 is a corporation since the capital account is labeled stockholders' equity. In addition, other typical corporation entity accounts used that are also shown in this example are paid-in capital, capital stock, paid-in capital in excess of par, and total paid-in capital. Business entity #3 is a sole proprietorship since it has an amount invested by a single owner. Diff: 2 Objective: L.O. 1-6
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Learning Objective 1.7 Questions 1) The principal task of the FASB is to A) be a link between the business community and the Securities and Exchange Commission (SEC). B) establish GAAP in the United States. C) audit each public company's financial statements and records. D) act as a counsel and advocate for business in its dealings with the government, particularly, but not solely, to the SEC. E) review financial statements, so as to ensure adherence to GAAP. Answer: B Diff: 1 Objective: L.O. 1-7
2) With respect to the role of the government in establishing accounting standards in the United States, which of the following statements is incorrect? A) Most accounting reporting requirements are determined by the FASB, which is a non-government institution. B) The SEC, and not the FASB, has the ultimate legal authority over most financial reporting to investors. C) The FASB can act independently of the SEC and does not need the SEC's support in establishing accounting standards. D) The SEC, which is an agency of the federal government, is empowered to ensure full and fair disclosures by corporations. E) The SEC is allowed to take an active role in establishing accounting standards. Answer: C Diff: 2 Objective: L.O. 1-7
3) The hierarchy (1 is top) of U.S. accounting rule-making responsibility is A) 1. congress, 2. AICPA, 3. FASB. B) 1. SEC, 2. IASB, 3. FASB. C) 1. FASB, 2. IASB, 3. AICPA. D) 1. congress, 2. SEC, 3. FASB. E) 1. PCAOB, 2. FASB, 3. IASB. Answer: D Diff: 2 Objective: L.O. 1-7
4) International Financial Reporting Standards are A) used by all European Union countries. B) never used by corporations operating in the United States. C) identical to Generally Accepted Accounting Principles. D) guidelines used by corporations to determine a company's fair value upon cessation. E) drastically different from Generally Accepted Accounting Principles. Answer: A Diff: 2 Objective: L.O. 1-7
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5) The Financial Accounting Standards Codification A) classifies U.S. GAAP to make it easy to research financial reporting issues. B) classifies U.S. tax laws to make it easy to research U.S. tax laws. C) classifies International Financial Reporting Standards to make it easy to research reporting issues. D) classifies international tax laws to make it easy to research international tax laws. E) classifies financial statements by type of organization and structure. Answer: A Diff: 2 Objective: L.O. 1-7
6) The U.S. Congress has charged the SEC with ultimate responsibility for specifying GAAP for publicly traded companies. Answer: TRUE Diff: 1 Objective: L.O. 1-7
Learning Objective 1.8 Questions 1) An auditor's opinion is not A) a report describing the auditor's examination of transactions and financial statements. B) included in the financial statements in the annual report issued by the corporation. C) another name for independent opinion. D) certified by the Securities Exchange Commission. E) a third party review. Answer: D Diff: 1 Objective: L.O. 1-8
2) The auditor's opinion includes all except which of the following statements? A) The financial statements are in conformity with generally accepted accounting principles. B) The financial statements are the responsibility of the company's management. C) The audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. D) The auditor's responsibility is to express an opinion on the financial statements. E) The financial statements are free of any and all misstatements. Answer: E Diff: 2 Objective: L.O. 1-8
3) Public accounting is A) the field of accounting where accountants work for businesses, government agencies, or other nonprofit organizations. B) the field of accounting where services are offered to the general public on a fee basis. C) a field of accounting where no audits occur. D) the field that provides management with internal company reports. E) unregulated. Answer: B Diff: 1 Objective: L.O. 1-8
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4) Generally accepted accounting principles A) are advisory guidelines for management. B) are only applicable to balance sheets. C) are to be followed in the preparation of financial statements. D) can never be deviated from. E) are uniform world-wide. Answer: C Diff: 2 Objective: L.O. 1-8
5) The accuracy and truthfulness of the financial statements is the responsibility of the A) external auditors. B) stockholders. C) management. D) staff accountants. E) external auditors and the staff accountants. Answer: C Diff: 2 Objective: L.O. 1-8
6) To ensure proper application of a CPA's technical knowledge, the Public Company Accounting Oversight Board issues: A) Generally Accepted Accounting Principles. B) Statements of Financial Accounting Standards. C) Accounting Standards Updates. D) Generally Accepted Auditing Standards. E) Sarbanes-Oxley Acts for Accounting. Answer: D Diff: 1 Objective: L.O. 1-8
7) The Sarbanes-Oxley Act was passed in 2002 to regulate the accounting profession. Although the act encompasses many aspects, what is one of the parts of the act? A) Requires rotation every ten years of the lead audit or coordinating partner and the reviewing partner on an audit B) Established the Public Company Accounting Oversight Board C) Requires all accounting firms to register with the SEC D) Prohibits public accounting firms from auditing SEC regulated companies E) Excludes certain industries from conducting business with public accounting firms Answer: B Diff: 1 Objective: L.O. 1-8
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8) Which of the following international public accounting firms is not considered one of the four largest? A) Deloitte Touche Tohmatsu B) Ernst & Young C) KPMG D) PwC E) Grant Thornton Answer: E Diff: 1 Objective: L.O. 1-8
9) The auditor's opinion is also called an independent opinion. Answer: TRUE Diff: 1 Objective: L.O. 1-8
10) The auditor's opinion is included with the annual report issued by the corporation. Answer: TRUE Diff: 1 Objective: L.O. 1-8
11) An audit is an examination of transactions and financial statements. Answer: TRUE Diff: 2 Objective: L.O. 1-8
12) Public accountants are those whose services are offered to the general public on a fee basis. Answer: TRUE Diff: 1 Objective: L.O. 1-8
13) The American Institute of Certified Public Accountants prepares and grades a CPA exam on a national basis. Answer: TRUE Diff: 1 Objective: L.O. 1-8
14) The American Institute of Certified Public Accountants is responsible for establishing GAAP in the United States Answer: FALSE Diff: 1 Objective: L.O. 1-8
15) The U.S. Congress has charged the Public Company Accounting Oversight Board with the ultimate responsibility for developing generally accepted accounting principles. Answer: FALSE Diff: 2 Objective: L.O. 1-8
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Learning Objective 1.9 Questions 1) Public accountants follow the code of ethics for professional conduct established by the A) Sarbanes-Oxley Act. B) Securities and Exchange Commission. C) Financial Accounting Standards Board. D) Congress of the United States. E) American Institute of Certified Public Accountants. Answer: E Diff: 1 Objective: L.O. 1-9
2) The AICPA Code of Professional Ethics is especially concerned with integrity and independence. Answer: TRUE Diff: 2 Objective: L.O. 1-9
3) How do generally accepted accounting principles present an ethical issue in financial accounting? Answer: Because financial accounting provides information to external decision makers, the information must be relevant and reliable. Those individuals who generate the information must do so according to generally accepted accounting principles or the decision makers will misallocate resources. The preparers of information are typically different people than the investors/financial statement users. The preparers of information may have incentives to make the company's performance look better than it really is. Managers may be overly optimistic about company conditions because they are making the decisions and plans. Their bonuses and salaries may also be dependent on the reported net income figures. Diff: 2 Objective: L.O. 1-9
Learning Objective 1.10 Questions 1) The regulatory body overseeing disclosures for governmental organizations is A) Government Accounting Standards Board B) Government Accounting Standards Commission C) Governmental Financial Reporting Board D) Governmental Financial Reporting Commission E) Governmental Taxation Standards Board Answer: A Diff: 1 Objective: L.O. 1-10
2) Nonprofit organizations do not need to analyze financial statement information since their purpose is not to increase net income like profit-seeking organizations. Answer: FALSE Diff: 2 Objective: L.O. 1-10
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Introduction to Financial Accounting, 11e (Horngren) Chapter 2 Measuring Income to Assess Performance Learning Objective 2.1 Questions 1) The operating cycle begins with A) the acquisition of goods. B) the receipt of cash from customers. C) the payment for goods. D) the initial investment by owners. E) the sales to customers. Answer: A Diff: 1 Objective: L.O. 2-1
2) Net income is A) the difference between revenues and dividends B) the difference between revenues and retained earnings. C) the difference between cash and dividends. D) the difference between revenues and total assets. E) the difference between revenues and expenses. Answer: E Diff: 1 Objective: L.O. 2-1
3) Revenues are A) increases in liabilities resulting from delivering goods or services to customers. B) decreases in net assets resulting from delivering goods or services to customers. C) increases in net assets resulting from delivering goods or services to customers. D) decreases in retained earnings resulting from delivering goods or services to customers. E) another term for assets. Answer: C Diff: 2 Objective: L.O. 2-1
4) For which company would it seem sensible to use a fiscal year ending on June 30? A) A landscaping company B) A retail store that sells lawn mowers and lawn equipment C) A swimming pool retailer D) A snowboard retailer E) A hardware store Answer: D Diff: 2 Objective: L.O. 2-1
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5) Kronic Enterprises sold inventory costing $500 for $900 on account. If Kronic Enterprises operates under the accrual basis, what net effect will this transaction have on the owners' equity side of the balance sheet? A) None, since the customer to whom the inventory was sold has not yet paid B) None, since sales and/or cost of goods sold are income statement accounts C) Decrease owners' equity by $1,400 D) Increase owners' equity by $400 E) Increase owners' equity by $1,400 Answer: D Diff: 3 Objective: L.O. 2-1
6) An accountant records a transaction when cash is paid or received under which basis of accounting? A) Cash B) Accrual C) Deferral D) Prepaid E) Cost recovery Answer: A Diff: 1 Objective: L.O. 2-1
7) Which of the following circumstances would result in a decrease in income under the accrual basis but would not result in a decrease in income under the cash basis? A) Purchase of inventory on account B) Payment of 2 months' rent in advance C) The expiration of prepaid rent D) The return of defective inventory purchased on account, where full credit was given E) The payment of the current period's utility bill Answer: C Diff: 3 Objective: L.O. 2-1
8) Hilac Plumbing records revenue as cash is received. Which method of income measurement is Hilac Plumbing using? A) The accrual basis B) The cash basis C) The recognition basis D) The revenue basis E) The realization basis Answer: B Diff: 2 Objective: L.O. 2-1
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9) Which of the following circumstances would result in an increase in income under the cash basis and an increase in income under the accrual basis? A) The return of defective inventory purchased on account, where full credit was given B) Cash collection from a credit customer C) The cash sale of inventory at a sales price in excess of cost D) The expiration of prepaid rent E) The sale of inventory on account, at a sales price in excess of cost Answer: C Diff: 3 Objective: L.O. 2-1
10) Which of the following circumstances would result in a decrease in income under both the accrual and cash basis? A) The payment of last period's rent B) The payment of this period's rent C) The payment of next period's rent D) The cash purchase of land E) The purchase of equipment on account Answer: B Diff: 2 Objective: L.O. 2-1
11) An operating loss occurs when A) revenues exceed expenses. B) expenses exceed revenues. C) assets exceed liabilities. D) liabilities exceed assets. E) liabilities exceed owners equity. Answer: B Diff: 1 Objective: L.O. 2-1
12) Expenses are A) increases in net assets as a result of consuming resources in the process of providing services to a customer. B) decreases in net assets as a result of consuming resources in the process of providing services to a customer. C) increases in liabilities resulting from purchasing assets. D) increases in retained earnings resulting from operations. E) increases in equity resulting from operations. Answer: B Diff: 2 Objective: L.O. 2-1
13) The operating cycle is the time it takes for a company to buy goods. Answer: FALSE Diff: 1 Objective: L.O. 2-1
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14) Because of the difficulty of measuring income, there is no reason to compare income levels between different companies. Answer: FALSE Diff: 1 Objective: L.O. 2-1
15) The additional owners' equity generated by net income or net profits is used to increase retained earnings. Answer: TRUE Diff: 1 Objective: L.O. 2-1
16) Because net income is the excess of revenues over liabilities, retained earnings increases by the amount of net income reported during the period less any dividends. Answer: FALSE Diff: 1 Objective: L.O. 2-1
17) According to accounting rules, fiscal years are required to be established over calendar years. Answer: FALSE Diff: 1 Objective: L.O. 2-1
18) An interim period is a time span that is less than a year and is established for accounting purposes. Answer: TRUE Diff: 1 Objective: L.O. 2-1
19) For revenue to be earned under the cash basis of accounting, the cash from the customer must be received. Answer: TRUE Diff: 1 Objective: L.O. 2-1
20) Cash for services performed in 20X8 is received in 20X9. Using the accrual basis of accounting, the revenue would appear on the 20X9 income statement. Answer: FALSE Diff: 2 Objective: L.O. 2-1
21) Revenue is recorded when accounts receivable are collected under the cash basis of accounting. Answer: TRUE Diff: 1 Objective: L.O. 2-1
22) Under the cash method, revenue is recorded when cash is collected. Answer: TRUE Diff: 1 Objective: L.O. 2-1
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23) The accrual basis of accounting provides a better measure of economic performance than the cash basis. Answer: TRUE Diff: 1 Objective: L.O. 2-1
24) Analyze the following transactions in the accounting equation using the following worksheet. 1. Sales of inventory for $20,000 on account; merchandise cost is $13,000. 2. Rent payment made in advance for $1,500. 3. Acquire additional inventory for $8,000; paid $2,000 cash with remainder on credit. 4. Received payment of $4,000 from customer who purchased goods on credit last month. 5. Returned defective inventory in the amount of $500. The inventory was purchased on account.
Cash
Accounts Prepaid Receivable Inventory Rent
Accounts Payable
Retained Earnings
Accounts Prepaid Receivable Inventory Rent +20,000 -13,000 +1,500 +8,000 -4,000 -500
Accounts Payable
Retained Earnings +20,000 -13,000
1 1 2 3 4 5 Answer: Cash 1 1 2 3 4 5
-1,500 -2,000 +4,000
+6,000 -500
Diff: 3 Objective: L.O. 2-1
25) Why doesn't the cash basis of accounting require adjusting accounts with accruals? Answer: The cash basis of accounting only records revenues and expenses when cash changes hands, while the accrual basis of accounting recognizes revenues when they are earned and expenses when they are incurred. Adjustments are necessary under the accrual basis of accounting since revenue can be earned even if cash is not received and expenses can be incurred even if cash is not paid. Diff: 2 Objective: L.O. 2-1
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26) Describe the advantages of the accrual basis of accounting and the cash basis of accounting. Answer: The cash basis of accounting has the advantage of producing financial statements when cash is received and paid, giving users a clearer picture of the company's cash position. Proponents suggest that this is important since companies can appear to be doing well based on net income, yet go bankrupt for a lack of cash. The accrual basis of accounting has the advantage of producing a more complete summary of the entity's value-producing activities since it recognizes revenues when they are earned and expenses when they are incurred. Diff: 2 Objective: L.O. 2-1
Learning Objective 2.2 Questions 1) According to U.S. GAAP, revenue is recognized when it is A) realized or realizable only. B) earned only. C) received in a timely fashion. D) earned and realized or realizable. E) received in cash. Answer: D Diff: 2 Objective: L.O. 2-2
2) Which of the following is an example of revenue that may be realized but not yet earned? A) A customer paying in advance for services to be performed in the future. B) A credit sale made to a customer who has a strong credit history. The goods have been delivered. C) A credit sale made to a customer with a weak credit history such that the collection of the outstanding receivable is questionable. The goods have been delivered. D) The cash sale of a fixed asset, as opposed to the sale of inventory. The fixed asset has been delivered. E) It is impossible to have revenue that is realized but not earned. Answer: A Diff: 3 Objective: L.O. 2-2
3) Performing a service and receiving a promise to pay from the customer would A) increase revenue. B) decrease assets. C) increase liabilities. D) decrease expenses. E) decrease revenue. Answer: A Diff: 1 Objective: L.O. 2-2
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4) Ace Office Equipment is an office equipment company specializing in sales of printers, scanners, and copiers. When should Ace Office Equipment recognize revenue from its sales? A) When the customer calls to accept delivery of a new copier B) When the customer signs a contract to buy a copier C) When the copier is delivered to the customer D) When the payment is received from the customer E) When the financial statements are prepared that includes this sale Answer: C Diff: 2 Objective: L.O. 2-2
5) Armingham Cable Company sells cable services and related accessories. Which of these situations demonstrate proper revenue recognition for Armingham Cable Company? A) Insurance is paid one month in advance of the due date because the Armingham Cable Company has extra cash. B) Cable services are sold to customers, and customers are billed in advance of receiving services. Revenue is recorded before rendering services. C) Cable boxes are purchased for sale to customers, but the accountant has not yet paid the bill. D) An interest bearing certificate of deposit is purchased. Interest will be received at the end of 60 days. Interest revenue will be recorded at the end of 60 days. E) Employees are paid for hours worked last month. Answer: D Diff: 2 Objective: L.O. 2-2
6) Revenue is recognized when a customer's promise to pay exists, even if the company is not relatively certain that they will receive payment. Answer: FALSE Diff: 1 Objective: L.O. 2-2
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Learning Objective 2.3 Questions 1) Mac's Computer Skills Training, purchased equipment for $30,000 on January 1, 20X8, and believes the equipment has a useful life of 36 months. What will be the effect of the equipment's depreciation on the balance sheet equation? A) Decreases Equipment account and decreases Stockholders' Equity B) Decreases Equipment account and increases Stockholders' Equity C) Increases Equipment account and decreases Stockholders' Equity D) Increases Equipment account and increases Stockholders' Equity E) There is no effect on the balance sheet equation. Answer: A Diff: 2 Objective: L.O. 2-3
2) The recording of expenses in the same time period as the related revenues are recognized is known as A) cost recovery. B) realization. C) matching. D) recognition. E) period costs. Answer: C Diff: 2 Objective: L.O. 2-3
3) Which of the following costs are identified directly as expenses of the time period in which they are incurred? A) Product costs B) Period costs C) Both product and period costs D) Neither product nor period costs E) Period costs as long as the goods have not been sold Answer: B Diff: 2 Objective: L.O. 2-3
4) Which of the following costs are linked to the revenues earned during a period? A) Product costs B) Period costs C) Both product and period costs D) Neither product nor period costs E) Product costs as long as the goods remain in inventory Answer: A Diff: 2 Objective: L.O. 2-3
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5) Rent is paid one year in advance. The payment is recorded as an asset, Prepaid Rent, and 1/12 of the amount each month is recorded as Rent Expense. This is an example of which of the following concepts? A) Recognition B) Neutrality C) Realization D) Matching E) Product costs Answer: D Diff: 2 Objective: L.O. 2-3
6) Which of the following accounts may be thought of as stored costs that are carried forward to future periods rather than immediately recorded as an expense? A) Prepaid insurance B) Utilities expense C) Salaries expense D) Depreciation expense E) Cost of goods sold Answer: A Diff: 1 Objective: L.O. 2-3
7) What is the effect on a company's balance sheet equation when depreciation expense is recognized? A) This transaction affects only the income statement, so no change on the balance sheet will occur. B) Total assets and total stockholders' equity will decrease by the same amount. C) There will be no change in the total assets, liabilities, and stockholders' equity account. D) Total liabilities will increase and total stockholders' equity will decrease by the same amount. E) Without knowing the exact dollar amount of depreciation, the effect on the balance sheet cannot be determined. Answer: B Diff: 3 Objective: L.O. 2-3
8) When a portion of prepaid rent expires, what will be the effect on the balance sheet equation? A) This transaction affects only the income statement, so there will be no effect on the balance sheet. B) There will be no overall effect on total assets, because two different asset accounts will change by the exact dollar amount, with one increasing and the other decreasing. C) Total assets and total liabilities will go down by the exact same dollar amount. D) Total assets and total stockholders' equity will go down by the exact same dollar amount. E) Without knowing the dollar amount of the transaction, the effect on the balance sheet equation cannot be determined. Answer: D Diff: 3 Objective: L.O. 2-3
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9) Expenses that are naturally linked to revenues are product costs. Examples of product costs include ________ and ________. A) Advertising Expense; Utilities Expense B) Rent Expense; Depreciation Expense C) Interest Revenue; Interest Expense D) Cost of Goods Sold; Sales Commissions Expense E) Administrative Expense; Selling Expense Answer: D Diff: 2 Objective: L.O. 2-3
10) Floral Deliveries, Inc. paid $6,000 for January, February, March and April's rent in advance on January 1, 20X9. The company recorded this transaction by increasing the balance in the Prepaid Rent account. The balance in the Prepaid Rent account as of March 1, 20X9, will be A) $-0-. B) $1,500. C) $2,000. D) $3,000. E) $6,000. Answer: D Diff: 2 Objective: L.O. 2-3
11) Floral Deliveries, Inc. paid $6,000 for January, February, March and April's rent in advance on January 1, 20X9. The company recorded this transaction by increasing the balance in the Prepaid Rent account. The balance in the Rent Expense account for the period, January 1, 20X9 through March 31, 20X9, as of March 31, 20X9, will be A) $-0-. B) $4,500. C) $2,000. D) $3,000. E) $6,000. Answer: B Diff: 2 Objective: L.O. 2-3
12) On March 1, 20X9, Schmor Incorporated paid 6 months' insurance in advance, covering the period of March 1 to August 31, 20X9. The total payment was $4,200. At the time of the payment, the entire amount was used to increase the balance in the Prepaid Insurance account. What will be the balance in the Prepaid Insurance account as of March 31, 20X9? A) $-0B) $700 C) $2,800 D) $3,500 E) $4,200 Answer: D Diff: 2 Objective: L.O. 2-3
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13) Which situation violates the matching principle? A) Employees are paid for wages worked in a previous month. The wages expense was recorded in the previous month. B) Consulting fees incurred have been recorded as an expense even though a bill has not yet been received. C) Depreciation was recorded for equipment even though the equipment was purchased on a date other than January 1. D) A 1-year insurance policy was paid in full on January 1 and the total amount of the bill was recorded as an expense in January. E) Customers are billed for services even though the company knows a portion of the customers will never pay. Answer: D Diff: 2 Objective: L.O. 2-3
14) On January 1, 2015, equipment is purchased for $100,000. The equipment will be used for ten years and has no salvage value. What is the depreciation expense for the year ending December 31, 2016? A) $1,000 B) $2,000 C) $10,000 D) $20,000 E) $100,000 Answer: C Diff: 2 Objective: L.O. 2-3
15) Accrual accounting uses the matching principle. Answer: TRUE Diff: 1 Objective: L.O. 2-3
16) The matching concept is closely related to the cash basis of accounting. Answer: FALSE Diff: 1 Objective: L.O. 2-3
17) Expenses, such as utilities, whose benefit is consumed by the passage of time rather than by the level of sales, are known as period costs. Answer: TRUE Diff: 2 Objective: L.O. 2-3
18) Costs that are linked with revenues and are charged as expenses when the related revenue is recognized are known as product costs. Answer: TRUE Diff: 2 Objective: L.O. 2-3
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19) The process of allocating the cost of long-lived or fixed assets to expense is referred to as depreciation. Answer: TRUE Diff: 1 Objective: L.O. 2-3
20) Assets such as prepaid rent may be thought of as costs that are stored to be carried forward to future periods and recorded as expenses in the future. Answer: TRUE Diff: 2 Objective: L.O. 2-3
21) Under the accrual basis of accounting, prepaid assets become expenses when they expire. Answer: TRUE Diff: 1 Objective: L.O. 2-3
22) Use the following balance sheet equation format to show the effect of the following transactions. Write the account names that will be used for each transaction.
Account name
Total assets
Total liabilities
Paid-in capital
Retained Earnings
1. The owners invest $42,000 in the company. 2. The company purchases equipment costing $6,000, paying $2,000 with the remainder as a note payable. 3. The company acquires inventory costing $2,500, paying $1,500 with the remainder on account. 4. Depreciation on the equipment was $200. Answer: Total Paid-in Retained Item Account name Total assets liabilities capital Earnings 1. Cash +42,000 Paid-in capital +42,000 2. Equipment +6,000 Cash (2,000) Note payable +4,000 3. Inventory +2,500 Cash (1,500) Accounts Payable +1,000 4. Depreciation expense (200) Accumulated DepreciationEquipment (200) Diff: 2 Objective: L.O. 2-2 & 2-3
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23) Describe how the matching concept is necessary to produce an income statement. Answer: The matching concept is necessary to relate product and period costs to the revenues that are generated in a given time period. Expenses are matched with revenues whenever it is reasonable and practicable to do so. Thus, the recognition of expense on the income statement is tied to the recognition of revenues. Diff: 2 Objective: L.O. 2-1 & 2-3
Learning Objective 2.4 Questions 1) Net income is defined as A) revenues minus expenses. B) expenses minus revenues. C) assets minus revenues. D) assets plus revenues. E) owners' equity assets minus expenses. Answer: A Diff: 1 Objective: L.O. 2-4
2) Under accrual basis accounting, the recognition of salaries earned and the immediate payment of salaries to employees would A) increase assets. B) increase owners' equity. C) increase net income. D) decrease net income. E) increase revenue. Answer: D Diff: 1 Objective: L.O. 2-4
3) The following data pertains to Greenwold Manufacturing. Total assets at January 1, 20X9, were $290,000; at December 31, 20X9, total assets were $334,000. During 20X9, sales were $995,000; cash dividends declared were $10,000; and operating expenses (exclusive of cost of goods sold) were $545,000. Total liabilities at December 31, 20X9, were $128,000; at January 1, 20X9, total liabilities were $105,000. There was no additional paid-in capital during 20X9. What was the amount of stockholders' equity as of January 1, 20X9? A) $450,000 B) $440,000 C) $185,000 D) $635,000 E) $175,000 Answer: C Diff: 1 Objective: L.O. 2-4
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4) The following data pertains to Greenwold Manufacturing. Total assets at January 1, 20X9, were $290,000; at December 31, 20X9, total assets were $334,000. During 20X9, sales were $995,000; cash dividends declared were $10,000; and operating expenses (exclusive of cost of goods sold) were $545,000. Total liabilities at December 31, 20X9, were $128,000; at January 1, 20X9, total liabilities were $105,000. There was no additional paid-in capital during 20X9. What was net income for 20X9? A) $26,000 B) $31,000 C) $201,000 D) $440,000 E) $450,000 Answer: B Diff: 3 Objective: L.O. 2-4
5) The following data pertains to Greenwold Manufacturing. Total assets at January 1, 20X9, were $290,000; at December 31, 20X9, total assets were $334,000. During 20X9, sales were $995,000; cash dividends declared were $10,000; and operating expenses (exclusive of cost of goods sold) were $545,000. Total liabilities at December 31, 20X9, were $128,000; at January 1, 20X9, total liabilities were $105,000. There was no additional paid-in capital during 20X9. What was cost of goods sold for 20X9? A) $450,000 B) $435,000 C) $429,000 D) $419,000 E) $440,000 Answer: D Diff: 3 Objective: L.O. 2-4
6) In an analysis of transactions using the balance sheet equation, revenues and expenses are adjustments to the ________ account. A) Accounts Receivable B) Accounts Payable C) Cash D) Capital Stock E) Retained Earnings Answer: E Diff: 1 Objective: L.O. 2-4
7) Which statement is the major link between two balance sheets? A) Statement of Retained Earnings B) Statement of Stockholders Equity C) Statement of Cash Flows D) Statement of Balancing Equity E) Income Statement Answer: E Diff: 1 Objective: L.O. 2-4
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8) An account that may cause ethical conflict because of its need for judgment is A) utilities expense. B) accounts payable. C) accounts receivable. D) notes payable. E) depreciation expense. Answer: E Diff: 1 Objective: L.O. 2-4
9) If sales amount to $150,000, rent expense is $2,000, utilities expense is $3,000, and net income is $55,000, how much is Cost of Goods Sold? A) $95,000 B) $145,000 C) $90,000 D) $50,000 E) $148,000 Answer: C Diff: 2 Objective: L.O. 2-4
10) An income statement is a report of all revenues and expenses pertaining to a specific date. Answer: FALSE Diff: 1 Objective: L.O. 2-4
11) Net income appears on the income statement and balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 2-4
12) The balance sheet provides a snapshot of an entity's financial position at an instant of time, while the income statement provides a moving picture of events over a span of time. Answer: TRUE Diff: 2 Objective: L.O. 2-4
13) The ending balance in retained earnings appears on the income statement. Answer: FALSE Diff: 1 Objective: L.O. 2-4
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14) The Dyer Corporation began business operations on April 1, 20X9. The following transactions occurred during April 20X9: 1. The owner invested $32,000 in the company. 2. Inventory costing $13,000 was purchased. $900 in cash was paid; the remainder was put on account. 3. Equipment costing $23,000 was purchased, of which one-half was paid in cash. The remainder was paid with a note payable. Ignore interest expense. Depreciation for the month relating to the equipment was $1,500. 4. The rent for April, May, and June 20X9 was paid. The rent payment was $1,200. 5. Cash sales during the month totaled $8,900. The cost of the inventory sold was $5,100. 6. Credit sales during the month totaled $11,000. The cost of the inventory sold was $7,500. 7. The wages earned by the employees for the month were $4,000, although only $3,500 had been paid as of the end of the month. Given the previous transactions, determine the net income or loss using the accrual basis for the Dyer Corporation for the month of April, 20X9. Answer: Sales revenue ($8,900 + $11,000) $19,900 Expenses: Cost of goods sold ($5,100 + $7,500) 12,600 Wage expense 4,000 Rent expense 400 Depreciation expense 1,500 Total expenses 18,500 Net income $ 1,400 Diff: 2 Objective: L.O. 2-4
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15) Dynamic Enterprises had the following information during November 20X9: Inventory purchases on account $ 6,800. Inventory purchases for cash $2,800. Sales on account $15,000. Cash sales $3,500. 1. Cost of goods sold on cash and credit sales 2. Payment of 3 months' rent in advance (1 month's rent should be recognized in November) 3. Payment of inventory purchased on account 4. Collections from credit customers 5. Wages earned and paid during November 6. Wages earned but not paid during November 7. Credit purchases of supplies 8. Supplies used during November
$9,200 2,100 3,000 9,900 5,000 3,200 1,200 200
Required: Prepare an income statement for Dynamic Enterprises for the month of November, 20X9, under the accrual basis. Answer: Dynamic Enterprises Income Statement - Accrual Basis For the Month Ended November 30, 20X9 Sales Expenses: Cost of goods sold Rent expense Wage expense Supply expense Total expenses Net income
$18,500 9,200 700 8,200 200 18,300 $ 200
Diff: 2 Objective: L.O. 2-4
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16) Following is the balance sheet for Value Creation, Inc. as of January 31, 20X9: Value Creation, Inc. Balance Sheet January 31, 20X9 Assets: Cash Accounts Receivable Merchandise Inventory Prepaid Rent Store Equipment
$ 7,100 4,000 13,500 3,300 15,600
Total Assets
$43,500
Liabilities: Accounts Payable Notes Payable Total Liabilities Stockholders' Equity: Paid-in Capital Retained Earnings Total Stockholders' equity Total Liab. and Stockholders' Equity
$ 6,200 8,300 14,500 $17,600 11,400 29,000 $43,500
The following transactions occurred during January: 1. The company paid $2,100 of the accounts payable. 2. The company acquired $3,500 of merchandise inventory, paying 40% in cash and the remainder on open account. 3. The utility bill of $1,400 for the month of January was paid. 4. The company received $2,200 from its credit customers. 5. Sales of merchandise inventory for the month of January totaled $22,500, of which $10,000 was paid in cash and the remaining amount was on open account. The cost of the merchandise sold was $15,000. 6. The company paid $1,600 of the note payable. Ignore interest expense. 7. Depreciation on the store equipment was $900 for the month. 8. Additional store equipment of $1,700 was acquired. Of this amount, $700 was paid in cash and the remainder was added to the note payable balance. 9. The balance in the prepaid rent account represented 3 months' worth of rent paid in advance as of January 31, 20X9. Required: Prepare an income statement for the month ended January 31, 20X9. Answer: Value Creation, Inc. Income Statement For the Month Ended January 31, 20X9 Sales Expenses: Cost of goods sold Depreciation expense Utility expense Rent expense Total expenses Net income
$22,500 15,000 900 1,400 1,100 18,400 $ 4,100
Diff: 3 Objective: L.O. 2-4
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17) Following is the balance sheet for the Pratley Corporation as of March 31, 20X9: Assets Cash Accounts Receivable Merchandise Inventory Prepaid Rent Store Equipment
$ 7,100 4,000 13,500 3,300 15,600
Total Assets
$43,500
Liabilities Accounts Payable Notes Payable Total Liab. Paid-in Capital Retained Earnings Total Stockholders' equity Total Liab. and Stockholders' Equity
$ 6,200 8,300 14,500 $17,600 11,400 29,000 $43,500
The following transactions occurred during April: 1. The company paid $2,100 of the accounts payable. 2. The company acquired $3,500 of merchandise inventory, paying 40% in cash and the remainder on open account. 3. The utility bill of $600 for the month of April was paid. 4. The company received $2,200 from its credit customers. 5. Sales of merchandise inventory for the month of April totaled $12,900, of which $5,400 was paid in cash and the remaining amount was on open account. The cost of the merchandise sold was $8,100. 6. The company paid $1,600 of the note payable. 7. Depreciation on the store equipment was $600 for the month. 8. Additional store equipment of $1,700 was acquired. Of this amount, $700 was paid in cash and the remainder was added to the note payable balance. 9. The balance in the prepaid rent account represented 3 months' worth of rent paid in advance as of March 31, 20X9. 10. Net income for the month ended April, 20X9, was $2,500. Required: Prepare an analysis of the above transactions using the balance sheet equation. Prepare a balance sheet dated April 30, 20X9.
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Answer: Transaction
Accounts Merch. Prepaid Store Accounts Notes Paid-in Retained Cash Receiv. Rent Equip. Payable Payable Capital Earnings Inventory $7,100 $4,000 $13,500 $3,300 $15,600 $6,200 $8,300 $17,600 $11,400 1 -2,100 -2,100 2 -1,400 +3,500 +2,100 3 -600 -600 4 +2,200 -2,200 5 +5,400 +7,500 +12,900 -8,100 -8,100 6 -1,600 -1,600 7 -600 -600 8 -700 +1,700 +1,000 9 -1,100 -1,100 $8,300 $9,300 $8,900 $2,200 $16,700 $6,200 $7,700 $17,600 $13,900
Pratley Corporation Balance Sheet April 30, 20X9 Assets: Cash $ 8,300 Accounts Receivable 9,300 Merchandise Inventory 8,900 Prepaid Rent 2,200 Store Equipment 17,300 Accum. Deprec. (600) 16,700 Total Assets
$45,400
Liabilities: Accounts Payable Notes Payable Total Liabilities Stockholders' Equity: Paid in Capital Retained Earnings Total Stockholders' equity Total Liabilities and Stockholders' Equity
Diff: 3 Objective: L.O. 2-4
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$ 6,200 7,700 13,900 17,600 13,900 31,500 $45,400
18) Specify whether each of the following terms belong on the Balance Sheet, Income Statement, or Statement of Stockholders' Equity and whether each is an asset, liability, revenue, expense, or neither. 1. accrual 2. sales 3. accounts receivable 4. account payable 5. cost of sales 6. prepaid rent 7. equipment 8. net earnings 9. dividends 10. predictive value Answer: Financial statement Account 1. neither neither 2. income statement revenue 3. balance sheet asset 4. balance sheet liability 5. income statement expense 6. balance sheet asset 7. balance sheet asset 8. income statement, statement of neither stockholders' equity 9. statement of stockholders' equity neither 10. neither neither Diff: 2 Objective: L.O. 2-4 & 2-5
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Learning Objective 2.5 Questions 1) The Goaling Company declared a $3,500 cash dividend on March 1, 2012 payable on April 2, 2012. The effect of the March 1st transaction on the Goaling Company would be to A) decrease the balance in the cash account and decrease the balance in the retained earnings account by $3,500. B) increase the balance in the dividend expense account and increase the balance in the dividend payable account by $3,500. C) increase the balance in the dividend expense account and increase the balance in the retained earnings account by $3,500. D) increase the balance in the dividend payable account and increase the balance in the prepaid dividend account by $3,500. E) increase the balance in the dividend payable account and decrease the balance in the retained earnings account by $3,500. Answer: E Diff: 2 Objective: L.O. 2-5
2) On May 1, 2011, Chickla Corporation's balance sheet had the following information available: Total Assets Total Liabilities Total Stockholders' Equity
$500,000 $400,000 $100,000
During the month of May, Chickla Corporation earned revenues of $120,000 and incurred expenses of $30,000. Dividends declared during May were $20,000. The dividends will be paid in June. No other capital transactions occurred. What amount did Chickla Corporation's total stockholders' equity increase by in May? A) $90,000 B) $120,000 C) $100,000 D) $70,000 E) $190,000 Answer: D Diff: 2 Objective: L.O. 2-5
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3) On September 12, 2012, Infinity Enterprises declared a $7,000 cash dividend payable on October 1, 2012. The effect of the October 1, 2012, transaction on Infinity Enterprises would be to A) increase the balance in the cash account and decrease the balance in the prepaid dividend account by $7,000. B) decrease the balance in the cash account and decrease the balance in the dividend payable account by $7,000. C) decrease the balance in the cash account and increase the balance in the dividend expense account by $7,000. D) decrease the balance in the cash account and increase the balance in the prepaid dividend account by $7,000. E) decrease the balance in the cash account and decrease the balance in the retained earnings account by $7,000. Answer: B Diff: 2 Objective: L.O. 2-5
4) A liability for a cash dividend is recorded on the A) stockholder appreciation date. B) record date. C) payment date. D) declaration date. E) dividends date. Answer: D Diff: 2 Objective: L.O. 2-5
5) Cash dividends A) are distributions of cash to trade creditors. B) are expenses like rent and depreciation. C) should not be deducted from revenues on the income statement. D) must be paid annually, regardless of the amount of cash in the bank. E) cannot be paid if a net loss is incurred. Answer: C Diff: 2 Objective: L.O. 2-5
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6) Solar Communications had the following balances in its stockholders' equity accounts as of December 31, 20X9: Paid-in Capital $53,000 Retained Earnings $31,000 During the year ended December 31, 20X9, Solar Communications generated $36,000 in net income, and declared and paid $16,000 in dividends. The ending balance in the retained earnings account at December 31, 20X8, was A) $11,000. B) $26,000. C) $13,000. D) $67,000. E) $40,000. Answer: A Diff: 2 Objective: L.O. 2-5
7) The Computing Company's balance sheet on September 30, 2012 follows: Total Assets $75,000 Total liabilities $20,000 Paid-in-Capital $25,000 Retained Earnings $30,000 During the month of October, the Computing Company recognized revenues of $52,000, cost of goods sold of $39,000, depreciation expense of $3,000, the payment of November and December's rent totaling $2,000, and salary expense of $6,000. The retained earnings balance at October 31, 2012, will be A) $33,000. B) $54,000. C) $32,000. D) $56,000. E) $36,000. Answer: A Diff: 3 Objective: L.O. 2-5
8) Carpenter and Sons' balance sheet on January 1, 2012, had total assets of $73,000, total liabilities of $20,000, paid-in capital of $30,000, and retained earnings of $23,000. During the month of January, Carpenter and Sons' recognized revenues of $73,000, cost of goods sold of $47,000, depreciation expense of $12,000, the payment of February and March's rent totaling $2,500, and salary expense of $8,000. The retained earnings balance at January 31, 2012, will be A) $29,000. B) $27,750. C) $31,000. D) $41,000. E) $26,500. Answer: A Diff: 3 Objective: L.O. 2-5
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9) Cash dividends are an expense, and therefore they appear on the income statement. Answer: FALSE Diff: 1 Objective: L.O. 2-5
10) The date the board of directors declares a dividend is known as the record date. Answer: FALSE Diff: 2 Objective: L.O. 2-5
11) Frequently, the statement of retained earnings is added to the bottom of the balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 2-5
12) Determine the missing values. Revenues $250 Expenses 200 Dividends Declared 20 Additional investments by owners A Net income B Retained Earnings, Beginning C Retained Earnings, Ending 110 Paid-in Capital, Beginning 60 Paid-in Capital, Ending 60 Total Assets, Beginning D Total Assets, Ending 250 Total Liabilities, Beginning 95 Total Liabilities, Ending E Answer: A = 0 Beginning Paid-in Capital + Additional Investments by Owners = Ending Paid-in Capital; 60 + Additional Investments by Owners = 60; A = Additional Investments by Owners = 0 B = 50 Net income = Revenues - Expenses; B = 250 - 200 C = 80 Retained Earnings, Beg + Net income - Dividends = Retained Earnings, End; C + 50 - 20 = 110 D =235 Assets, Beg = Liabilities, Beg + (Retained Earnings, Beg + Paid-in Capital, Beg) D = 95 + (80 +60) E = 80 Assets, End = Liabilities, End + (Retained Earnings, End + Paid-in Capital, End) 250 = E + (110+60); E = 80 Diff: 2 Objective: L.O. 2-4 & 2-5
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13) The Lone Maple Corporation had net income during 2012 of $46,000. During the year, dividends of $14,000 were declared, of which $10,000 had been paid as of year end. As of the beginning of 2012, the Paid-in Capital account had a balance of $38,000 and the Retained Earnings account had a balance of $54,000. Prepare the Retained Earnings column for the Statement of Stockholders' Equity for the Lone Maple Corporation for the year ended December 31, 2012. Answer: Retained Earnings, Beginning Balance $ 54,000 Add: Net Income 46,000 Less: Dividends Declared (14,000) Retained Earnings, Ending Balance $ 86,000 Diff: 2 Objective: L.O. 2-5
Learning Objective 2.6 Questions 1) Which financial ratio is required to be reported on the face of the income statement of publicly-held corporations? A) Earnings per share B) Price-earnings ratio C) Dividend-yield ratio D) Dividend payout ratio E) Inventory turnover ratio Answer: A Diff: 2 Objective: L.O. 2-6
2) Which financial ratio measures how much the investing public is willing to pay for a chance to share the company's potential earnings? A) Earnings per share B) Price-earnings ratio C) Dividend-yield ratio D) Dividend payout ratio E) Profit margin ratio Answer: B Diff: 2 Objective: L.O. 2-6
3) Mason Manufacturing had 2012 earnings of $850,000. Cash dividends per share were $1.25. The company had an average of 350,000 shares of common stock outstanding. The market price of the stock at the end of the year was $30 per share. What are the earnings per share for 2012? A) $ 1.50. B) $24.00. C) $ 2.43. D) $ 21.50. E) This cannot be determined from the information given. Answer: C Diff: 2 Objective: L.O. 2-6
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4) Mason Manufacturing had 2012 earnings of $850,000. Cash dividends per share were $1.25. The company had an average of 350,000 shares of common stock outstanding. The market price of the stock at the end of the year was $30 per share. What was the price-earnings ratio for Mason Manufacturing? A) 24.0 B) 18.4 C) 9.36 D) 12.35 E) Cannot be determined from the information provided Answer: D Diff: 2 Objective: L.O. 2-6
5) Mason Manufacturing had 2012 earnings of $850,000. Cash dividends per share were $1.25. The company had an average of 350,000 shares of common stock outstanding. The market price of the stock at the end of the year was $30 per share. What was the dividend-yield for Mason Manufacturing? A) 4.17% B) 1.25% C) 4.80% D) 15.0% E) Cannot be determined from the information provided Answer: A Diff: 2 Objective: L.O. 2-6
6) Stone, Inc. had 2012 earnings of $1,500,000. Cash dividends per share were $0.50. The company had an average of 1,225,000 shares of common stock outstanding. The market price of the stock at the end of the year was $6.00 per share. What was the earnings per share for 2012? A) $0.60 B) $0.75 C) $1.22 D) $1.25 E) $5.50 Answer: C Diff: 2 Objective: L.O. 2-6
7) Stone, Inc. had 2012 earnings of $1,500,000. Cash dividends per share were $0.50. The company had an average of 1,225,000 shares of common stock outstanding. The market price of the stock at the end of the year was $6.00 per share. What was the price-earnings ratio for Stone, Inc.? A) 6.5 B) 4.92 C) 3.00 D) 12 E) 5.20 Answer: B Diff: 2 Objective: L.O. 2-6
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8) Stone, Inc. had 2012 earnings of $1,500,000. Cash dividends per share were $0.50. The company had an average of 1,225,000 shares of common stock outstanding. The market price of the stock at the end of the year was $6.00 per share. What was the dividend-yield for Stone, Inc.? A) 12.00% B) 10.00% C) 20.33% D) 8.33% E) Cannot be determined from the information provided Answer: D Diff: 2 Objective: L.O. 2-6
9) Which financial ratio measures the return on an investment in common stock by dividing the cash dividends per share by the market price per share? A) Earnings per share B) Price-earnings ratio C) Dividend-yield ratio D) Dividend payout ratio E) Accounts receivable turnover ratio Answer: C Diff: 2 Objective: L.O. 2-6
10) The dividend-yield ratio must appear on the face of the balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 2-6
11) Another name for the P-E ratio is the earnings multiple. Answer: TRUE Diff: 2 Objective: L.O. 2-6
12) The price-earnings ratio is earnings per share of common stock divided by the market price per share of common stock. Answer: FALSE Diff: 2 Objective: L.O. 2-6
13) The dividend-yield ratio is computed as the current market price of the stock divided by the current dividend per share. Answer: FALSE Diff: 2 Objective: L.O. 2-6
14) Companies with exceptional growth (growth stocks) tend to pay a higher percentage of their earnings in dividends. Answer: FALSE Diff: 1 Objective: L.O. 2-6
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15) The dividend-payout ratio is computed as common dividends per share divided by earnings per share. Answer: TRUE Diff: 2 Objective: L.O. 2-6
16) Following is a list of selected financial data for a series of companies:
Company Jacobs Simons Russell
|
Per-share Data
| Price | $50 | $35 |G
Earnings $1.75 D $5.25
|
Ratios and Percentages
Dividends | P-E A |B $2.25 |E $1.75 | 12.0
Dividend-yield C F I
Dividend-payout 30% 40% J
1. Compute the missing figures and identify the company with a. the highest dividend-yield. b. the highest dividend-payout percentage. c. the lowest market price relative to earnings. 2. Assume that you know nothing about any of these companies other than the data given and the computations you have made from the data. If you were interested in receiving dividend income, which company would you choose as a. the most attractive investment? Why? b. the least attractive investment? Why? Answer: 1. A = .53 Dividend-payout = dividends/earnings; .30 = A/1.75 B = 28.6 P-E = Price/earnings; B = 50/1.75; C = .0106 Dividend-yield = Dividends/Price; C = .53/50; C = 1.06% D = 5.63 Dividend-payout = dividends/earnings; .40 = 2.25/D; D = 5.63 E = 6.22 P-E = Price/earnings; E = 35/5.63; E = 6.22 F = .0643 Dividend-yield = Dividends/Price; F = 2.25/35; F = 6.43% G = 63 P-E = Price/earnings; 12.0 = G/5.25; G = 63 I = .0278 Dividend-yield = Dividends/Price; I = 1.75/63 = 2.78% J = 33% Dividend Payout = dividends/earnings; J = 1.75/5.25 = .33 a. Simons b. Simons c. Simons 2. a. Simons Simons has the highest dividend-yield and has the highest dividend-payout. It also has the highest dividends per share. b. Jacobs Jacobs has the lowest dividend-yield ratio and the lowest dividend-payout ratio. Diff: 3 Objective: L.O. 2-6
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Learning Objective 2.7 Questions 1) The cost-effectiveness constraint requires that standard setting bodies choose rules that A) have decision-making benefits that exceed the costs of providing the information. B) have revenue generating ability. C) have revenue generating ability that exceeds the cost of providing the information. D) have costs known to the SEC. E) are not costly to implement. Answer: A Diff: 2 Objective: L.O. 2-7
2) R&D costs are expensed in the period that they occur, A) which is a violation of the matching principle. B) because FASB determined that the benefits of R&D are often harder to pinpoint than the costs. C) because is was the only way FASB could get verifiability. D) because IASB lobbied FASB to do so. E) because the U.S. Congress passed a law on it. Answer: B Diff: 2 Objective: L.O. 2-7
3) The primary objective of financial reporting focuses on A) consistency. B) representational faithfulness. C) validity. D) decision usefulness in making investment, credit and resource allocation decisions. E) the matching concept. Answer: D Diff: 2 Objective: L.O. 2-7
4) The two main qualities that make accounting information useful for decision making are ________ and ________. A) relevance and reliability B) relevance and faithful representation C) understandability and verifiability D) comparability and consistency E) timeliness and reliability Answer: B Diff: 2 Objective: L.O. 2-7
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5) Standards issued by the Financial Accounting Standards Board are A) products of logic and philosophical discussions with Congress. B) issued by the FASB without the input of interested parties such as corporate accountants, financial analysts and lobbyists. C) often the result of compromises among the interested parties. D) never influenced by the SEC. E) None of the above statements is true. Answer: C Diff: 2 Objective: L.O. 2-7
6) The two attributes that make financial information relevant are ________ and ________. A) reliability; faithful representation B) reliability; verifiability C) comparability; consistency D) understandability; timeliness E) predictive value; confirmatory value Answer: E Diff: 2 Objective: L.O. 2-7
7) ________ is the capability of information to make a difference to the decision maker. A) Verifiability B) Reliability C) Relevance D) Validity E) Neutrality Answer: C Diff: 2 Objective: L.O. 2-7
8) Relevance is defined as A) choosing accounting policies without attempting to achieve purposes other than measuring economic impact. B) the capability of information to make a difference to the decision maker. C) the quality of information that allows users to depend on it to represent the conditions or events that it purports to represent. D) a correspondence between the accounting numbers and the resources or events those numbers purport to represent. E) a quality of information such that there would be a high extent of consensus among independent measurers of an item. Answer: B Diff: 2 Objective: L.O. 2-7
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9) ________ is a quality of information that helps users form their expectations about the future. A) Timeliness B) Faithful representation C) Verifiability D) Predictive value E) Confirmatory value Answer: D Diff: 2 Objective: L.O. 2-7
10) Verifiability is defined as A) the quality of information that allows users to depend on it to represent the conditions or events that it purports to represent. B) the capability of information to make a difference to the decision maker. C) choosing accounting policies without attempting to achieve purposes other than measuring economic impact. D) a correspondence between the accounting numbers and the resources or events those numbers purport to represent. E) a quality of information such that it can be checked to ensure it is correct. Answer: E Diff: 2 Objective: L.O. 2-7
11) Neutrality is defined as A) information which is free from bias and not slanted to influence the behavior of decision makers. B) the capability of information to make a difference to the decision maker. C) the quality of information that allows users to depend on it to represent the conditions or events that it purports to represent. D) a correspondence between the accounting numbers and the resources or events those numbers purport to represent. E) a quality of information such that there would be a high extent of consensus among independent measures of an item. Answer: A Diff: 2 Objective: L.O. 2-7
12) Faithful representation requires information to be ________, ________ and free from material errors. A) timely; comparable B) relevant; reliable C) consistent; verifiable D) confirmatory; predictive E) complete, neutral Answer: E Diff: 2 Objective: L.O. 2-7
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13) ________ requires all companies in an industry to follow similar accounting principles and methods. For example, most companies in the department store industry use the same inventory method. A) Validity B) Verifiability C) Faithful representation D) Consistency E) Comparability Answer: E Diff: 2 Objective: L.O. 2-7
14) ________ requires accountants to present information clearly and concisely. A) Verifiability B) Validity C) Understandability D) Relevance E) Reliability Answer: C Diff: 1 Objective: L.O. 2-7
15) The characteristics that enhance relevance and faithful representation are A) predictive value; confirmatory value. B) validity; verifiability. C) understandability; timeliness; predictive value. D) comparability; verifiability; timeliness; understandability. E) consistency; understandability; confirmatory value. Answer: D Diff: 1 Objective: L.O. 2-7
16) Using LIFO to value inventory one year and using FIFO the next is a violation of which accounting principle? A) Conservatism B) Recognition C) Neutrality D) Matching E) Consistency Answer: E Diff: 2 Objective: L.O. 2-7
17) The cost-effectiveness constraint asserts that an item should be included in a financial statement if its omission or misstatement would tend to mislead the reader. Answer: FALSE Diff: 1 Objective: L.O. 2-7
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18) Relevance means that the information can be counted on to represent faithfully the condition of the company, given the rules in use. Answer: FALSE Diff: 2 Objective: L.O. 2-7
19) With verifiability, knowledgeable and independent observers would agree that the information presented has been appropriately measured. Answer: TRUE Diff: 2 Objective: L.O. 2-7
20) U.S. financial reporting follows the IASB framework for decision usefulness. Answer: FALSE Diff: 2 Objective: L.O. 2-7
21) Relevance and validity are the two main qualities that make accounting information useful for decision making. Answer: FALSE Diff: 1 Objective: L.O. 2-7
22) One of the components of relevance is neutrality. Answer: FALSE Diff: 2 Objective: L.O. 2-7
23) Define the following terms: a. Neutrality b. Relevance c. Consistency d. Verifiability Answer: a. Neutrality: free from bias; the information is not slanted to influence behavior in a particular direction b. Relevance: the capability of information to make a difference to the decision-maker c. Consistency: using the same accounting policies and procedures from period to period d. Verifiability: A quality of information such that it can be checked to ensure it is correct Diff: 2 Objective: L.O. 2-7
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Learning Objective 2.8 Questions 1) Reliability is defined as A) the quality of information that allows it to help users form their expectations about the future. B) the capability of information to make a difference to the decision maker. C) the quality of information that allows decision makers to depend on it to represent the conditions or events that it purports to represent. D) choosing accounting policies without attempting to achieve purposes other than measuring economic impact. E) a quality of information such that there would be a high extent of consensus among independent measurers of an item. Answer: C Diff: 2 Objective: L.O. 2-8
2) What is the concept that differentiates a corporation from its management? A) Entity B) Going concern C) Reliability D) Cost-benefit criterion E) Materiality Answer: A Diff: 1 Objective: L.O. 2-8
3) The reason that companies use historical costs to value long-term assets is the A) entity concept. B) materiality convention. C) going concern convention. D) periodicity convention. E) neutrality principle. Answer: C Diff: 2 Objective: L.O. 2-8
4) Which item would most likely be expensed even though it is an asset? A) desk B) computer C) filing cabinets D) printer E) trash can Answer: E Diff: 2 Objective: L.O. 2-8
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5) The convention that gives financial statement users more timely information is the A) stable monetary unit B) materiality convention C) going concern convention D) periodicity convention E) entity concept Answer: D Diff: 1 Objective: L.O. 2-8
6) Reliability is the assumption that, ordinarily, an entity persists indefinitely. Answer: FALSE Diff: 1 Objective: L.O. 2-8
7) The stable monetary unit concept is based on a principle of low inflation. Answer: TRUE Diff: 2 Objective: L.O. 2-8
8) Reliability refers to whether the information makes a difference to the decision maker. Answer: FALSE Diff: 2 Objective: L.O. 2-8
9) The assumption that in all ordinary situations an entity persists indefinitely is known as the reliability assumption. Answer: FALSE Diff: 1 Objective: L.O. 2-8
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10) Which of the following concepts applies to situations 1-6 below. Entity Reliability Going Concern Materiality
Periodicity Stable monetary unit Cost-effectiveness constraint
1. Rhodes, Inc. acquired equipment with a fair market value of $22,000 and only paid $1,000 for the equipment at an auction. Following company policy which expenses assets with a cost of $1,000 or less, Rhodes, Inc. recorded an expense of $1,000. 2. McElwain, Inc. has divisions in several countries. Before publishing financial statements, McElwain, Inc. translates its divisional financial information to U.S. dollars. 3. Smith Enterprises, is experiencing financial difficulties due to poor economic conditions. The organization has been in existence for 50 years and has experienced these conditions in the past with little financial impact to the organization. Although Smith Enterprises may be impacted, there is no reason to believe that it will go bankrupt. 4. Komar Cable Company, owned by Katherine Hoots and Kate Coleman, each deposited $50,000 into the business's bank account. Both Katherine and Kate have access to the bank account and periodically transfer money from their personal accounts to the business account, but they never access the business account for personal use. 5. Mower Technology prepares monthly financial statements even though it is costly to do so. 6. Water Waste Systems only records accounting transactions when there is convincing evidence that can be verified by independent auditors. Answer: 1. Materiality 2. Stable monetary unit 3. Going concern 4. Entity 5. Periodicity 6. Reliability Diff: 2 Objective: L.O. 2-8
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11) For each example, write the qualitative characteristic(s) or accounting term that best corresponds. a. A company that uses a different inventory method every year is not following this characteristic of financial information. b. An error of $100 of revenue for Sherry's Dairy King versus $100 of revenue for McDonald's. c. Record revenue when it is earned and record expenses when incurred regardless of when cash changes hands. d. A parent corporation, a subsidiary, and a retail store are examples of this concept. e. The SEC requires companies with publicly traded securities to file financial reports with the SEC quarterly. f. Three auditors count the same amount of cash. Answer: a. consistency b. materiality c. accrual accounting d. entity e. periodicity f. verifiability Diff: 2 Objective: L.O. 2-7 & 2-8
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Introduction to Financial Accounting, 11e (Horngren) Chapter 3 Recording Transactions Learning Objective 3.1 Questions 1) Which of the following transactions would not affect owners' equity? A) Recording cost of goods sold B) Recording a cash sale C) Recording a sale on account D) Recording utilities expense E) Purchasing inventory for cash Answer: E Diff: 2 Objective: L.O. 3-1
2) Which of the following statements is true regarding attributes of the general ledger and the general journal? A) Both the general ledger and the general journal focus on general accounting concepts and not specific events or occurrences. B) The general journal displays the balance in a particular account. C) The general ledger and the general journal are separate and distinct accounting records that are not related or cross-referenced to each other. D) The general ledger is account driven and the general journal is transaction driven. E) General ledger accounts are only used in ERP systems. Answer: D Diff: 1 Objective: L.O. 3-1
3) Which of the following accounts is classified differently from the others in the list? A) Notes Payable B) Accounts Receivable C) Merchandise Inventory D) Prepaid Rent E) Cash Answer: A Diff: 1 Objective: L.O. 3-1
4) Which of the following accounts is increased with a debit? A) Accounts Payable B) Notes Payable C) Merchandise Inventory D) Capital E) Sales Revenue Answer: C Diff: 1 Objective: L.O. 3-1
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5) A ledger contains only balance sheet accounts kept up-to-date in a systematic way. Answer: FALSE Diff: 1 Objective: L.O. 3-1
6) T-accounts focus on account balances while journal entries focus on transactions. Answer: TRUE Diff: 1 Objective: L.O. 3-1
7) The right side of a T-account always increases an account balance and the left side of a T-account always decreases an account balance. Answer: FALSE Diff: 1 Objective: L.O. 3-1
8) T-accounts facilitate the preparation of financial statements at any instant if the account balances are kept up-to-date. Answer: TRUE Diff: 1 Objective: L.O. 3-1
9) T-accounts can only be used for income statement accounts. Answer: FALSE Diff: 1 Objective: L.O. 3-1
10) A T-account is an analysis of an account. Answer: TRUE Diff: 1 Objective: L.O. 3-1
11) Indicate whether each of the following accounts normally possesses a debit (DR) or a credit (CR) balance. 1. Wage expense 9. Merchandise Inventory 2. Prepaid rent 10. Salary expense 3. Cost of goods sold 11. Equipment 4. Cash 12. Accounts receivable 5. Sales 13. Accumulated depreciation 6. Paid-in-capital 14. Notes payable 7. Depreciation expense 15. Utilities expense 8. Accounts payable Answer: 1. DR, 2. DR, 3. DR, 4. DR, 5. CR, 6. CR, 7. DR, 8. CR, 9. DR, 10. DR, 11. DR, 12. DR, 13. CR, 14. CR, 15. DR Diff: 2 Objective: L.O. 3-1
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12) Listed below are several accounts from Process Improvements, Inc. for the year ended December 31, 2012. Next to each account indicate its normal balance and whether you would need to debit or credit the account to decrease it. Use DR for debit and CR for credit. Account Prepaid rent Notes payable Retained earnings Sales revenue Cash Store equipment Paid in capital Wage expense Accounts receivable Cost of goods sold Accounts payable Inventory Utilities expense Depreciation expense Accumulated depreciation Answer: Account Prepaid rent Notes payable Retained earnings Sales revenue Cash Store equipment Paid in capital Wage expense Accounts receivable Cost of goods sold Accounts payable Inventory Utilities expense Depreciation expense Accumulated depreciation
Normal Balance
To Decrease
Normal Balance DR CR CR CR DR DR CR DR DR DR CR DR DR DR CR
To Decrease CR DR DR DR CR CR DR CR CR CR DR CR CR CR DR
Diff: 2 Objective: L.O. 3-1
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Learning Objective 3.2 Questions 1) The recording process has a sequence of five steps. What is the specific order of the steps? A) Journal, trial balance, financial statements, ledger, transaction documentation B) Transaction documentation, journal, ledger, trial balance, financial statements C) Transaction documentation, ledger, journal, trial balance, financial statements D) Ledger, journal, transaction documentation, trial balance, financial statements E) Trial balance, financial statements, ledger, journal, transaction documentation Answer: B Diff: 1 Objective: L.O. 3-2
2) What is the final step in the recording process? A) preparation of trial balance B) preparation of journal entries C) preparation of source documents D) transferring journal entries in the general journal to the ledger E) preparation of financial statements Answer: E Diff: 2 Objective: L.O. 3-2
3) Which of the following is not an example of a source document? A) Check stubs B) Sales receipts C) Purchase orders D) Minutes of the board of directors E) The Wall Street Journal Answer: E Diff: 1 Objective: L.O. 3-2
4) Source documents are prepared A) continuously as transactions occur. B) once per month in order to finalize financial statements. C) once per quarter in accordance with U.S. GAAP. D) twice per year in accordance with IFRS. E) once per year in order to finalize year-end financial statements for investors. Answer: A Diff: 1 Objective: L.O. 3-2
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5) The account numbers from the chart of accounts are A) not allowed to be used to prepare journal entries; account names must be used. B) allowed to be used to prepare journal entries. C) allowed to be used to prepare journal entries if an organization has 100 or more account numbers. D) allowed to be used to prepare journal entries if an organization has $1 million or more in total revenues. E) allowed to be used to prepare journal entries if an organization also uses the account numbers in financial statements prepared for investors and creditors. Answer: B Diff: 1 Objective: L.O. 3-2
6) A book of original entry is a chronological record of an entity's transactions. Answer: TRUE Diff: 1 Objective: L.O. 3-2
7) Harry Chull purchased supplies from Party Supplies Company on August 14, 2012 for $540 cash. Party Supplies Company purchased the supplies for $75 on August 1, 2012. What steps must Party Supplies Company follow to record the sale to Harry Chull? After listing the step, describe in detail the specific transaction Party Supplies Company is recording. Answer: 1. Transaction documentation: Party Supplies Company would prepare a sales receipt, keeping one copy for itself and giving one copy to Harry as receipt for payment of the supplies as a source document. 2. Journal: The company would record the transaction, including accounts, in the general journal. 3. Ledger: The company would enter the journal entry in the ledger, recording each component on either the left or right side depending on the account. 4. Trial balance: The company would prepare a trial balance listing all accounts with their positive, normal balances. 5. Financial statements: Closing entries would be prepared and an income statement, balance sheet, statement of owners' equity, and statement of cash flows would also be prepared Diff: 2 Objective: L.O. 3-2
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Learning Objective 3.3 Questions 1) The posting reference number in the general journal is obtained from: A) source documents. B) the account number for each account posted to the ledger. C) the transaction amount. D) the Income Summary account. E) the normal balance in each account. Answer: B Diff: 2 Objective: L.O. 3-3
2) Posting is the process of transferring information from the A) journal to the ledger. B) ledger to the journal. C) journal to the balance sheet. D) income statement to the balance sheet. E) ledger to the income statement and balance sheet. Answer: A Diff: 1 Objective: L.O. 3-3
3) A compound journal entry A) is a general ledger transfer that affects more than two accounts. B) is a general journal transfer that affects more than two accounts. C) is a journal entry for more than two transactions that affects one or more accounts. D) is a journal entry for a transaction that affects more than two accounts. E) is not allowed in accordance with U.S. GAAP, but is allowed in accordance with IFRS. Answer: D Diff: 2 Objective: L.O. 3-3
4) The entry to collect cash on account involves a A) debit to Cash and a credit to Accounts Payable. B) debit to Accounts Receivable and a credit to Cash. C) debit to Cash and a credit to Accounts Receivable. D) debit to Accounts Receivable and a credit to Accounts Payable. E) debit to Cash and a credit to Sales Revenue. Answer: C Diff: 2 Objective: L.O. 3-3
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5) The entry to record the cost of merchandise inventory sold involves a A) debit to Merchandise Inventory and a credit to Sales Revenue. B) debit to Cost of Goods Sold and a credit to Merchandise Inventory. C) debit to Merchandise Inventory and a credit to Cost of Goods Sold. D) debit to Cost of Goods Sold and a credit to Sales Revenue. E) debit to Merchandise Inventory and a credit to Accounts Receivable. Answer: B Diff: 2 Objective: L.O. 3-3
6) Bethany Industries purchased $3,000 of merchandise inventory, paying cash for 20% of the purchase, with the remainder on account. The entry would include a A) debit to Cash for $600, debit to Accounts Payable for $2,400, and credit to Merchandise Inventory for $3,000. B) debit to Cash for $800, debit to Notes Payable for $2,200, and credit to Merchandise Inventory for $3,000. C) debit to Merchandise Inventory for $3,000, credit to Cash for $600, and credit to Notes Payable for $2,400. D) debit to Merchandise Inventory for $3,000, credit to Cash for $600, and credit to Accounts Payable for $2,400. E) debit to Merchandise Inventory for $600, and credit to Cash for $600. Answer: D Diff: 2 Objective: L.O. 3-3
7) Application Technologies has acquired equipment costing $15,000. The company paid $5,000 and gave a 10-month note for the balance. The bookkeeper should A) debit Equipment for $15,000, credit Cash for $5,000, and credit Notes Receivable for $10,000. B) debit Cash for $5,000, debit Notes Receivable for $10,000, and credit Equipment for $15,000. C) debit Equipment for $15,000, credit Cash for $5,000, and credit Notes Payable for $10,000. D) debit Cash for $5,000, debit Notes Payable for $10,000, and credit Equipment for $15,000. E) debit Equipment for $15,000, debit Cash for $5,000, credit Notes Payable for $10,000, and credit Paid-in Capital for $5,000. Answer: C Diff: 2 Objective: L.O. 3-3
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8) Kasper Shack, Inc. acquired merchandise inventory for $1,300 cash on January 12 th. On January 21st, it noticed that the wrong merchandise had been shipped and returned it to the supplier for a cash refund. Which of the following is the journal entry that would be required for the return of the merchandise on January 21st? A) Cash Merchandise Inventory B) Merchandise Inventory Cash C) Accounts Payable Merchandise Inventory D) Merchandise Inventory Accounts Payable E) Cash Accounts Payable Answer: A
Dr. 1,300 Dr. 1,300 Dr. 1,300 Dr. 1,300 Dr. 1,300
Cr. 1,300 Cr. 1,300 Cr. 1,300 Cr. 1,300 Cr. 1,300
Diff: 2 Objective: L.O. 3-3
9) Contributor Enterprise borrowed $2,400 on February 1, 2012. All interest has been paid and properly recorded for separately. On March 31, 2012, the company repaid the loan. Which of the following is the journal entry to be made at the time of the loan repayment? A) Dr. Cr. Notes Payable Expense 2,400 Cash 2,400 B) Dr. Cr. Notes Payable 2,400 Cash 2,400 C) Dr. Cr. Cash 2,400 Notes Payable Expense 2,400 D) Dr. Cr. Cash 2,400 Notes Payable 2,400 E) Dr. Cr. Cash 2,400 Notes Receivable 2,400 Answer: B Diff: 2 Objective: L.O. 3-3
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10) If a company would like to repay a bank loan of $7,000, the bookkeeper would A) debit Cash and credit Notes Receivable for $7,000. B) debit Notes Receivable and credit Cash for $7,000. C) debit Cash and credit Accounts Payable for $7,000. D) debit Cash and credit Notes Payable for $7,000. E) debit Notes Payable and credit Cash for $7,000. Answer: E Diff: 2 Objective: L.O. 3-3
11) Publishing for Personnel, Inc., received and paid its utility bill of $800. As the accountant, you would tell the bookkeeper to A) debit Utility Expense and credit Cash for $800. B) debit Cash and credit Utility Payable for $800. C) debit Cash and credit Utility Expense for $800. D) debit Cash and credit Retained Earnings for $800. E) debit Utility Receivable and credit Cash for $800. Answer: A Diff: 2 Objective: L.O. 3-3
12) Materials Handling Company sold merchandise inventory costing $7,000 for $12,000 in cash. How should Materials Handling Company record this transaction? A) debit Cash for $12,000, credit Sales for $7,000, and credit Merchandise Inventory for $7,000 B) debit Cash for $12,000, debit Cost of Goods Sold for $7,000, credit Sales for $12,000, and credit Merchandise Inventory for $7,000 C) debit Cash for $12,000, debit Merchandise Inventory for $7,000, credit Sales for $12,000, and credit Cost of Goods Sold for $7,000 D) debit Sales for $12,000, debit Merchandise Inventory for $7,000, credit Cash for $12,000, and credit Cost of Goods Sold for $7,000 E) debit Sales for $12,000, debit Cost of Goods Sold for $7,000, credit Cash for $12,000, and credit Merchandise Inventory for $7,000 Answer: B Diff: 2 Objective: L.O. 3-3
13) Darla Documentation, paid $1,900 to the local newspaper for advertising that will begin in 30 days and continue for the following 6 weeks. How would Darla Documentation record this transaction? A) Debit Cash and credit Advertising Expense for $1,900 B) Debit Prepaid Advertising and credit Advertising Expense for $1,900 C) Debit Advertising Expense and credit Prepaid Advertising for $1,900 D) Debit Cash and credit Prepaid Advertising for $1,900 E) Debit Prepaid Advertising and credit Cash for $1,900 Answer: E Diff: 2 Objective: L.O. 3-3
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14) The journal entry to acquire equipment costing $30,000 with a $12,000 down payment and a note issued for the difference would include a A) debit to Cash for $18,000 and a credit to Equipment for $30,000. B) debit to Equipment for $30,000 and a credit to Notes Payable for $12,000. C) debit to Equipment for $30,000, credit to Notes Payable for $18,000, and a credit to Cash for $12,000. D) debit to Equipment for $30,000, credit to Notes Payable for $12,000, and a credit to Cash for $18,000. E) debit to Equipment for $30,000 and a credit to Cash for $30,000. Answer: C Diff: 2 Objective: L.O. 3-3
15) Wilham Roofing acquired merchandise inventory for $12,000, paying one-fourth in cash and the remainder on open account. Which of the following is the journal entry necessary to record this transaction? A) Dr. Cr. Cash 3,000 Merchandise Inventory 3,000 B) Dr. Cr. Cash 3,000 Accounts Receivable 9,000 Merchandise Inventory 12,000 C) Dr. Cr. Cash 3,000 Accounts Payable 9,000 Merchandise Inventory 12,000 D) Dr. Cr. Merchandise Inventory 12,000 Cash 3,000 Accounts Payable 9,000 E) Dr. Cr. Merchandise Inventory 12,000 Cash 3,000 Accounts Receivable 9,000 Answer: D Diff: 2 Objective: L.O. 3-3
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16) Sharpington, Inc. manufactures and sells phone cases. The company sold a shipment of cases costing $5,000 to a customer for $8,000. The customer paid cash. Which of the following is the journal entry that Sharpington would make to record the sale of the shipment of cases? A) Dr. Cr. Cash 8,000 Sales 3,000 Merchandise Inventory 5,000 B) Merchandise Inventory Sales Cash C) Cash Net Income Merchandise Inventory D) Cash Cost of Goods Sold Sales Merchandise Inventory E) Sales Merchandise Inventory Cash Cost of Goods Sold Answer: D
Dr. 5,000 3,000 Dr. 8,000
Dr. 8,000 5,000
Dr. 8,000 5,000
Cr.
8,000 Cr. 3,000 5,000 Cr.
8,000 5,000 Cr.
8,000 5,000
Diff: 2 Objective: L.O. 3-3
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17) On July 1, 2012, Norton Company paid $2,400 for rent on the building it occupies. This rent payment is for the 3-month period of July 1 to September 30, 2012. Which of the following is the journal entry to be made on July 1, 2012? A) Dr. Cr. Rent Expense 2,400 Prepaid Rent 2,400 B) Cash Rent Expense C) Prepaid Rent Cash D) Cash Prepaid Rent E) Prepaid Rent Rent Expense Answer: C
Dr. 2,400 Dr. 2,400 Dr. 2,400 Dr. 2,400
Cr. 2,400 Cr. 2,400 Cr. 2,400 Cr. 2,400
Diff: 3 Objective: L.O. 3-3
18) On October 1, 2012, Water Works paid $3,600 for 6 months' rent in advance. The appropriate journal entry was made at the time using Prepaid Rent. No other journal entry has been made. As of December 31, 2012, Water Works should A) debit Rent Expense and credit Prepaid Rent for $1,200. B) debit Rent Expense and credit Prepaid Rent for $1,800. C) debit Prepaid Rent and credit Rent Expense for $1,800. D) debit Prepaid Rent and credit Rent Expense for $1,200. E) No journal entry is necessary as of December 31, 20X9. Answer: B Diff: 3 Objective: L.O. 3-3
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19) Palladia Publishing paid $450 for an advertisement that will appear in today's newspaper. Which of the following is the journal entry to record this transaction? A) Dr. Cr. Cash 450 Prepaid Advertising 450 B) Advertising Receivable Cash C) Advertising Expense Prepaid Advertising D) Cash Advertising Expense E) Advertising Expense Cash Answer: E
Dr. 450 Dr. 450 Dr. 450 Dr. 450
Cr. 450 Cr. 450 Cr. 450 Cr. 450
Diff: 2 Objective: L.O. 3-3
20) Chordley Manufacturing borrowed $12,000 from the Second National Bank of Tahoma on October 1, 2012. The note carries an annual interest rate of 10%, which will be paid once a year on September 30. The company has not recognized any interest expense during 2012. What is the journal entry necessary to recognize interest expense as of December 31, 2012? A) Dr. Cr. Interest Expense 300 Interest Payable 300 B) Interest Expense Notes Payable C) Interest Payable Interest Expense D) Interest Expense Interest Payable E) Interest Expense Notes Payable Answer: A
Dr. 300 Dr. 300 Dr. 1,200 Dr. 1,200
Cr. 300 Cr. 300 Cr. 1,200 Cr. 1,200
Diff: 3 Objective: L.O. 3-3
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21) Indirect Personnel, Inc. obtained a $20,000 note payable on August 1, 2012, that is due in 5 years. Interest, at an annual rate of 12%, will be paid once a year on July 31. The accountant made the appropriate journal entry on August 1, 2012. No other journal entry has been made. What journal entry is necessary as of December 31, 2012? A) Debit Interest Expense and credit Notes Payable for $1,000 B) Debit Interest Expense and credit Notes Payable for $2,400 C) Debit Interest Expense and credit Interest Payable for $1,000 D) Debit Interest Expense and credit Interest Payable for $2,400 E) Debit Interest Expense and credit Interest Receivable for $2,400 Answer: C Diff: 3 Objective: L.O. 3-3
22) Picture Perfect Videos acquired $18,000 of equipment by paying $6,000 in cash, with the remaining balance on a note due in 6 months. Which set of T-accounts best describes this transaction? A) Cash Notes Receivable Equipment ---------------------------------------------|6,000 |12,000 18,000| | | | B) Cash Notes Receivable Equipment -------------------------------------------6,000| 12,000| |18,000 | | | C) Cash Equipment Accounts Payable ------------------------------------------6,000| |18,000 12,000| | | | D) Cash Equipment Notes Payable ------------------------------------------6,000| |18,000 12,000| | | | E) Cash Equipment Notes Payable ------------------------------------------|6,000 18,000 | |12,000 | | | Answer: E Diff: 2 Objective: L.O. 3-3
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23) Given the following transactions, what is the ending balance in the Cash account? 1. The owner started the company by investing $6,000 cash. 2. The company paid $1,200 for 6 months' rent in advance. 3. The company acquired $2,400 in merchandise inventory with one-half of the purchase on account. 4. The company sold merchandise inventory costing $1,500 for $3,100 on account. A) $3,600 debit balance B) $3,600 credit balance C) $5,100 credit balance D) $4,800 debit balance E) $4,800 credit balance Answer: A Diff: 2 Objective: L.O. 3-3
24) From the following information, determine the ending balance in Retained Earnings. 1. Beginning Retained Earnings $ 6,200 2. Cash 1,900 3. Accounts Payable 1,100 4. Sales 27,000 5. Merchandise Inventory 9,200 6. Cost of Goods Sold 14,400 7. Salary Expense 9,900 A) $ 6,200 B) $ 8,900 C) $12,700 D) $18,900 E) $20,000 Answer: B Diff: 2 Objective: L.O. 3-3
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25) Florings Company purchased merchandise costing $900, one-fourth of which was acquired on open account, and the rest was paid in cash. Which set of T-accounts best describes this transaction? A) Accounts Merchandise Cash Payable Inventory ------------------------------------| 675 | 225 900 | | | | B) Accounts Merchandise Cash Payable Inventory ------------------------------------| 675 900 | | 225 | | | C) Accounts Merchandise Cash Receivable Inventory ------------------------------------675 | 225 | | 900 | | | D) Accounts Merchandise Cash Payable Inventory ------------------------------------675 | | 900 225 | | | | E) Notes Merchandise Cash Payable Inventory ------------------------------------675 | | 900 225 | | | | Answer: A Diff: 2 Objective: L.O. 3-3
26) To record the prepaid rent that has expired during the period, the entry would include a debit to A) Prepaid Rent. B) Rent Expense. C) Retained Earnings. D) Accrued Rent. E) Unearned Rent. Answer: B Diff: 2 Objective: L.O. 3-3
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27) Full Scale Cleaning and More paid 8 months insurance in advance amounting to $3,200. A prepaid asset was established. At the end of the first month, the entry would include a A) debit to Prepaid Insurance for $3,200. B) credit to Insurance Expense for $3,200. C) debit to Insurance Expense for $2,800. D) debit to Insurance Expense for $400. E) debit to Prepaid Insurance for $400. Answer: D Diff: 2 Objective: L.O. 3-3
28) All Handles, Inc. began operations on February 1, 2012, and purchased $4,000 of supplies. On December 31, 2012, $1,200 were still on hand. The December 31, 2012, entry would include a A) debit to Supplies Expense for $1,200. B) debit to Supplies for $4,000. C) credit to Supplies Expense for $1,200. D) credit to Supplies Expense for $2,800. E) debit to Supplies Expense for $2,800. Answer: E Diff: 2 Objective: L.O. 3-3
29) Accumulated depreciation is classified as a(n) A) asset account. B) liability account. C) contra asset account. D) contra liability account. E) equity account. Answer: C Diff: 2 Objective: L.O. 3-3
30) Holand, Inc., determines that depreciation amounts to $900 for the period. The entry includes a A) debit Depreciation Expense and credit Accumulated Depreciation for $900. B) debit Accumulated Depreciation and credit Equipment for $900. C) debit Depreciation Expense and credit Equipment for $900. D) debit Equipment and credit Accumulated Depreciation for $900. E) debit Accumulated Depreciation and credit Depreciation Expense for $900. Answer: A Diff: 2 Objective: L.O. 3-3
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31) Grogle Company had to calculate book value on its die cutting machine. The company paid $32,000 for the equipment on January 1, 2012, but its current appraised value is $46,000. On December 31, 2015, accumulated depreciation on the machine is $12,000. What is Grogle Company's book value on the die cutting machine at December 31, 2015? A) $14,000 B) $32,000 C) $46,000 D) $20,000 E) $34,000 Answer: D Diff: 2 Objective: L.O. 3-3
32) Which of the following is a distinguishing feature of a contra account? A) If a contra account has a credit balance, then its companion account will usually have a debit balance. B) If a contra account has a credit balance, then its companion account will usually have a credit balance. C) A contra account usually has a dollar balance larger than its companion account. D) Contra accounts are found only in the liability section of the balance sheet. E) Contra accounts do not follow generally accepted accounting principles, while their companion accounts do follow generally accepted accounting principles. Answer: A Diff: 2 Objective: L.O. 3-3
33) Which of the following accounts are expected to have a debit normal balance? 1. Merchandise Inventory 2. Rent Expense 3. Paid-in Capital 4. Accumulated Depreciation 5. Sales 6. Prepaid Rent 7. Accounts Payable A) Merchandise Inventory, Rent Expense, Prepaid Rent B) Merchandise Inventory, Paid-in Capital, Sales, Prepaid Rent C) Paid-in Capital, Accumulated Depreciation, Sales, Accounts Payable D) Rent Expense, Accumulated Depreciation, Accounts Payable E) Merchandise Inventory, Paid-in Capital, Accumulated Depreciation, Accounts Payable Answer: A Diff: 2 Objective: L.O. 3-3
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34) Randy Stall invests $25,000 in cash in the company to start his own company. Randy Stall should: A) debit Retained Earnings and credit Cash for $25,000. B) debit Cash and credit Retained Earnings for $25,000. C) debit Paid-in Capital and credit Retained Earnings for $25,000. D) debit Paid-in Capital and debit Retained Earnings for $25,000. E) debit Cash and credit Paid-in Capital for $25,000. Answer: E Diff: 2 Objective: L.O. 3-3
35) Which of the following accounts are expected to have a credit normal balance? 1. Cash 2. Salary Expense 3. Retained Earnings 4. Accumulated Depreciation 5. Sales 6. Prepaid Rent 7. Accounts Payable A) Cash, Retained Earnings, Sales B) Salary Expense, Accounts Payable, Accumulated Depreciation C) Cash, Retained Earnings, Accumulated Depreciation, Prepaid Rent, Accounts Payable D) Cash, Salary Expense, Prepaid Rent E) Retained Earnings, Accumulated Depreciation, Sales, Accounts Payable Answer: E Diff: 2 Objective: L.O. 3-3
36) Which of the following would not be found in a general journal? A) The ending balance in an account B) Separate columns for debits and credits C) The date of the transaction D) The account names in a transaction E) A posting reference Answer: A Diff: 2 Objective: L.O. 3-3
37) Journalizing is the analysis of the effects of a transaction on the accounts, usually accompanied by an explanation. Answer: TRUE Diff: 2 Objective: L.O. 3-3
38) Debits are always journalized after credits. Answer: FALSE Diff: 1 Objective: L.O. 3-3
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39) Negative numbers are never used in the journal or the ledger; the effect on the account is conveyed by the side on which the number appears. Answer: TRUE Diff: 1 Objective: L.O. 3-3
40) Posting is the process of transferring amounts from the ledger to the financial statements. Answer: FALSE Diff: 1 Objective: L.O. 3-3
41) Posting is the transferring of amounts from the journal to the appropriate accounts in the ledger. Answer: TRUE Diff: 1 Objective: L.O. 3-3
42) The purchase of office supplies on account would include a debit to accounts payable and a credit to office supplies. Answer: FALSE Diff: 2 Objective: L.O. 3-3
43) The purchase of office equipment on account would increase assets and decrease stockholders' equity. Answer: FALSE Diff: 2 Objective: L.O. 3-3
44) A compound entry is when two or more journal entries are made. Answer: FALSE Diff: 2 Objective: L.O. 3-3
45) The purchase of a building with a down payment of cash and the signing of a note payable for the remainder would include a debit to both the Building account and the Notes Payable account, and a credit to the Cash account. Answer: FALSE Diff: 2 Objective: L.O. 3-3
46) Since revenues and expenses are associated with stockholders' equity, revenues and expenses must have normal balances on the same side of a T-account. Answer: FALSE Diff: 1 Objective: L.O. 3-3
47) The normal balance for any account is the side of the account where increases are recorded. Answer: TRUE Diff: 2 Objective: L.O. 3-3
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48) Assets, expenses, and revenues have normal balances on the debit side of a T-account. Answer: FALSE Diff: 1 Objective: L.O. 3-3
49) A debit increases the balance of assets and liabilities. Answer: FALSE Diff: 2 Objective: L.O. 3-3
50) A credit decreases the balance of assets and expenses. Answer: TRUE Diff: 2 Objective: L.O. 3-3
51) Liabilities are known as contra assets. Answer: FALSE Diff: 1 Objective: L.O. 3-3
52) The accumulated depreciation is sometimes referred to as the allowance for depreciation. Answer: TRUE Diff: 1 Objective: L.O. 3-3
53) Prepare the necessary journal entries for each of the following transactions for Klokel, Inc. a. Klokel, Inc. sold 1,200 shares of common stock at $30 per share in cash. b. The company purchased equipment for $14,000, paying $4,000 in cash and the remainder in a note. c. The company paid the current month's rent, which amounted to $900, and the current month's utilities, which amounted to $400. d. Merchandise inventory costing $1,900 was sold on account for $4,100. e. Depreciation on the equipment amounted to $600. Answer: Dr. Cr. a. Cash 36,000 Paid-in Capital 36,000 b. Equipment 14,000 Cash 4,000 Notes Payable 10,000 c. Rent Expense 900 Utility Expense 400 Cash 1,300 d. Accounts Receivable 4,100 Sales 4,100 Cost of Goods Sold 1,900 Merchandise inventory 1,900 e. Depreciation Expense 600 Accumulated Depreciation, Equipment 600 Diff: 2 Objective: L.O. 3-3
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54) Following are accounts in alphabetical order, which are numbered for identification, followed by a series of transactions. For each transaction, determine what account(s) should be debited and credited, and place the number associated with that account in the appropriate debit or credit column. 1. Accounts Receivable 9. Notes Payable 2. Accounts Payable 10. Paid-in Capital 3. Accumulated Depreciation-equipment 11. Prepaid Rent 4. Cash 12. Rent Expense 5. Cost of Goods Sold 13. Sales 6. Depreciation Expense 14. Wage Expense 7. Equipment 15. Utility Expense 8. Merchandise Inventory Debit Credit a. Purchased equipment by offering a six month note. ________ ________ b. Received and paid the current utility bill. ________ ________ c. Purchased merchandise inventory on account. ________ ________ d. Recorded depreciation on the equipment. ________ ________ e. Recognized expense of 1 month's rent (prepaid rent recorded on the books) ________ ________ f. Sold merchandise inventory on account, sale price above cost. ________ ________ g. Collected cash from customers on account. ________ ________ h. Sold merchandise inventory for cash, sale price above cost. ________ ________ i. Sold shares of common stock for cash. ________ ________ j. Paid 6 months rent in advance. ________ ________ k. Wages were earned and paid to employees. ________ ________ Answer: Debit Credit a. 7 9 b. 15 4 c. 8 2 d. 6 3 e. 12 11 f. 1, 5 8, 13 g. 4 1 h. 4, 5 8, 13 i. 4 10 j. 11 4 k. 14 4 Diff: 3 Objective: L.O. 3-3
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55) Prepare the journal entries for each of the six transactions depicted in the following T-accounts, along with a brief explanation as to the nature of the transaction.
Cash --------------(1) 11,000| 350 (2) (5) 400|450 (6)
Prepaid Rent --------------(2) 350| |
Sales ------------|1,600 (4)
Accounts Receivable ----------------(4) 1,600|400 (5) |
Accounts Payable ------------| 2,800 (3) |
Cost of Goods Sold ---------------(4) 1,100| |
Merchandise Inventory ---------------(3) 2,800|1,100 (4) |
Paid-In Capital --------------|11,000 (1) |
Wage Expense ---------------(6) (450) | |
Answer: 1. Cash 11,000 Paid-in Capital 11,000 The owners invested $11,000 cash in the company. 2. Prepaid Rent 350 Cash 350 The company paid rent in advance. 3. Merchandise Inventory 2,800 Accounts Payable 2,800 The company acquired merchandise inventory on account. 4. Accounts Receivable 1,600 Sales 1,600 Cost of Goods Sold 1,100 Merchandise inventory 1,100 The company sold merchandise inventory costing $1,100 for $1,600 on account. 5. Cash 400 Accounts Receivable 400 The company collected cash from credit customers. 6. Wage Expense 450 Cash 450 Wages earned and paid to employees. Diff: 2 Objective: L.O. 3-3
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56) Northstar Enterprises had the following balances as of December 31, 2011: Accounts Receivable Accounts Payable Unearned Revenue
$ 21,600 $ 14,300 $ 6,100
During 2012, the following activity occurred: 1. $73,100 was paid by customers in advance for work to be performed by the company. The balance in the unearned revenue account as of December 31, 2012, was $7,700. 2. Credit sales were $497,100. As of December 31, 2012, the accounts receivable balance was $32,900. 3. Accounts payable is solely attributable to the acquisition of merchandise inventory on account. Credit purchases of merchandise inventory during 2012 were $291,000. The balance in accounts payable as of December 31, 2012, was $13,100. Required: a. What was the amount of cash received from credit customers in 2012? b. How much cash was paid by the company for the credit purchase of merchandise inventory related to its accounts payable in 2012? c. How much sales revenue was recognized by the company in 2012, related to the work performed for customers who paid in advance? Answer: a. $485,800 = cash received from credit customers b. $292,200 = cash paid by the company for the credit purchase of merchandise inventory c. $ 71,500 = sales revenue in 2012 for work performed for customers who paid in advance Diff: 3 Objective: L.O. 3-3
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57) Selected accounts from Taylor Company as of March 31, 2012, follow: Cash Inventory Prepaid rent Plant Accumulated depreciation, plant Accounts payable Paid in capital Retained earnings
$ 5,300 10,250 100 40,500 10,000 6,300 20,000 ?
In addition, the following transactions occurred in the month of March. 1. Depreciation for the month amounted to $700 2. Purchased inventory on account for $3,000 3. Returned a portion of the inventory deemed defective for $200 4. Paid creditors $2,200 for inventory purchased in #2 5. Paid 6 months' rent of $600 in advance, covering April 1, 2012 through September 30, 2012. The contract price did not increase from the previous 6 months' period and covered October 1, 2011 through March 31, 2012 6. Sold inventory for $4,100 cash that cost Taylor Company $2,600 Required: 1. Journalize the transactions for Taylor Company. 2. Prepare an analysis of the transactions using the balance sheet equation. 3. Prepare an income statement for the month ending March 31. 4. Prepare a balance sheet at March 31. Answer: 1. Depreciation expense 700 Accumulated depreciation, plant 700 2. Inventory 3,000 Accounts payable 3,000 3. Accounts payable 200 Inventory 200 4. Accounts payable 2,200 Cash 2,200 5. Prepaid rent 600 Cash 600 Rent expense 100 Prepaid rent 100 6. Cash 4,100 Sales revenue 4,100 Cost of goods sold 2,600 Inventory 2,600
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2. TransPrepaid Accum. Accounts Paid in Retained action Cash Inventory Rent Plant Depr. Payable Capital Earnings Beg. bal. $5,300 $10,250 $100 $40,500 ($10,000) $6,300 $20,000 $19,850 (1) (700) -700 (2) +3,000 +3,000 (3) -200 -200 (4) -2,200 -2,200 (5) -600 +600 -100 -100 (6) +4,100 +$4,100 -2,600 -2,600 End. Bal. $6,600 $10,450 $600 $40,500 ($10,700) $6,900 $20,000 $20,550 3.
Taylor Company Income Statement For the Month Ended March 31, 2012 Sales revenue Cost of goods sold Rent expense Depreciation expense Net income
4.
$ 4,100 2,600 100 700 $700
Taylor Company Balance Sheet March 31, 2012 Assets: Cash Inventory Prepaid Rent Plant 40,500 Less: Accumulated depreciation (10,700) Total Assets Liabilities: Accounts payable Owners' Equity: Paid in capital 20,000 Retained earnings 20,550 Total Owners' Equity Total Liabilities and Owners' Equity
$ 6,600 10,450 600 29,800 $47,450 $6,900
40,550 $47,450
Diff: 3 Objective: L.O. 3-3
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Learning Objective 3.4 Questions 1) Which of the following accounts would not be found on the credit side of a trial balance? A) Equipment B) Accounts Payable C) Retained Earnings D) Sales Revenue E) Paid-in Capital Answer: A Diff: 1 Objective: L.O. 3-4
2) Given the following balances, what would the total credits in the trial balance equal? 1. Equipment $52,000 2. Accounts Payable 1,000 3. Sales 51,000 4. Accumulated Depreciation 3,000 5. Accounts Receivable 4,000 6. Retained Earnings 13,000 7. Salary Expense 4,000 8. Cash 12,000 9. Paid-in Capital 10,000 10. Cost of Goods Sold 25,000 A) $103,000 B) $129,000 C) $ 97,000 D) $78,000 E) $83,000 Answer: D Diff: 2 Objective: L.O. 3-4
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3) Given the following complete list of balances, what will be the total credits in the trial balance, assuming no errors exist in the accounts? Note: The accounts payable records were damaged by a flood, and the company is not certain what the correct balance should be. 1. Retained Earnings $ 28,000 2. Merchandise Inventory 9,000 3. Accumulated Depreciation 5,000 4. Sales 42,000 5. Selling Expenses 11,000 6. Accounts Receivable $ 7,000 7. Cost of Goods Sold 22,000 8. Accounts Payable ? 9. Cash 5,000 10. Equipment 33,000 A) $72,000 B) $69,000 C) $58,000 D) $87,000 E) Due to the damage of the accounts payable records, it is impossible to determine the amount of the total credits on the trial balance. Answer: D Diff: 3 Objective: L.O. 3-4
4) The trial balance should be prepared A) after preparing the financial statements. B) before posting beginning balances to new accounts. C) after posting closing entries. D) before posting journal entries to the ledger. E) after posting journal entries to the ledger. Answer: E Diff: 2 Objective: L.O. 3-4
5) If an accountant erroneously records an $8,000 credit to Accounts Payable instead of an $8,000 debit to the Cash account, the Accounts Payable account will be A) understated by $8,000. B) overstated by $8,000. C) understated by $16,000. D) overstated by $16,000. E) correct since the erroneous entry caused the trial balance to equal. Answer: B Diff: 2 Objective: L.O. 3-4
6) A trial balance is similar to a balance sheet in that it only includes balance sheet accounts. Answer: FALSE Diff: 1 Objective: L.O. 3-4
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7) In a trial balance, the number of accounts that are debited do not have to equal the number of accounts that are credited, but the total dollar amount of the debits must equal the total dollar amount of the credits. Answer: TRUE Diff: 1 Objective: L.O. 3-4
8) The trial balance serves two purposes. It verifies the clerical accuracy of the posting process and assists in preparing the financial statements. Answer: TRUE Diff: 2 Objective: L.O. 3-4
9) The trial balance is an internal report that helps accountants prepare the financial statements. Answer: TRUE Diff: 1 Objective: L.O. 3-4
10) A trial balance proves the equality of the total debits and total credits of the accounts listed. Answer: TRUE Diff: 2 Objective: L.O. 3-4
11) If the debit side of a journal entry is posted but the credit side is not, the trial balance will not balance. Answer: TRUE Diff: 2 Objective: L.O. 3-4
12) If an entry involving only two assets is not posted, the trial balance will be out of balance. Answer: FALSE Diff: 2 Objective: L.O. 3-4
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13) Given the following account balances for Felay's Second Hand Shop on December 31, 2012, prepare a trial balance. Accounts Payable Sales Merchandise Inventory Accum. Depreciation, Equipment Supplies Paid-in Capital Cost of Goods Sold Retained Earnings Wages Payable Cash Wage Expense Rent Expense Equipment Answer: Felay's Second Hand Shop Trial Balance December 31, 2012 Cash Merchandise Inventory Supplies Equipment Accumulated Depreciation, Equipment Accounts Payable Wages Payable Paid-in Capital Retained Earnings Sales Cost of Goods Sold Rent Expense Wage Expense
$15,000 93,000 32,000 3,000 2,000 32,000 38,000 20,000 8,000 26,000 29,000 17,000 27,000
DR. $26,000 32,000 2,000 27,000
CR.
$3,000 15,000 8,000 32,000 20,000 93,000 38,000 17,000 29,000 $171,000
Diff: 2 Objective: L.O. 3-4
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_______ $171,000
14) Given the following account balances for Nelson Communications, prepare a trial balance for March 31, 2012. Wage Expense 19,000 Paid-in Capital $51,000 Cost of Goods Sold 21,000 Prepaid Rent 500 Wages Payable 2,000 Accounts Receivable 9,000 Sales 49,000 Equipment 64,000 Cash 6,000 Accounts Payable 8,000 Retained Earnings 17,500 Rent Expense 2,000 Merchandise Inventory 11,000 Accum. Depreciation, Equipment 5,000 Answer: Nelson Communications Trial Balance March 31, 2012
Cash Accounts Receivable Merchandise Inventory Prepaid Rent Equipment Accumulated Depreciation, Equipment Accounts Payable Wages Payable Paid-in Capital Retained Earnings Sales Cost of Goods Sold Rent Expense Wage Expense
Dr. $6,000 9,000 11,000 500 64,000
Cr.
$5,000 8,000 2,000 51,000 17,500 49,000 21,000 2,000 19,000 $132,500
Diff: 2 Objective: L.O. 3-4
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0 $132,500
Learning Objective 3.5 Questions 1) The entry to close revenue accounts involves A) a debit to Income Summary and credits to all the revenue accounts. B) debits to all the revenue accounts and a credit to Income Summary. C) debits to all the expense accounts and credits to all the revenue accounts. D) a debit to Retained Earnings and a credit to Income Summary. E) a debit to Income Summary and a credit to Retained Earnings. Answer: B Diff: 2 Objective: L.O. 3-5
2) The entry to close expense accounts involves A) a credit to Income Summary and debits to all the revenue accounts. B) debits to all the revenue accounts and a credit to Income Summary. C) credits to all the expense accounts and a debit to Income Summary. D) a debit to Retained Earnings and a credit to Income Summary. E) a debit to Income Summary and a credit to Retained Earnings. Answer: C Diff: 2 Objective: L.O. 3-5
3) The entry to close net income at the end of the accounting period involves a A) debit to Retained Earnings and a credit to Income Summary. B) debit to Income Summary and a credit to Retained Earnings. C) debit to Accounts Receivable and a credit to Retained Earnings. D) debit to Retained Earnings and a credit to Accounts Receivable. E) debit to Income Summary and a credit to Accounts Receivable. Answer: B Diff: 2 Objective: L.O. 3-5
4) What is the purpose of closing the books? A) To reset the revenue and expense accounts to zero so that they are ready to record the next period's transactions B) To reset the asset and liability accounts to zero so that they are ready to record the next period's transactions C) To transfer all account activity to retained earnings so that they are ready to record the next period's transactions D) To transfer all account activity to paid-in-capital so that they are ready to record the next period's transactions E) To transfer and reset any account with activity during the prior period to zero Answer: A Diff: 2 Objective: L.O. 3-5
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5) The Income Summary account A) can be found on the Income Statement since it is an expense account. B) can be found on the Income Statement since it is a revenue account. C) can be found on the Balance Sheet since it is an asset account. D) can be found on the Balance Sheet since it is a liability account. E) cannot be found on any of the financial statements. Answer: E Diff: 2 Objective: L.O. 3-5
6) Closing entries deal primarily with balance sheet accounts. Answer: FALSE Diff: 1 Objective: L.O. 3-5
7) The only accounts that are closed are income statement accounts. Answer: FALSE Diff: 2 Objective: L.O. 3-5
8) Closing entries are generally performed at the beginning of the accounting period. Answer: FALSE Diff: 1 Objective: L.O. 3-5
9) After all the revenue and expense accounts are closed, the Income Summary account will have a credit balance if the entity has net income. Answer: TRUE Diff: 1 Objective: L.O. 3-5
10) When expense accounts are closed, we credit each expense account. Answer: TRUE Diff: 1 Objective: L.O. 3-5
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11) Formation, Inc. had the following balances as of December 31, 2012. Prepare closing entries based on these balances. Equipment Retained Earnings Accumulated Depreciation Paid-in Capital Cost of Goods Sold Supplies Wages Payable Sales Cash Accounts Payable Wage Expense Rent Expense Merchandise Inventory Dividends (Amount Declared) Answer: 1.
2.
3.
4.
$26,000 7,000 $ 4,500 21,400 59,000 4,300 1,200 112,000 34,000 7,200 36,000 8,000 12,700 3,000
Sales Income Summary
112,000
Income Summary Cost of Goods Sold Wage Expense Rent Expense
103,000
Retained Earnings Dividends
3,000
Income Summary Retained Earnings
9,000
112,000
59,000 36,000 8,000
3,000
9,000
Diff: 2 Objective: L.O. 3-5
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12) Morrill Law Offices had the following transactions in November, 2012. Prepare closing entries followed by an income statement for Morrill Law Offices for the month ending November 30, 2012. 1. Morrill Law Offices sold $210,000 worth of services. Two-thirds was collected in November with the remainder collected in December. 2. The company paid wages of $53,000 to its employees. 3. The company paid utilities of $750 to Brenton Electric Company. 4. The company's prepaid rent account expired in the month of November. Morrill Law Offices purchased an additional 3 months of rent on October 1, 2012 for $3,600. The landlord did not increase rent for Morrill Law Offices. 5. A declaration of dividends for $3,200 occurred on November 1, 2012. Answer: 1. Service Revenue 210,000 Income Summary 210,000 2, 3, 4
5.
Income Summary Wage Expense Rent Expense Utilities Expense
54,950
Retained Earnings Dividends
3,200
Income Summary Retained Earnings
155,050
53,000 1,200 750
3,200
155,050
Morrill Law Firm Income Statement For the month ended November 30, 2012 Service Revenue Expenses: Wage expense Rent expense Utilities expense Net income
$ 210,000 $ 53,000 1,200 750
54,950 $ 155,050
Diff: 3 Objective: L.O. 3-5
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Learning Objective 3.6 Questions 1) Which of the following errors would a trial balance help the accounting staff to find? A) A sale for $8,300 occurred, and instead of debiting Cash for $8,300, Accounts Receivable was debited for $8,300. B) A sale for $8,300 occurred, and instead of debiting Cash for $8,300, Accounts Payable was debited for $8,300. C) A sale for $8,300 occurred, and instead of debiting Cash and crediting Sales for $8,300, Cash was credited and Sales was debited for $8,300. D) A sale for $8,300 occurred, and instead of debiting Cash and crediting Sales for $8,300, Cash was debited for $700, and Sales was credited for $8,300. E) A sale for $8,300 occurred and instead of debiting Cash for $8,300 and crediting Sales for $8,300, Cash was debited for $7,000 and Sales was credited for $7,000. Answer: D Diff: 2 Objective: L.O. 3-6
2) Failure to record depreciation at year-end will A) overstate total liabilities. B) understate assets. C) overstate assets. D) understate owners' equity. E) overstate revenue. Answer: C Diff: 3 Objective: L.O. 3-6
3) Marc's Cleaning Services purchased merchandise inventory on account for $500. This transaction was properly recorded. A week later, Marc's Cleaning Services discovered a defect in the merchandise inventory and returned the merchandise inventory to the supplier for credit. As the accountant, you would tell the bookkeeper to record the return of the merchandise inventory by A) debiting Merchandise Inventory and crediting Accounts Payable for $500. B) debiting Accounts Payable and crediting Merchandise Inventory for $500. C) debiting Merchandise Inventory and crediting Cash for $500. D) debiting Cash and crediting Merchandise Inventory for $500. E) debiting Cash and crediting Accounts Payable for $500. Answer: B Diff: 2 Objective: L.O. 3-6
4) Failure to record the expiration of a prepaid asset account will A) overstate assets. B) understate assets. C) overstate liabilities. D) understate liabilities. E) understate net income. Answer: A Diff: 3 Objective: L.O. 3-6
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5) Given the following two T-accounts, what can definitely be said about this company's transactions? Cash Acc. Receivable (1) 17,700|700 (2) (3) 1,400|1,900 (4) (3) 400|700 (5) | (4) 1,900| | A) Transaction 1 indicates the company sold merchandise for $17,700. B) Transaction 2 indicates the company bought merchandise for $700. C) Transaction 3 indicates the company returned merchandise for $1,000. D) Transaction 4 indicates the company received $1,900 from its credit customers. E) Transaction 5 indicates the company paid $700 in salaries. Answer: D Diff: 2 Objective: L.O. 3-6
6) Whitestone Remodeling, Inc. journalized a $600 repair to the Supplies account in error. Which of the following is the correcting entry to be made? A) Dr. Cr. Accounts Payable 600 Supplies 600 B) Dr. Cr. Repair Expense 600 Cash 600 C) Dr. Cr. Repair Expense 600 Supplies 600 D) Dr. Cr. Supplies 600 Repair Expense 600 E) Dr. Cr. Cash 600 Accounts Payable 600 Answer: C Diff: 2 Objective: L.O. 3-6
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7) A credit customer paid $200 to Iron Works Company to reduce the customer's outstanding balance. However, Iron Works Company erroneously increased sales. Which of the following is the correcting entry to be made? A) Dr. Cr. Accounts Receivable 200 Sales 200 B) Dr. Cr. Cash 200 Accounts Receivable 200 C) Dr. Cr. Cash 200 Sales 200 D) Dr. Cr. Sales 200 Accounts Receivable 200 E) Dr. Cr. Sales 200 Cash 200 Answer: D Diff: 3 Objective: L.O. 3-6
8) Altoon Manufacturing's records were partially destroyed in a flood. The company does not know what sales have been for the year, but it does know all sales were on account. Also, the beginning accounts receivable balance was $19,000, and its accounts receivable balance at the time of the flood was $25,000. From the beginning of the year until the flood, cash collections from credit customers were $158,000. Given this information, what are Altoon Manufacturing's sales for the year until the flood? A) $164,000 B) $114,000 C) $202,000 D) $209,000 E) $189,000 Answer: A Diff: 3 Objective: L.O. 3-6
9) Which of the following is true regarding accounting errors? A) Only the income statement of the second period is affected. B) Only the balance sheet of the first period is affected. C) Errors in the current period may be offset by errors in the next accounting period. D) Only auditors can change them. E) Because they reverse, it is not necessary to do anything after the fact. Answer: C Diff: 2 Objective: L.O. 3-6
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10) If an expense is understated in the current period, then A) net income is understated in the current period. B) net income is overstated in the current period. C) revenues are overstated in the current period. D) revenues are understated in the current period. E) dividends are overstated in the current period. Answer: B Diff: 2 Objective: L.O. 3-6
11) Not recognizing depreciation expense in a given month will A) understate total assets. B) understate total revenues. C) overstate total liabilities. D) overstate net income. E) have no effect since this is a temporary error. Answer: D Diff: 2 Objective: L.O. 3-6
12) If depreciation expense is not recorded for the current accounting period, total assets will be understated. Answer: FALSE Diff: 3 Objective: L.O. 3-6
13) If the entry to journalize expired supplies is not prepared, liabilities will be overstated. Answer: FALSE Diff: 2 Objective: L.O. 3-6
14) If expired insurance is not recorded at the end of the current accounting period, net income will be overstated. Answer: TRUE Diff: 3 Objective: L.O. 3-6
15) If the credit portion of a journal entry is posted but the debit side is not, liabilities will always be overstated. Answer: FALSE Diff: 2 Objective: L.O. 3-6
16) Some errors are counterbalanced by off-setting errors in the ordinary bookkeeping process in the next period. Such errors misstate net income in both periods. Answer: TRUE Diff: 2 Objective: L.O. 3-6
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17) The following errors occurred in the accounting records of Lorenzo Catering for the year ended December 31, 2012: 1. Lorenzo Catering received $3,000 in 2012 from a customer in advance of work to be performed. At the time of the cash receipt, revenue was recognized for the full amount. As of year end, 30% of the work had been completed, with the remainder completed in 2013. 2. Lorenzo Catering provided services of $2,300 for one of its customers in 2012, but did not bill the customer until 2013. 3. Lorenzo Catering paid $5,400 on September 1, 2012, for one year's rent in advance. At the time of the payment, the company used the prepaid rent account for the full amount. No other journal entry was made with respect to this transaction. 4. Lorenzo Catering failed to record wages earned but unpaid as of December 31, 2012, of $2,600. The wages were paid and recognized as an expense in 2013. State whether each item has understated (U), overstated (O), or had no effect (N) on the 2012 revenue, expense, and net income, as well as the year-end total assets, total liabilities, and total stockholder's equity balances. Answer: Revenues Expenses Net Income 1. O N O 2. U N U 3. N U O 4. N U O
1. 2. 3. 4.
Assets N U O N
Liabilities U N N U
Stockholders' Equity O U O O
Diff: 3 Objective: L.O. 3-6
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18) Stile Paving Company had the following journal entries for each of the transactions described. Prepare the correcting entry needed for each transaction. a. A credit customer paid $200 to Stile Paving Company for the customer's outstanding balance. The journal entry made by the company was Cash 200 Sales 200 b. A repair was made on some equipment. The cost was supposed to be charged to Repair Expense. The journal entry made by the company was Equipment 550 Accounts Payable 550 c. Depreciation for the current year was supposed to be $2,800, however the company made the following journal entry: Depreciation Expense 800 Equipment 800 d. Supplies were acquired on account for $1,300. The company made the following journal entry: Supplies 1,300 Accounts Receivable 1,300 e. The company paid $100 on account. The journal entry was: Accounts Receivable 100 Cash 100 Answer: a. Sales 200 Accounts Receivable 200 b. Repair Expense 550 Equipment 550 c. Depreciation Expense 2,000 Equipment 800 Accumulated Depreciation, Equip. 2,800 d. Accounts Receivable 1,300 Accounts Payable 1,300 e. Accounts Payable 100 Accounts Receivable 100 Diff: 3 Objective: L.O. 3-6
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Learning Objective 3.7 Questions 1) The SEC requires publicly held companies to file 10-K reports within ________ after the fiscal year ends. A) 30 days B) 60 days C) 90 days D) 120 days E) none of the above Answer: B Diff: 1 Objective: L.O. 3-7
2) Two of the largest developers of ERP systems are ________ and ________. A) Microsoft and Oracle B) Microsoft and Apple C) Windows and SAP D) QuickBooks and NetSuite E) SAP and Oracle Answer: E Diff: 1 Objective: L.O. 3-7
3) Small firms use computer software systems such as ________ to process accounting information quickly and efficiently. A) ERP B) Oracle C) SAP D) QuickBooks E) H & R Block Tax Filer Answer: D Diff: 1 Objective: L.O. 3-7
4) XBRL A) is only used in the United States. B) requires ERP programs. C) is used to compare different companies. D) is not an XML-based computer language. E) does not work with accounting data. Answer: C Diff: 1 Objective: L.O. 3-7
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5) ERP is a means of organizing computer accounting information. Answer: TRUE Diff: 1 Objective: L.O. 3-7
6) Over time, the cost of processing accounting information has increased. Answer: FALSE Diff: 2 Objective: L.O. 3-7
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Introduction to Financial Accounting, 11e (Horngren) Chapter 4 Accrual Accounting and Financial Statements Learning Objective 4.1 Questions 1) Which of the following is an example of an accrual? A) Wages incurred but not yet paid. B) Payment of insurance 8 months in advance. C) Purchase of equipment for use in the business. D) Revenue collected in advance from customer. E) All of the above. Answer: A Diff: 3 Objective: L.O. 4-1
2) Which of the following statements regarding adjusting entries is true? A) Accountants use adjusting entries to record explicit transactions at the end of each reporting period. B) Adjusting entries are made on a daily basis as cash is exchanged between parties. C) Adjusting entries have nothing to do with accrual accounting. D) Adjusting entries are made at periodic intervals, usually when the financial statements are about to be prepared. E) The recording of cash receipts from customers is an example of an adjusting entry. Answer: D Diff: 1 Objective: L.O. 4-1
3) An example of an explicit transaction is A) accruing interest payable at the end of the fiscal year. B) recognizing depreciation expense. C) cash disbursement for the payment of 3 months' rent in advance. D) accruing wages payable at month end. E) recognizing rent expense by reducing prepaid rent. Answer: C Diff: 2 Objective: L.O. 4-1
4) An example of an explicit transaction is A) depreciation expense. B) expiration of prepaid rent. C) accrual of interest payable. D) accrual of wages payable. E) purchasing inventory on account. Answer: E Diff: 2 Objective: L.O. 4-1
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5) An example of an implicit transaction is A) a cash sale. B) a credit purchase of inventory. C) the receipt of cash in advance of providing services. D) the expiration of prepaid rent. E) a credit sale. Answer: D Diff: 2 Objective: L.O. 4-1
6) An example of an entry that is not an adjusting entry is A) reducing Prepaid Rent to record rent expense for the current month. B) reducing Unearned Revenue to record revenue for services provided during the month. C) accruing wage expense for labor costs which have been incurred but not yet paid. D) purchase of land for cash and a note payable. E) accruing revenue for services that have been provided but not yet billed. Answer: D Diff: 2 Objective: L.O. 4-1
7) Which of the following situations does NOT involve an adjusting entry? A) Recording the expiration of prepaid insurance. B) Recording depreciation on equipment. C) Recording wages owed to employees. D) Recording revenue earned when cash was received in advance. E) Recognizing sales when they occur. Answer: E Diff: 2 Objective: L.O. 4-1
8) Adjusting entries affect A) neither an income statement account nor a balance sheet account B) an income statement account and a balance sheet account C) income statement accounts only D) balance sheet accounts only E) a cash account Answer: B Diff: 2 Objective: L.O. 4-1
9) Recording an accrual entry involves recording a(n) ________ or ________ at the end of an accounting period even though no explicit transaction occurs. A) fixed asset; long-term liability B) intangible asset; long-term liability C) cash sale; credit sale D) dividends; retained earnings E) receivable; payable Answer: E Diff: 1 Objective: L.O. 4-1
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10) The accountant uses adjusting entries to record implicit transactions at the end of each reporting period. Answer: TRUE Diff: 1 Objective: L.O. 4-1
11) Implicit transactions are events such as cash receipts and disbursements that trigger nearly all day-today routine entries. Answer: FALSE Diff: 1 Objective: L.O. 4-1
12) Some explicit transactions (e.g., the loss of assets due to fire) do not involve actual exchanges of goods and services between parties. Answer: TRUE Diff: 1 Objective: L.O. 4-1
13) Every adjusting entry affects one income statement account and one balance sheet account. Answer: TRUE Diff: 2 Objective: L.O. 4-1
14) All creditor transactions will result in an adjusting entry. Answer: FALSE Diff: 1 Objective: L.O. 4-1
15) Although it does not occur often, the Cash account can be used to record adjusting entries. Answer: FALSE Diff: 1 Objective: L.O. 4-1
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16) Define the term "implicit transaction" and explain how these transactions are recorded in the financial records. In addition, list two of the four principal types of adjustments and give an example of each. Answer: Implicit transactions are events that are temporarily ignored in day-to-day recording procedures and are recognized only at the end of an accounting period. The accountant uses adjusting entries to record implicit transactions at the end of each reporting period. The principal types of adjustments can be classified into four types: ∙ Expiration or consumption of unexpired costs ∙ Realization (earning) of revenues received in advance ∙ Accrual of unrecorded expenses ∙ Accrual of unrecorded revenues Examples of the expiration of unexpired costs include the recognition of monthly depreciation expense and the write-offs to expense of such assets as Supplies Inventory, Prepaid Insurance, and Prepaid Rent. Examples of the realization of unearned revenues include the reduction of the liability "Unearned Rent Revenue" at the end of each month or the reduction of the liability "Unearned Subscription Revenue" each time an issue of a magazine is mailed to the customer. Examples of the accrual of unrecorded expenses are the accrual of wage expense, interest expense, and income tax expense. Examples of unrecorded revenues include "unbilled" fees generated by attorneys, public accountants, physicians, and advertising agencies. Diff: 2 Objective: L.O. 4-1
Learning Objective 4.2 Questions 1) The adjusting entry to recognize periodic depreciation expense has what effect on the basic accounting equation? A) Decrease in assets, decrease in liabilities B) Decrease in assets, increase in liabilities C) Decrease in assets, increase in stockholders' equity D) Decrease in assets, decrease in stockholders' equity E) None of these Answer: D Diff: 2 Objective: L.O. 4-2
2) An example of an adjusting entry is A) cash collections from credit customers. B) payment of the principal and interest on a note. C) recognizing rent expense by reducing Prepaid Rent. D) declaring a cash dividend. E) buying inventory on open account. Answer: C Diff: 2 Objective: L.O. 4-2
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3) Blockade Consulting Services paid 3 months' rent in advance on July 1, at a total cost of $2,400. The rent covers the period from July 1 to September 30. At the time of the payment, prepaid rent was increased by $2,400. What adjusting entry is necessary on July 31? A) Prepaid rent 800 Rent expense 800 B) Rent expense 800 Prepaid rent 800 C) Prepaid rent 1,600 Rent expense 1,600 D) Rent expense 1,600 Prepaid rent 1,600 E) No adjusting entry is necessary. Answer: B Diff: 2 Objective: L.O. 4-2
4) On October 1, Hurt Enterprises paid 4 months' insurance in advance for $3,600. At the time of the payment, prepaid insurance was increased by $3,600. What adjusting entry is necessary as of December 31? A) Prepaid insurance 2,700 Insurance expense 2,700 B) Insurance expense 2,700 Prepaid insurance 2,700 C) Prepaid insurance 900 Insurance expense 900 D) Insurance expense 900 Prepaid insurance 900 E) No adjusting entry is necessary Answer: B Diff: 2 Objective: L.O. 4-2
5) The entry to record equipment depreciation when the equipment depreciates $100 per month, the balance in the Accumulated Depreciation, Equipment account is $600 and the balance in the Equipment account is $5,600 is A) Depreciation expense 100 Accumulated depreciation, Equipment 100 B) Accumulated depreciation, Equipment 100 Depreciation expense 100 C) Equipment 5,500 Depreciation expense 5,500 D) Equipment 5,500 Accumulated depreciation, Equipment 5,500 E) Accumulated depreciation, Equipment 5,500 Equipment 5,500 Answer: A Diff: 2 Objective: L.O. 4-2
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6) On March 31, Getze Family Automotive performed a month-end inventory and counted office supplies valued at $2,100. On March 1, the balance in the Supplies account was $1,200. Assume that $2,900 of purchases for the month was posted to the Supplies account, what adjusting entry would Getze Family Automotive make on March 31? A) Supplies expense 2,000 Supplies 2,000 B) Supplies 2,000 Supplies expense 2,000 C) Supplies 900 Supplies expense 900 D) Supplies expense 900 Supplies 900 E) Supplies expense 2,900 Supplies 2,900 Answer: A Diff: 2 Objective: L.O. 4-2
7) During March, Getze Family Automotive installed a new engine with a billed price of $3,500. The company did not bill for the engine until April 1. Ignore the cost of the engine installed. What adjusting entry would Getze Family Automotive make on March 31? A) Prepaid revenue 3,500 Service revenue 3,500 B) Service revenue 3,500 Unearned revenue 3,500 C) Unearned revenue 3,500 Service revenue 3,500 D) Service revenue 3,500 Prepaid revenue 3,500 E) Accounts receivable 3,500 Service revenue 3,500 Answer: E Diff: 2 Objective: L.O. 4-2
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8) At March 31, Getze Family Automotive owes $5,400 for wages to be paid on April 8. What adjusting entry is necessary on March 31? A) Wage expense 5,400 Unearned Wages 5,400 B) Wage expense 5,400 Accrued wages payable 5,400 C) Prepaid Wages 5,400 Wage expense 5,400 D) Unearned Wages 5,400 Wage expense 5,400 E) Wage expense 5,400 Prepaid Wages 5,400 Answer: B Diff: 2 Objective: L.O. 4-2
9) On March 1, Getze Family Automotive received $7,000 cash for services to be rendered in March and April. The company recorded unearned revenue upon receipt of cash. What adjusting entry would Getze Family Automotive make on March 31, assuming that $2,000 of services was performed in March? A) Unearned revenue 5,000 Service revenue 5,000 B) Accounts receivable 5,000 Service revenue 5,000 C) Unearned revenue 2,000 Service revenue 2,000 D) Service revenue 2,000 Accounts receivable 2,000 E) Accounts receivable 2,000 Unearned revenue 2,000 Answer: C Diff: 2 Objective: L.O. 4-2
10) Oleke Manufacturing paid $1,800 for 4 months' rent in advance on January 1. Assuming only asset accounts were used in the January 1 journal entry, what adjusting entry is necessary on January 31? A) Prepaid rent 450 Rent expense 450 B) Rent expense 450 Prepaid rent 450 C) Rent expense 450 Rent payable 450 D) Unearned rent 450 Rent expense 450 E) Prepaid rent 450 Rent payable 450 Answer: B Diff: 2 Objective: L.O. 4-2
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11) Oleke Manufacturing received $800 in advance on January 1 from Zinger Company for services to be performed over the next 3 months. If the $800 received from Zinger Company was placed into the Unearned Revenue account, and Oleke had completed 30% of the work as of the end of the month, what adjusting entry would Oleke Manufacturing make on January 31? A) Prepaid revenue 240 Revenue 240 B) Revenue 240 Unearned revenue 240 C) Unearned revenue 240 Revenue 240 D) Revenue 560 Unearned revenue 560 E) Unearned revenue 560 Revenue 560 Answer: C Diff: 2 Objective: L.O. 4-2
12) Oleke Manufacturing borrowed $20,000 from Second National Bank on January 1. The note is for 9 months with all interest due at the end of the note. The bank is charging the company 9% interest. What adjusting entry is necessary for Oleke Manufacturing on January 31? A) Interest expense 150 Accrued interest payable 150 B) Interest expense 150 Notes payable 150 C) Interest expense 200 Accrued interest payable 200 D) Interest expense 200 Notes payable 200 E) Interest expense 1,800 Notes payable 1,800 Answer: A Diff: 2 Objective: L.O. 4-2
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13) Milton Company, a valued customer, placed an order for $1,500 on January 1. Because Milton is experiencing financial difficulties, it has been allowed to pay with a 3-month note receivable. The interest rate on the note is 8%. What adjusting entry is necessary for Oleke Manufacturing on January 31? A) Notes receivable 10 Interest revenue 10 B) Accrued interest receivable 120 Interest revenue 120 C) Accrued interest receivable 10 Interest revenue 10 D) Notes receivable 120 Interest revenue 120 E) Notes receivable 60 Interest revenue 60 Answer: C Diff: 2 Objective: L.O. 4-2
14) Oleke Manufacturing performed services for a client during January valued at $5,000. The client was billed on February 9. What adjusting entry would Oleke Manufacturing make on January 31? A) Accounts receivable 5,000 Revenue 5,000 B) Revenue 5,000 Accounts receivable 5,000 C) Unearned revenue 5,000 Revenue 5,000 D) Revenue 5,000 Unearned revenue 5,000 E) No adjusting entry is necessary on June 30. Answer: A Diff: 2 Objective: L.O. 4-2
15) On April 30, Hilte Corporation performed a month-end inventory and counted office supplies valued at $1,425. On April 1, the balance in the Supplies account was $750. Assuming that $2,900 of purchases for the month was posted to the Supplies account, what adjusting entry would Hilte Corporation make on April 30? A) Supplies expense 2,225 Supplies 2,225 B) Supplies 2,225 Supplies expense 2,225 C) Supplies 675 Supplies expense 675 D) Supplies expense 675 Supplies 675 E) None of the above Answer: A Diff: 2 Objective: L.O. 4-2
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16) On April 30, Hilte Corporation performed services valued at $3,325. The company did not bill for the services until May 1. What adjusting entry would Hilte Corporation make on April 30? A) Prepaid revenue 3,325 Revenue 3,325 B) Revenue 3,325 Unearned revenue 3,325 C) Unearned revenue 3,325 Revenue 3,325 D) Revenue 3,325 Prepaid revenue 3,325 E) Accounts Receivable 3,325 Revenue 3,325 Answer: E Diff: 2 Objective: L.O. 4-2
17) On April 30, Hilte Corporation owes $14,100 for wages to be paid on May 6. What adjusting entry is necessary on April 30? A) Wage expense 14,100 Unearned wages 14,100 B) Wage expense 14,100 Accrued wages payable 14,100 C) Prepaid wages 14,100 Wage expense 14,100 D) Unearned wages 14,100 Wage expense 14,100 E) Wage expense 14,100 Prepaid wages 14,100 Answer: B Diff: 2 Objective: L.O. 4-2
18) Failure to adjust for depreciation results in the overstatement of assets and the understatement of net income. Answer: FALSE Diff: 3 Objective: L.O. 4-2
19) If the adjusting entry to record the current period's prepaid rent that is expired is omitted, current assets will be overstated. Answer: TRUE Diff: 3 Objective: L.O. 4-2
20) The adjusting entry to record $650 of expired insurance would include a debit to Unearned Insurance. Answer: FALSE Diff: 1 Objective: L.O. 4-2
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21) Examples of adjusting for asset expirations include the write-offs to expense of such assets as Office Supplies and Prepaid Insurance. Answer: TRUE Diff: 1 Objective: L.O. 4-2
22) Prepare any necessary adjusting or correcting entries called for by the following situations. Assume that no entries have been made regarding the situation other than those specifically described. Consider each situation separately. a. Equipment is repaired and maintained by an outside maintenance company on an annual fee basis, payable in advance. The $2,400 fee was paid in advance on September 1 (for 12 months beginning September 1) and was charged to Repair and Maintenance Expense. What adjustment is necessary on December 31? b. On January 1, $10,500 of machinery was purchased. $500 cash was paid down and a 3-month, 12% note payable was signed for the balance. The January 1 transaction was properly recorded. Prepare the adjustment for the interest as of January 31. c. On February 1, $1,200 was paid in advance to the landlord for three month's rent. The tenant debited Prepaid Rent for $1,200 on February 1. What adjustment is necessary as of February 28? Answer: a. Prepaid repairs and maintenance 2,400 Repair and maintenance expense 2,400 Repairs and maintenance expense 800 Prepaid repairs and maintenance 800 b. Interest expense* 100 Accrued interest payable 100 *($10,000 × .12 × 1/12) c. Rent expense 400 Prepaid rent 400 Diff: 3 Objective: L.O. 4-2, 4-4
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Learning Objective 4.3 Questions 1) Which of the following situations involves a deferral? A) Recording accrued interest B) Recording accrued wages C) Recording revenue earned but not yet received D) Recording revenue earned that was collected in advance E) None of the above are deferrals. Answer: D Diff: 3 Objective: L.O. 4-3
2) The adjustment for revenue received in advance, which has been earned in the current period, involves a A) debit to unearned revenue. B) debit to accrued revenue. C) credit to accrued revenue. D) debit to cash. E) credit to cash. Answer: A Diff: 2 Objective: L.O. 4-3
3) The adjustment for revenue received in advance that has now been earned involves a debit to A) Cash and a credit to Prepaid Revenue. B) Unearned Revenue and a credit to Revenue. C) Prepaid Revenue and a credit to Unearned Revenue. D) Revenue and a credit to Unearned Revenue. E) Prepaid Revenue and a credit to Cash. Answer: B Diff: 2 Objective: L.O. 4-3
4) What effect does the earning of revenue previously collected have on the basic accounting equation? Assume Unearned Revenue had been increased when the cash was collected in advance. A) Increase in assets, decrease in liabilities B) Decrease in assets, decrease in liabilities C) Decrease in liabilities, increase in stockholders' equity D) Decrease in assets, decrease in stockholders' equity E) Increase in assets, increase in stockholders' equity Answer: C Diff: 3 Objective: L.O. 4-3
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5) Scrumptious Donuts sold $2,000 worth of gift certificates in December. As of December 31, $500 worth of the $2,000 gift certificates had been redeemed. All gift certificates sold use the Deferred Revenue account. The balance in the Deferred Revenue account as of December 31 is A) $2,000 B) $2,500 C) $500 D) $1,500 E) not enough information to answer Answer: D Diff: 2 Objective: L.O. 4-3
6) The adjusting entry to record $675 of earned revenue received in advance would include a debit to Unearned Revenue. Answer: TRUE Diff: 2 Objective: L.O. 4-3
7) Circle Knitting, Inc. recorded $4,000 of unearned revenue being earned and the collection of $1,500 cash for services previously accrued. The impact of these two entries on total revenue is an increase of $5,500. Answer: FALSE Diff: 3 Objective: L.O. 4-3
8) Module Accounting Services receives $8,000 cash for service revenue to be earned in the future. The company credits Service Revenue upon receipt of the cash. Answer: FALSE Diff: 3 Objective: L.O. 4-3
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9) Auto Detailing, Inc. had the following transactions on August 1: a. The company sold $2,100 of inventory costing $1,400. The customer will not be billed until September. As of August 31, no entries have been made with respect to the inventory that has been sold or the sale. b. The company received a $2,000 payment from a customer for services to be performed during August and September. On August 1, the entire $2,000 was placed in the Unearned Revenue account. As of August 31, 40% of the work had been completed. c. The company paid $7,200 for 4 months' rent in advance. The entire amount was placed into Prepaid Rent. d. The company sold equipment costing $2,400 for $5,400 to a customer in return for a 3-month note. The sale was properly recorded on August 1. Auto Detailing, Inc. is charging 12% interest on the note. The customer will pay the note and all interest after 3 months. Prepare the appropriate journal entries for Auto Detailing, Inc. as of August 31, for each of the above transactions. Answer: a. Accounts Receivable 2,100 Sales 2,100 Cost of Goods Sold 1,400 Inventory 1,400 b. Unearned Revenue 800 Revenue 800 c. Rent expense 1,800 Prepaid rent 1,800 d. Accrued interest receivable 54 Interest revenue 54 Diff: 3 Objective: L.O. 4-1, 4-2, 4-3, 4-5
10) Chordall Authors Company circulates a monthly magazine, charging $36 to subscribers for a 12month subscription. Subscribers are required to forward the entire $36 yearly subscription fee before Chordall Authors Company will furnish the subscriber with the magazine. Chordall Authors Company sold 300 magazine subscriptions in the month of March, while the balance in the Unearned Subscription Revenue account was $20,000 on March 1, 2009. After the necessary adjusting entry for March, the balance in the Unearned Subscription Revenue account was $25,200. Required: 1. Prepare the appropriate journal entry for Chordall Authors Company as of March 31. 2. How would net income be affected for the month ending March 31 if Chordall Authors Company did not record the above entry? Answer: 1. Unearned Subscription revenue* 5,600 Subscription revenue 5,600 *(20,000 + (300 × $36) - 25,200) 2. Net income would be understated by $5,600 if the above entry was not recorded. Diff: 3 Objective: L.O. 4-3
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Learning Objective 4.4 Questions 1) An example of an adjusting entry is A) the payment of wages that have been accrued. B) the accruing of interest expense. C) the return of defective inventory. D) the payment of rent in advance. E) collection of an accounts receivable. Answer: B Diff: 2 Objective: L.O. 4-4
2) An adjusting entry made to record accrued interest on a note payable involves a credit to A) interest expense. B) accrued interest payable. C) interest revenue. D) accrued interest receivable. E) cash. Answer: B Diff: 2 Objective: L.O. 4-4
3) The adjusting entry to record accrued salaries has what effect on the basic accounting equation? A) Increases liabilities, decreases stockholders' equity B) Increases liabilities, increases stockholders' equity C) Decrease assets, decreases stockholders' equity D) Decrease assets, increases stockholders' equity E) Decrease liabilities, decrease assets Answer: A Diff: 3 Objective: L.O. 4-4
4) The entry to record the cash payment of salaries that had previously been accrued has what effect on the basic accounting equation? A) Decrease liabilities, decrease assets B) Decrease liabilities, decrease stockholders' equity C) Decrease assets, decrease stockholders' equity D) Decrease assets, increase stockholders' equity E) Decrease assets, increase liabilities Answer: A Diff: 3 Objective: L.O. 4-4
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5) Howard Products has a daily payroll of $2,200, 5 days a week. The employees are paid every Friday for that week's wages. July 31 was on a Wednesday and the employees were paid $11,000 on August 2. What is the journal entry on August 2, assuming the appropriate month ending adjusting entry was made on July 31? A) Cash 11,000 Prepaid wages 6,600 Unearned wages 4,400 B) Cash 11,000 Prepaid wages 6,600 Wage expense 4,400 C) Wage expense 11,000 Cash 11,000 D) Prepaid wages 6,600 Wage expense 4,400 Cash 11,000 E) Wage expense 4,400 Accrued wages payable 6,600 Cash 11,000 Answer: E Diff: 2 Objective: L.O. 4-4
6) Cupling Enterprises borrowed $6,000 from Escada Bank on October 1, 2012. At that time, the company made the appropriate journal entry; however, no other journal entry pertaining to the note has been made. Given that the bank is charging interest at a rate of 9%, what adjusting entry is necessary as of Cupling Enterprise's year-end date of December 31, 2012? A) Interest expense 135 Accrued interest payable 135 B) Interest expense 135 Notes payable 135 C) Interest expense 540 Accrued interest payable 540 D) Interest expense 540 Notes payable 540 E) Notes payable 540 Interest expense 540 Answer: A Diff: 2 Objective: L.O. 4-4
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7) The adjusting entry to record the accrual of interest expense has what effect on the basic accounting equation? A) Increase assets, increase liabilities B) Decrease assets, decrease liabilities C) Increase assets, decrease liabilities D) Increase liabilities, decrease stockholders' equity E) Decrease liabilities, increase stockholders' equity Answer: D Diff: 3 Objective: L.O. 4-4
8) What is the effect on the basic accounting equation of the cash payment of accrued interest payable previously accrued? A) Increase assets, increase liabilities B) Decrease assets, decrease liabilities C) Decrease assets, increase liabilities D) Increase liabilities, decrease stockholders' equity E) Decrease liabilities, increase stockholders' equity Answer: B Diff: 3 Objective: L.O. 4-4
9) The entry to accrue $2,000 of income tax monthly is A) Deferred income tax 2,000 Income tax expense 2,000 B) Income tax expense 2,000 Deferred income tax 2,000 C) Income tax expense 2,000 Accrued income tax payable 2,000 D) Accrued income tax payable 2,000 Income tax expense 2,000 E) no entry is needed; taxes are recognized when paid Answer: C Diff: 2 Objective: L.O. 4-4
10) Income before income tax is A) a subtotal before net income on the income statement B) a subtotal after net income on the income statement C) included in net income on the income statement D) included in stockholders' equity on the income statement E) included in stockholders' equity on the balance sheet Answer: A Diff: 1 Objective: L.O. 4-4
11) The adjusting entry to record accrued salaries earned includes a debit to accrued salaries payable. Answer: FALSE Diff: 2 Objective: L.O. 4-4
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12) Failure to adjust for an unrecorded expense such as wages expense will overstate net income and stockholders' equity for the period. Answer: TRUE Diff: 3 Objective: L.O. 4-4
13) Failure to adjust for an unrecorded expense such as interest expense will understate liabilities. Answer: TRUE Diff: 3 Objective: L.O. 4-4
14) Recording an unrecorded expense will increase expenses and decrease revenues. Answer: FALSE Diff: 2 Objective: L.O. 4-4
15) Stake, Inc., records the payment of $200 cash for a previously accrued expense and the accrual of $625 for another expense. The impact of these two entries is to decrease net income by $825. Answer: FALSE Diff: 3 Objective: L.O. 4-4
16) Dell Catering accrues its income taxes quarterly for the sole manufacturing facility located in Brunswick, Florida. Although Dell Catering is not subject to local tax, it is required to pay both state and federal income taxes, which are 12% and 28% of net income, respectively. Second quarter income for Dell Catering amounted to $550,000. Required: 1. Prepare the appropriate journal entry for Dell Catering as of June 30. 2. Explain how income taxes are shown on a multi-step income statement. Answer: 1. Income tax expense 220,000 Income tax payable 220,000 2. Income taxes are shown below Income before Income Tax and above Net Income in a multi-step income statement. Income tax Expense of $220,000 will be deducted from Income before Income Tax of $550,000. Diff: 3 Objective: L.O. 4-4, 4-8
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17) Fletcher Products records adjusting entries monthly. The accountant at Fletcher Products is having difficulty figuring out what amount to include as the adjustment. Below are the accounts and amounts from Fletcher Products' month-end balances on February 28. February 28, 2009 Current assets Cash Accounts Receivable Office Supplies Prepaid Rent Long-term assets Equipment Accumulated Depreciation Current liabilities Accounts Payable Interest Payable Long-term liabilities Notes Payable
45,100 98,500 2,700 3,000 10,000 917 55,700 400 10,000
Additional Information: ∙ Office supplies of $250 were purchased in the month of March. On March 31, office supplies are $1,900. ∙ Fletcher Products committed to a one-year rental agreement on February 28, 2009 and paid $3,000 for the 12 month period starting March 1, 2009. This is the only rental agreement for Fletcher Products. ∙ A stamping machine is the only piece of equipment owned by Fletcher Products. It was purchased on April 1, 2008 for $10,000 and the company estimates a zero salvage value on it. Fletcher Products uses the straight line method of depreciation. The machine has a useful life of 10 years. ∙ Fletcher Products signed a 1-year, 24% note on January 1, 2009. The company recognizes interest on a monthly basis and is required to pay the entire amount of interest and principal upon the maturity date of December 31, 2009. Required: Prepare any necessary adjusting entries on March 31 based on the above information. Assume that no adjusting entries have been made for the month ending March 31. Answer: a. Office Supplies Expense 1,050* Office Supplies 1,050 *(2,700 + 250 - 1,900) b. Rent Expense 250 Prepaid Rent 250 c. Depreciation Expense 83 Accumulated Depreciation, Equipment 83 d. Interest Expense 200 Accrued interest Payable 200 Diff: 3 Objective: L.O. 4-2, 4-4
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Learning Objective 4.5 Questions 1) If Company A has an accrual of interest to be received on a note receivable, then the company should debit A) Interest expense. B) Accrued interest payable. C) Accrued interest receivable. D) Interest revenue. E) Cash. Answer: C Diff: 2 Objective: L.O. 4-5
2) Which of the following is an example of an accrual of unrecorded revenues? A) Interest accrues each month, but is paid quarterly. B) Office supplies are purchased each month, but the account is not adjusted until the end of the month. C) Wages have been earned, but have not been paid at the end of the month. D) An attorney has performed work for a client, but has not billed the client yet. E) Equipment purchased will be beneficial for several years. Answer: D Diff: 2 Objective: L.O. 4-5
3) Which one of the following adjustments will increase revenues? A) Fees were not billed for services already performed. B) Depreciation is recorded. C) Supplies were used, but not recorded. D) Interest is incurred on borrowed money, but not yet paid to the bank. E) Wages have accrued, but will not be paid until next month. Answer: A Diff: 2 Objective: L.O. 4-5
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4) Small Business Bank loaned $9,000 to Weidenhammer Company on May 1, 2012, accepting a 2-year, 8% note. The bank recorded the transaction properly on May 1. No other journal entry pertaining to the note has been made since May 1. As of year-end on December 31, 2012, what adjusting entry will the bank make with respect to this note? A) Accrued interest receivable 480 Interest revenue 480 B) Notes receivable 480 Interest revenue 480 C) Accrued interest receivable 720 Interest revenue 720 D) Notes receivable 720 Interest revenue 720 E) Unearned interest 720 Interest revenue 720 Answer: A Diff: 2 Objective: L.O. 4-5
5) The adjusting entry to record accrued interest receivable has what effect on the basic accounting equation? A) Increase assets, increase liabilities B) Decrease assets, decrease liabilities C) Increase assets, increase stockholders' equity D) Increase assets, decrease stockholders' equity E) Decrease liabilities, increase stockholders' equity Answer: C Diff: 3 Objective: L.O. 4-5
6) The collection in cash of interest receivable previously accrued has what effect on the basic accounting equation? A) Increase assets, increase liabilities B) Decrease assets, decrease liabilities C) Increase assets, decrease liabilities D) Increase liabilities, decrease stockholders' equity E) It has no effect as one asset increases while another asset decreases. Answer: E Diff: 3 Objective: L.O. 4-5
7) Recording revenue in 2012 that is actually earned in 2013 will result in: A) overstatement of net income in 2012 B) overstatement of net income in 2013 C) understatement of net income in 2013 D) an overstatement of net income in 2012 and an understatement in net income in 2013 E) an overstatement of net income in 2013 and an understatement in net income in 2012 Answer: D Diff: 2 Objective: L.O. 4-5
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8) The adjusting entry to record accrued interest revenue includes a debit to interest payable. Answer: FALSE Diff: 2 Objective: L.O. 4-5
9) The adjusting entry to record revenue earned during the current period when cash was received in the last accounting period includes a credit to Unearned Revenue. Answer: FALSE Diff: 3 Objective: L.O. 4-5
10) Failure to adjust for accrued revenue will understate stockholders' equity. Answer: TRUE Diff: 3 Objective: L.O. 4-5
11) Journalizing amounts for unearned revenue can cause ethical dilemmas for many accountants since estimates are often used when exact completion amounts are uncertain. Discuss potential problems that this may cause for financial statement users. How does the concept of conservatism affect an accountant's recognition of revenue of a particular project? How would underestimating revenue of a project affect net income? Answer: Users of financial statements rely on unbiased information and because completion of a particular project or contract is often not entirely known, debates may occur as to how much revenue to recognize. If an organization is attempting to pay less taxes, for example, in a given year, that company may lean toward a more conservative estimate of the amount of the project that is completed. Conservatism is the concept that accountants select estimates and methods of measurement that anticipate expenses and liabilities and defer recognition of revenues and assets. Because accountants apply conservatism to their practice, there is the possibility that revenues can be understated enough to bias financial statement information. If an accountant underestimates the percentage of a project completed, revenue would be lower than it should be, thus decreasing net income as well. Diff: 2 Objective: L.O. 4-5
12) The following transactions occurred in August, 2012 for Applegate Consulting: August 1, 2012 Applegate loaned $2,000 to an employee with a 9% interest rate. The loan stipulates that principal and interest be paid back on August 1, 2013. August 31, 2012 Applegate Consulting performed $3,200 worth of services for Midatlantic Corp. The billing department at Applegate Consulting was unable to bill Midatlantic on August 31, 2012 because the company's computers were malfunctioning and awaiting service. What adjusting entries should Applegate Consulting make on August 31, 2012? Answer: Accrued interest receivable 15 Interest revenue 15 Accounts receivable 3,200 Service revenue 3,200 Diff: 2 Objective: L.O. 4-5
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Learning Objective 4.6 Questions 1) The order of the steps in the recording process has A) the adjusted trial balance after preparing the financial statements. B) the journalization and posting of adjustments before the ledger. C) the adjusted trial balance before the ledger. D) journalization after the adjusted trial balance. E) the unadjusted trial balance after the ledger. Answer: E Diff: 1 Objective: L.O. 4-6
2) Which of the following is the correct order in the recording process? A) Journalize and post adjustments, unadjusted trial balance, adjusted trial balance, ledger, financial statements B) Ledger, journalize and post adjustments, unadjusted trial balance, adjusted trial balance, financial statements C) Ledger, unadjusted trial balance, journalize and post adjustments, adjusted trial balance, and financial statements D) Unadjusted trial balance, journalize and post adjustments, ledger, adjusted trial balance, financial statements E) Journalize and post adjustments, adjusted trial balance, ledger, unadjusted trial balance, financial statements Answer: C Diff: 1 Objective: L.O. 4-6
3) Cash flows A) always follow the adjusting entries. B) always precede the adjusting entries. C) may precede or follow the adjusting entries. D) always follow the unadjusted trial balance. E) always precede the closing entries. Answer: C Diff: 2 Objective: L.O. 4-6
4) After the accrual of unrecorded expenses, ________ are decreased by later cash payments. A) assets B) equity C) expenses D) revenues E) liabilities Answer: E Diff: 2 Objective: L.O. 4-6
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5) Entries for the accrual of unrecorded expenses and the accrual of unrecorded revenues are made prior to the associated cash flows. Answer: TRUE Diff: 3 Objective: L.O. 4-6
6) Adjusting entries are journalized after the financial statements are prepared. Answer: FALSE Diff: 1 Objective: L.O. 4-6
7) Advance cash payments for future services to be received create noncash assets in the balance sheet. Answer: TRUE Diff: 1 Objective: L.O. 4-6
Learning Objective 4.7 Questions 1) A classified balance sheet A) can only be viewed by upper management. B) classifies assets as "current" if possessed at the end of the current month and as "deferred" if they are expected to be owned at the end of the following month. C) classifies accounts as either assets, liabilities, or owners' equity. D) groups accounts into subcategories to help readers quickly gain a perspective on the company's financial position. E) is always used when making organizational strategic decisions. Answer: D Diff: 2 Objective: L.O. 4-7
2) An example of a current asset is A) paid-in capital. B) equipment. C) accounts receivable. D) retained earnings. E) accounts payable. Answer: C Diff: 1 Objective: L.O. 4-7
3) An example of a current liability is A) unearned revenue. B) accumulated depreciation. C) long-term note payable. D) interest expense. E) retained earnings. Answer: A Diff: 1 Objective: L.O. 4-7
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4) Working capital is defined as A) the difference between paid-in capital and retained earnings. B) the difference between current assets and current liabilities. C) the difference between cash and retained earnings. D) the difference between sales and cost of goods sold. E) the difference between total assets and total liabilities. Answer: B Diff: 1 Objective: L.O. 4-7
5) Clokgel Inc. likes to maintain a current ratio near 1.4; however, the CFO for Clokgel, Inc. has noticed a decline in previous months. The current ratio for April, 2012 produced a ratio of 0.6. What would be the CFO's major concern with a declining current ratio? A) The company has not sold enough products on credit, thus distorting the accounts receivable balance and the current ratio. B) The company may have difficulty meeting its short-term obligations. C) The company has not purchased enough inventory to meet current demand. D) Long-term obligations such as notes payable may need to be deferred, causing potential investor concerns. E) The company has excessive holdings of current assets. Answer: B Diff: 2 Objective: L.O. 4-7
6) Which of the following statements regarding the current ratio is true? A) The current ratio is calculated as the difference between current assets and current liabilities. B) Other things being equal, the lower the current ratio, the more assurance creditors have about being paid in full and on time. C) The current ratio is widely used to evaluate liquidity. D) The main components of the current ratio are cash and property, plant, and equipment. E) The comparison of a company's current ratio to the industry average is meaningless. Answer: C Diff: 2 Objective: L.O. 4-7
7) Using the account format to prepare a balance sheet is A) as acceptable as using a report format. B) an unacceptable method under GAAP rules. C) permitted as long as the company has $1 million or less in total assets. D) permitted as long as the company has $1 million or less in total revenues. E) used primarily by companies following IFRS. Answer: A Diff: 1 Objective: L.O. 4-7
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8) Liquidity is an entity's ability A) to meet its dividend obligations with cash and near-cash assets as those obligations become due. B) to pay its employees a bonus at year-end based on the success of the organization. C) to meet its near-term financial obligations with cash and near-cash assets as those obligations become due. D) to liquidate its assets should a company decide to terminate operations. E) to purchase fixed assets at a reduced loan percentage based on credit ratings. Answer: C Diff: 1 Objective: L.O. 4-7
9) In times of economic stress and instability, companies typically have A) higher operating expenses. B) lower gross profits. C) stable revenues. D) higher current ratios. E) lower current ratios. Answer: D Diff: 2 Objective: L.O. 4-7
10) The quick ratio provides A) a better indicator than the current ratio of potential growth. B) a ratio of revenues to net income. C) a more restrictive view of a company's liquidity compared to the current ratio. D) more incentive for a company to invest in non-liquid assets. E) a company with liquidity levels compared to investment levels. Answer: C Diff: 1 Objective: L.O. 4-7
11) Prepaid expenses are listed as current assets on the balance sheet. Answer: TRUE Diff: 1 Objective: L.O. 4-7
12) Current assets must be greater than current liabilities. Answer: FALSE Diff: 1 Objective: L.O. 4-7
13) Current assets are cash plus those assets that are expected to be converted to cash or sold or consumed during the next 12 months or within the normal operating cycle if longer than a year. Answer: TRUE Diff: 2 Objective: L.O. 4-7
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14) The excess of cash over current liabilities is known as working capital. Answer: FALSE Diff: 1 Objective: L.O. 4-7
15) Working capital is the difference between total assets and total liabilities. Answer: FALSE Diff: 1 Objective: L.O. 4-7
16) The current ratio can help users of financial statements assess a business entity's liquidity. Answer: TRUE Diff: 2 Objective: L.O. 4-7
17) A high current ratio means that a company is highly profitable. Answer: FALSE Diff: 2 Objective: L.O. 4-7
18) The account format of the balance sheet reports assets at the top of the statement. Answer: FALSE Diff: 1 Objective: L.O. 4-7
19) An entity's ability to meet its immediate financial obligations as they become due is known as profitability. Answer: FALSE Diff: 2 Objective: L.O. 4-7
20) Current assets on the balance sheet are listed in descending order of monetary amount. Answer: FALSE Diff: 2 Objective: L.O. 4-7
21) A balance sheet that groups the accounts into subcategories to help users gain a perspective on the company's financial position is referred to as a single-step balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 4-7
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22) Prepare a classified balance sheet dated December 31, 2012 given the following account balances of Helder Company. Long-term Note Payable Accounts Receivable Accounts Payable Additional Paid-in Capital Prepaid Insurance Wages Payable Accumulated Depreciation, Equipment Capital Stock Inventory Interest Payable Retained Earnings Equipment Cash Answer: Helder Company Balance Sheet December 31, 2012 Current Assets: Cash Accounts Receivable Inventory Prepaid Insurance Total Current Assets Long-term Assets: Equipment Less: Accumulated Depreciation Total Long-term Assets Total Assets Current Liabilities: Accounts Payable Interest Payable Wages Payable Total Current Liabilities Long-term Liabilities: Notes Payable Total Liabilities Stockholders' Equity: Capital Stock Additional Paid-in Capital Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity
$ 11,000 4,400 6,300 12,500 900 2,600 9,100 3,700 8,200 3,700 24,000 55,200 4,200
$ 4,200 4,400 8,200 900 $17,700 55,200 (9,100) 46,100 $63,800
$ 6,300 3,700 2,600 $ 12,600 11,000 23,600 3,700 12,500 24,000 40,200 $63,800
Diff: 2 Objective: L.O. 4-7
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23) Given the following year-end balances, prepare a classified balance sheet for Briggs Manufacturing dated December 31, 2012. (Hint: Compute net income first.) Interest Expense $ 2,000 Beginning Retained Earnings 13,100 Depreciation Expense 5,200 Cash 26,900 Accounts Payable 3,300 Rent Expense 7,200 Accumulated Depreciation, Equipment 13,500 Wage Expense 59,200 Prepaid Rent 1,400 Paid-in Capital 9,000 Accounts Receivable 13,600 Wages Payable 3,200 Equipment 63,000 Sales 249,600 Inventory 14,400 Long-term Note Payable 20,000 Income tax Expense 24,500 Dividends Declared 21,000 Cost of Goods Sold 94,300 Dividends Payable 21,000 Answer: Briggs Manufacturing Balance Sheet December 31, 2012 Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Long-term Assets: Equipment Less: Accumulated Depreciation Total Assets Current Liabilities: Accounts Payable Dividends Payable Wages Payable Total Current Liabilities Long-term Liabilities: Note Payable Total liabilities Stockholders' Equity: Paid-in Capital
$26,900 13,600 14,400 1,400 $56,300 $63,000 (13,500)
49,500 $105,800
$ 3,300 21,000 3,200 $27,500 20,000 47,500 9,000 29 ..
Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity
49,300 58,300 $105,800
Diff: 3 Objective: L.O. 4-7
24) A classified balance sheet groups assets and liabilities into two categories. Identify and define those two categories for both assets and liabilities. Why is this categorization made? Finally, two measures of liquidity can be generated using these two categories. What are the two measures of liquidity and how are they calculated? Answer: A classified balance sheet groups assets and liabilities into two categories: current and longterm. Current assets are cash plus assets that are expected to be converted to cash or sold or consumed during the next 12 months or within the normal operating cycle if longer than a year. Similarly, current liabilities are those liabilities that fall due within the coming year or within the normal operating cycle if longer than a year. The distinction between short-term and long-term accounts is useful in assessing a company's ability to meet obligations as they become due. A classified balance sheet groups the accounts into subcategories to help readers quickly gain a perspective on the company's financial position and to draw attention to certain accounts or groups of accounts. The two measures of liquidity generated using the categories of current and long-term are working capital and current ratio. Working capital is the excess of current assets over current liabilities while the current ratio is calculated by dividing current assets by current liabilities. Diff: 2 Objective: L.O. 4-7
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25)
Logell Paper Products Balance Sheet December 31, 2012
Assets: Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Long-Term Assets: Fixed Assets Less: Accumulated Depreciation Total Assets
$ 25,000 62,500 66,500 4,800 $158,800 $ 135,900 (51,900)
Liabilities: Current Liabilities: Accounts Payable Wages Payable Income Taxes Payable Interest Payable Total Current Liabilities Long-Term Liabilities: Note Payable, long-term Total Liabilities Stockholders' Equity: Capital Stock ($10 par) Additional Paid-in Capital Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity
84,000 $242,800
$31,000 8,500 6,400 4,500 50,400 71,600 $122,000 15,000 45,000 60,800 120,800 $242,800
Logell Paper Products Income Statement For the Year Ended December 31, 2012 Sales Less: Cost of Goods Sold Gross Profit Less: Operating Expenses: Wages Expense Depreciation Expense Rent Expense Total Operating Expenses Operating Income Less: Other Expenses: Interest Expense
$973,700 706,750 266,950 $170,000 10,150 27,350 207,500 59,450 15,350 31 ..
Income Before Taxes Less: Income Tax Expense Net Income
44,100 17,600 $ 26,500
Required: 1. What is the current ratio? 2. What is the working capital? 3. What is the return on sales? 4. If the beginning stockholders' equity balance for Logell Paper Products was $85,000, then what is the return on stockholders' equity? Answer: 1. 3.15 2. $108,400 3. 2.7% 4. 25.8% Diff: 2 Objective: L.O. 4-7, 4-9
Learning Objective 4.8 Questions 1) Gross profit appears on a A) single-step income statement. B) classified balance sheet. C) multiple-step balance sheet. D) multiple-step income statement. E) single-step balance sheet. Answer: D Diff: 1 Objective: L.O. 4-8
2) Which account is usually a separate line item on the multiple-step income statement? A) Cash B) Dividends C) Paid-in capital D) Retained earnings E) Income taxes Answer: E Diff: 1 Objective: L.O. 4-8
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3) Gross profit is defined as A) net income before the effect of income taxes. B) the income generated by the company after subtracting all operating expenses. C) the difference between total assets and total liabilities. D) net income less the dividends declared during the period. E) sales minus cost of goods sold. Answer: E Diff: 1 Objective: L.O. 4-8
4) The multiple-step income statement is A) used by most U.S. companies. B) used when total revenues exceed $1 million. C) used to segregate current assets from non-current assets. D) used for income tax purposes. E) used in order to incorporate the current ratio into the statement. Answer: A Diff: 1 Objective: L.O. 4-8
5) An income statement without any intermediate subtotals is referred to as a multiple-step income statement. Answer: FALSE Diff: 1 Objective: L.O. 4-8
6) On a multiple-step income statement, operating expenses are deducted from cost of goods sold to obtain operating income. Answer: FALSE Diff: 2 Objective: L.O. 4-8
7) Gross profit equals sales minus operating expenses. Answer: FALSE Diff: 1 Objective: L.O. 4-8
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8) The following single-step income statement for Balm Butters and Jellies needs to be converted into a multiple-step income statement for the year ended December 31, 2012. Balm Butters and Jellies Income Statement For the year ended December 31, 2012 Revenues: Sales Interest Revenue
$840,000 3,000 $843,000
Expenses: Cost of Goods Sold Depreciation Expense Income tax Expense Insurance Expense Interest Expense Rent Expense Wage Expense Total Expenses: Net Income Answer: Balm Butters and Jellies Income Statement For the year ended December 31, 2012 Sales Cost of Goods Sold Gross Profit Operating Expenses: Wage Expense 103,700 Depreciation Expense 4,200 Rent Expense 14,800 Insurance Expense 8,100 Operating Income Add (Less) Other Revenues and Expenses: Interest Revenue 3,000 Interest Expense (3,700) Income Before Taxes Income Tax Expense Net Income
434,800 4,200 59,300 8,100 3,700 14,800 103,700 628,600 $ 214,400
$840,000 434,800 $405,200
130,800 274,400
(700) 273,700 59,300 $ 214,400
Diff: 2 Objective: L.O. 4-8
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9) Two companies have the following balance sheets as of December 31, 2012: Reef Company Cash Other Assets
$ 25,000 75,000
Total Assets
$100,000
Score Company Cash Other Assets
$ 25,000 75,000
Total Assets
$100,000
10% Note Payable, Stockholders' Equity Total Liabilities And Stockholders' Equity
$ 50,000 50,000 $100,000
Stockholders' Equity
$100,000
In 2012, each company had sales of $225,000 and expenses (excluding interest) of $200,000. Ignore income taxes. Assume Reef's 10% Note Payable is outstanding the entire year. Required: a. Calculate net income for both Reef and Score. b. Calculate operating income for both Reef and Score. Answer: a. Reef Company Score Company Income Statement Income Statement Sales Less: expenses Operating income Less: interest expense Net Income
$225,000 (200,000) 25,000 5,000 $ 20,000
Sales Less: expenses
$225,000 (200,000)
Net Income
$ 25,000
Net income for Reef = $20,000 Net income for Score= $25,000 b. Operating income for Reef = $25,000 Operating income for Score= $25,000 Both companies earned the same operating income of $25,000. Reef Company's net income, however, was $5,000 lower due to interest charges on the note payable. Diff: 2 Objective: L.O. 4-8
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10) Briefly explain the difference between operating income and net income. Why do companies calculate both? Answer: Operating income is the income that remains after cost of goods sold and other operating expenses are deducted from sales revenue. Operating expenses are recurring expenses that pertain to the firm's routine, ongoing operations. Operating income less other nonoperating revenues and expenses (including interest expense) and income tax expense gives net income. Companies calculate both operating income and net income because the two numbers provide different information. Diff: 2 Objective: L.O. 4-8
11) Name and define the subtotals that appear on a multiple-step income statement and not on a singlestep income statement. Explain why income tax expense is usually the final deduction on both single-step and multiple-step income statements. Answer: The subtotals that appear on a multiple-step income statement are as follows: ∙ Gross profit, the excess of sales revenue over the cost of goods sold ∙ Operating income, gross profit less all operating expenses ∙ Income before income taxes, operating income plus nonoperating revenues and less nonoperating expenses (i.e., those not directly related to the mainstream of a firm's operations) The amount of income tax expense is based on the income before income taxes. As such, most companies prefer to present these two items at the end of their income statements to emphasize this relationship. Diff: 2 Objective: L.O. 4-8
Learning Objective 4.9 Questions 1) Which of the following statements is true with respect to the gross profit percentage? A) The gross profit percentage shows the relationship of net income to sales revenue. B) The gross profit percentage is widely regarded as the ultimate measure of overall accomplishment. C) Retailers have high gross profit percentages because product costs are their main expense. D) The gross profit percentage is useful to retailers in choosing a pricing strategy and in judging its results. E) Gross profit percentages vary very little across industries. Answer: D Diff: 2 Objective: L.O. 4-9
2) Which of the following statements is NOT true? A) Companies where product costs represent a high percentage of total costs would be expected to have a low gross profit percentage. B) It is appropriate to compare a company's current financial ratio with the same financial ratio for (1) that company in prior years and/or (2) the ratio for the industry in which the company operates. C) Return on sales ratios are useful in choosing a pricing strategy for a company's products. D) Profitability evaluation ratios have a higher power than liquidity ratios for predicting a company's liquidity. E) Return on assets equals net income divided by average total assets. Answer: D Diff: 3 Objective: L.O. 4-9
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3) The return on assets ratio measures A) how effectively assets generate profits. B) how effectively assets generate stockholders equity. C) the relationship of total assets to current assets. D) the relationship of total assets to total liabilities. E) a company's ability to generate sales. Answer: A Diff: 1 Objective: L.O. 4-9
4) Ratios such as the return on sales ratio allow readers to assess whether or not a company will provide them with a particular rate of return on their investment. Answer: TRUE Diff: 2 Objective: L.O. 4-9
5) Analysts will compare a company's financial ratios from the current year with those of past years in order to make judgments about a company's financial status, but comparison to other companies' ratios is usually not performed. Answer: FALSE Diff: 2 Objective: L.O. 4-9
6) The gross profit percentage is calculated as sales divided by gross profit. Answer: FALSE Diff: 1 Objective: L.O. 4-9
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7) The income statement of Bearwald Company is shown below. Bearwald Corporation Condensed Income Statement Year Ended December 31, 2012 Sales $350,000 Cost of goods sold 217,000 Gross profit $ 133,000 Operating expenses Wages $45,000 Depreciation 2,000 Rent 8,000 55,000 Operating income $ 78,000 Other revenues and expenses Rent revenue $ 800 Interest revenue 200 Total other revenue $ 1,000 Deduct: interest expense 500 Income before income taxes $ 78,500 Income taxes 19,625 Net Income $ 58,875 Required: 1. Calculate the gross profit percentage. 2. Calculate the return on sales. 3. What term is often used in place of sales or sales revenue? Which organizations typically use this term? Answer: 1. 38% ($133,000 /$ 350,000) 2. 16.8% ($58,875 / $350,000) 3. Turnover is often used in place of sales or sales revenue typically in organizations utilizing IFRS. Diff: 3 Objective: L.O. 4-8, 4-9
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Introduction to Financial Accounting, 11e (Horngren) Chapter 5 Statement of Cash Flows Learning Objective 5.1 Questions 1) Which of the following statements show the results of a company over a period of time? 1. Balance sheet 2. Income statement 3. Statement of cash flows 4. Statement of stockholders' equity A) 2 and 4 B) 3 and 4 C) 1 D) 2 E) 2, 3, and 4 Answer: E Diff: 1 Objective: L.O. 5-1
2) The statement of cash flows has classifications of A) operating, investing, and debt activities. B) investing, operating, and expense activities. C) operating, investing, and equity activities. D) operating, financing, and equity activities. E) operating, investing, and financing activities. Answer: E Diff: 2 Objective: L.O. 5-1
3) Cash and cash equivalents include all of the following except A) an investment purchased in March, 2012 with a maturity of March, 2014. B) money market funds. C) cash balance in a savings account. D) cash balance in a checking account. E) Treasury bills. Answer: A Diff: 1 Objective: L.O. 5-1
4) The statement of cash flows reports on where cash came from and how it was used. Answer: TRUE Diff: 1 Objective: L.O. 5-1
5) Like the income statement, the statement of cash flows covers a period of time. Answer: TRUE Diff: 1 Objective: L.O. 5-1
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6) A firm may have a significant amount of net income, as computed by accountants on the accrual basis, and yet have a severe decline in cash. Answer: TRUE Diff: 1 Objective: L.O. 5-1
7) A statement of cash flows reports cash inflows and cash outflows on a particular day. Answer: FALSE Diff: 1 Objective: L.O. 5-1
8) One of the purposes of a statement of cash flows is to determine a company's ability to pay its debts when they become due. Answer: TRUE Diff: 1 Objective: L.O. 5-1
Learning Objective 5.2 Questions 1) Which of the following statements is false? A) The statement of cash flows reports the cash receipts and cash payments of an entity over a period of time. B) The statement of cash flows is similar to the income statement, as they both determine the net income for a company. C) The operating activities in a cash flow statement include transactions that affect the sale and the purchase or production of goods and services. D) Investing activities in a cash flow statement include acquiring and selling long-term assets. E) Financing activities in a cash flow statement include obtaining resources from owners and creditors and repaying amounts borrowed. Answer: B Diff: 2 Objective: L.O. 5-2
2) Cash payments to suppliers would appear on a statement of cash flows using the direct method as a(n) A) financing activity. B) operating activity. C) investing activity. D) debt activity. E) equity activity. Answer: B Diff: 2 Objective: L.O. 5-2
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3) The issuance of a long-term debt for cash would appear on the statement of cash flows as a(n) A) investing activity. B) operating activity. C) financing activity. D) equity activity. E) debt activity. Answer: C Diff: 2 Objective: L.O. 5-2
4) The issuance of stock for cash would be classified as a(n) A) investing activity on the statement of cash flows. B) equity activity on the statement of cash flows. C) operating activity on the statement of cash flows. D) would not appear on the statement of cash flows. E) financing activity on the statement of cash flows. Answer: E Diff: 2 Objective: L.O. 5-2
5) Activities or transactions that affect the income statement are primarily included in which section of the statement of cash flows? A) Operating B) Investing C) Financing D) Managing E) Net income Answer: A Diff: 1 Objective: L.O. 5-2
6) Activities that involve (1) providing and collecting cash as a lender and (2) acquiring and disposing of fixed assets are included in which section of the statement of cash flows? A) Operating B) Investing C) Financing D) Managing E) Fixed assets Answer: B Diff: 1 Objective: L.O. 5-2
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7) Activities that involve obtaining resources as a borrower or issuer of securities and repaying creditors and owners are included in which section of the statement of cash flows? A) Operating B) Investing C) Financing D) Managing E) Net income Answer: C Diff: 1 Objective: L.O. 5-2
8) All of the following would be included in a company's operating activities except A) dividend payments. B) collections from customers. C) cash payments to suppliers. D) income tax payments. E) interest and dividends collected. Answer: A Diff: 1 Objective: L.O. 5-2
9) Which of the following would be classified as an operating activity on a statement of cash flows? A) Purchase of a building B) Sale of another company's stock C) Borrowing money through a promissory note D) Payment of dividends E) Purchase of inventory for cash Answer: E Diff: 2 Objective: L.O. 5-2
10) Which of the following would be classified as an operating activity on a statement of cash flows? A) Issuing bonds B) Receipt of loan repayments C) Collections from customers D) Issuing stock E) Repayment of amounts borrowed Answer: C Diff: 2 Objective: L.O. 5-2
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11) All of the following activities would be included in a company's operating activities on a statement of cash flows except A) payments to employees. B) payment to a local government for property taxes. C) payment to suppliers. D) payment to the bank to reduce loan balance. E) payment to landlord for rent. Answer: D Diff: 2 Objective: L.O. 5-2
12) All of the following would be included in a company's investing activities except A) taking out a loan from the bank. B) purchase of equipment. C) sale of another company's stock. D) making loans to another company. E) sale of a building. Answer: A Diff: 2 Objective: L.O. 5-2
13) All of the following would be included in a company's investing activities except A) purchase of land. B) payment of dividends. C) collection of loan repayments. D) purchase of equipment. E) purchase of another company's stock. Answer: B Diff: 2 Objective: L.O. 5-2
14) All of the following would be included in a company's financing activities except A) issuing equity securities. B) purchasing treasury stock. C) repayment of amounts borrowed. D) borrowing cash from a bank. E) interest payments. Answer: E Diff: 2 Objective: L.O. 5-2
15) All of the following would be included in a company's financing activities except A) receipt of dividends. B) payment of dividends. C) issuing stock. D) purchase of treasury stock. E) issuing bonds. Answer: A Diff: 2 Objective: L.O. 5-2
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16) Which of the following would appear in the financing activities section of a statement of cash flows? A) Cash payments to employees B) Cash payment of dividends C) Cash purchase of equipment D) Cash paid for income taxes E) Cash purchase of land Answer: B Diff: 2 Objective: L.O. 5-2
17) Companies with divisions outside the United States A) prepare their Statement of Cash Flows with consolidated equipment purchases, but retain individual financial statements otherwise. B) confirm account balances on their Statement of Cash Flows using the throughput method. C) show the effect of exchange rate differences on their Statement of Cash Flows. D) indicate variances on material purchases on a separate coinciding schedule. E) label their Statement of Cash Flows by preceding the label with the term "International Operations." Answer: C Diff: 2 Objective: L.O. 5-2
18) Investing activities involve obtaining resources as a borrower and repaying creditors. Answer: FALSE Diff: 1 Objective: L.O. 5-2
19) The issuance of long-term debt results in a cash outflow as reported in the financing section. Answer: FALSE Diff: 2 Objective: L.O. 5-2
20) The purchase of another company's stock is an example of an investing activity. Answer: TRUE Diff: 1 Objective: L.O. 5-2
21) Cash flows from financing activities include borrowing cash through a lender. Answer: TRUE Diff: 1 Objective: L.O. 5-2
22) Cash flows from operating activities include the receipt of interest income. Answer: TRUE Diff: 2 Objective: L.O. 5-2
23) Cash flows from financing activities include the payment of interest on a note payable. Answer: FALSE Diff: 2 Objective: L.O. 5-2
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24) A transaction in which long-term debt of $50,000 is converted to common stock would be reported in the financing section of the cash flow statement. Answer: FALSE Diff: 2 Objective: L.O. 5-2
25) Dividends received from a subsidiary would be classified as an investing activity on a statement of cash flows. Answer: FALSE Diff: 2 Objective: L.O. 5-2
26) Issuing equity securities is an operating activity on the statement of cash flows. Answer: FALSE Diff: 2 Objective: L.O. 5-2
27) Operating activities on a statement of cash flows relate to acquiring assets such as buildings and equipment. Answer: FALSE Diff: 2 Objective: L.O. 5-2
28) Cash received from customers is a financing activity on the statement of cash flows. Answer: FALSE Diff: 1 Objective: L.O. 5-2
29) Cash dividends paid to stockholders are an operating activity on the statement of cash flows. Answer: FALSE Diff: 1 Objective: L.O. 5-2
30) The receipt of loan repayments is an investing activity on the statement of cash flows. Answer: TRUE Diff: 2 Objective: L.O. 5-2
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31) Designate how each transaction would be reported on the statement of cash flows using OP for operating activities, IN for investing activities, FI for financing activities, I for an inflow of cash and O for an outflow of cash. If the transaction is included only in a supplemental schedule, denote this as SS. Section Inflow or Outflow 1. Paid cash dividends ________ ________ 2. Purchased 6 months of insurance in advance ________ ________ 3. Sold inventory for cash ________ ________ 4. Purchased equipment signing a two-year note ________ ________ 5. Collected accounts receivable balance from a customer ________ ________ 6. Sold shares of another company's stock held for speculative purposes ________ ________ 7. Reclassified a note from long term to short term ________ ________ 8. Issued bonds at a premium ________ ________ Answer: Section Inflow or Outflow 1. Paid cash dividends FI O 2. Purchased 3 months of rent in advance OP O 3. Sold inventory for cash OP I 4. Purchased equipment signing a one-year note SS 5. Collected accounts receivable balance from a customer OP I 6. Sold shares of another company's stock held for speculative purposes IN I 7. Reclassified a note from long term to short term SS 8. Issued bonds at a premium FI I Diff: 2 Objective: L.O. 5-2
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Learning Objective 5.3 Questions 1) Cleft Company had the following account balances on its balance sheet at December 31, 2012 and 2011, respectively: 12/31/12 12/31/11 Long-term Bonds Payable $39,000 $36,000 Assume no bonds were retired during 2012. What was the positive cash flow associated with the longterm debt for Cleft Company in 2012? A) $10,000 B) $3,000 C) $13,000 D) $4,000 E) $7,000 Answer: B Diff: 3 Objective: L.O. 5-3
2) Cleft Company had the following account balances on its balance sheet at December 31, 2012 and 2011, respectively: 12/31/12 12/31/11 Long-term Bonds Payable $39,000 $36,000 Assume no bonds were retired during 2012. What was the negative cash flow associated with long-term debt for Cleft Company in 2012? A) $10,000 B) $4,000 C) $7,000 D) $0 E) $3,000 Answer: D Diff: 3 Objective: L.O. 5-3
3) If a company extinguishes debt, which of the following explains the effect of this transaction on a statement of cash flows? A) If the debt is extinguished with a loss, the loss is subtracted from the operating section if the company uses the direct method. B) If the debt is extinguished with a loss, the loss will not appear in the operating or the investing section if the company uses the direct method. C) If the debt is extinguished with a gain, the gain is added to the cash flow from financing section if the company uses the indirect method. D) If the debt is extinguished with a gain, the gain is added to the operating section if the company uses the indirect method. E) If the debt is extinguished with a loss, the loss is added to the financing section if the company uses the indirect method. Answer: B Diff: 3 Objective: L.O. 5-3
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4) When an increase in cash occurs, it ensues from A) increases in assets. B) increases in liabilities. C) increases in paid-in-capital. D) both A and B E) both B and C Answer: E Diff: 2 Objective: L.O. 5-3
5) Which of the following will not affect cash in the financing section of the Statement of Cash Flows? A) increasing long or short term debt B) selling common or preferred shares of stock C) converting debt to common stock D) repurchasing common shares of stock E) paying dividends Answer: C Diff: 2 Objective: L.O. 5-3
6) The purchase of an intangible asset such as a trademark would be a financing activity on the statement of cash flows. Answer: FALSE Diff: 1 Objective: L.O. 5-3
7) The purchase of treasury stock would be considered a financing activity. Answer: TRUE Diff: 1 Objective: L.O. 5-3
8) Payment of dividends is a financing activity. Answer: TRUE Diff: 2 Objective: L.O. 5-3
9) Receipt of loan repayments is a financing activity. Answer: FALSE Diff: 2 Objective: L.O. 5-3
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10) Retall Company refinanced its long-term debt in 2012. It bought and retired common shares of stock for cash of $20,000. The company spent $72,500 to retire long-term debt due in 3 years and issued $185,000 of 10-year bonds at par. Interest expense for 2012 was $21,000, of which $17,000 was paid in cash; the other $4,000 was still payable at the end of the year. Dividends declared and paid during the year were $12,500. Determine net cash flows from financing activities. Answer: Cash Flows from financing activities: Proceeds from issuance of long-term debt Payment to retire long-term debt Payment to retire common stock Dividends paid Net cash provided by financing activities
$185,000 (72,500) (20,000) (12,500) $80,000
Notice that both proceeds from the new issue of bonds and the retirement of long-term debt are listed. Presenting only the net amount of proceeds is not permitted. Also, the interest expense is omitted because it is an operating activity, not a financing activity. Diff: 2 Objective: L.O. 5-3
11) The Statement of Cash Flows for Urban Athletic Company included the following items, among others: Dividends paid $ 31,000 Depreciation on equipment 19,500 Issued common stock 98,000 Paid off long-term note payable 23,000 Net income 29,540 Purchases of stock of other companies 8,000 Purchases of equipment 60,000 Prepare the cash flows from financing activities section of the statement of cash flows. All items necessary for that section appear above, in addition to items that belong in the operating and investing sections. Answer: Cash Flows from Financing Activities: Dividends paid $(31,000) Issued common stock 98,000 Paid off long-term note payable (23,000) Net cash provided by financing activities $ 44,000 Diff: 2 Objective: L.O. 5-3
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Learning Objective 5.4 Questions 1) Chorba Chocolates had the following account balances on its balance sheets at December 31, 2012 and 2011, respectively:
Fixed Assets Accumulated Depreciation
12/31/12 $80,000 44,000
12/31/11 $67,000 39,000
Depreciation expense for 2012 was $7,000. There were no gains or losses on the 2012 income statement. One fixed asset with an original cost of $8,000 was sold during 2012.What was the cash flow associated with the acquisition of fixed assets by Chorba Chocolates in 2012? A) $(2,000) B) $(8,000) C) $(14,000) D) $(13,000) E) $(21,000) Answer: E Diff: 3 Objective: L.O. 5-4
2) Chorba Chocolates had the following account balances on its balance sheets at December 31, 2012 and 2011, respectively: 12/31/12 12/31/11 Fixed Assets $80,000 $67,000 Accumulated Depreciation 44,000 39,000 Depreciation expense for 2012 was $7,000. There were no gains or losses on the 2012 income statement. One fixed asset with an original cost of $8,000 was sold during 2012.What would be the net cash flow from investing activities for Chorba Chocolates in 2012? A) ($2,000) B) ($8,000) C) ($13,000) D) ($15,000) E) ($21,000) Answer: D Diff: 3 Objective: L.O. 5-4
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3) When a fixed asset is sold for other than its book value, which one of the following incorrectly states the effect of this transaction on a company's statement of cash flows? A) Under the direct method, no gain or loss from the sale of fixed assets is included in the operating activities section. B) Under the indirect method, gains from the sale of fixed assets are subtracted from net income in the operating activities section. C) Under the indirect method, losses from the sale of fixed assets are added back to net income to arrive at net cash from operations. D) Losses and gains from the sale of fixed assets are operating items to be listed in the operating activities section under both the direct and indirect methods. E) Under both the direct and indirect methods, the sale of a fixed asset would affect the investing activities section. Answer: D Diff: 2 Objective: L.O. 5-4
4) Which balance sheet accounts are most affected by investing activities? A) Current assets B) Current liabilities C) Long term assets D) Long term liabilities E) Stockholders' equity Answer: C Diff: 2 Objective: L.O. 5-4
5) Which of the following activities does not affect cash on the investing section of the Statement of Cash Flows? A) purchased store equipment on credit B) purchased stock in another company for investment purposes using cash C) collected partial payment on a loan made to an employee D) purchased building using cash E) sold investment securities and received cash Answer: A Diff: 2 Objective: L.O. 5-4
6) Important non-cash investing and financing activities A) belong in the investing and financing section of the Statement of Cash Flows. B) belong in the operating section of the Statement of Cash Flows. C) belong in a separate schedule of non-cash investing and financing activities. D) belong on the Income Statement. E) belong on the Balance Sheet. Answer: C Diff: 1 Objective: L.O. 5-4
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7) The investing section of the Statement of Cash Flows includes the sale of fixed assets for cash. Answer: TRUE Diff: 1 Objective: L.O. 5-4
8) The schedule of noncash investing and financing activities is used by investors to determine a company's net worth. Answer: FALSE Diff: 1 Objective: L.O. 5-4
9) A company acquired a small building by signing a mortgage payable. How would this transaction be shown in the statement of cash flows? Explain how this treatment fulfills the investors' need for information regarding the financial management of the company. Answer: This transaction would not be shown in the body of the statement of cash flows because it doesn't involve any cash activity. However, it should be reported in a separate schedule outlining significant investing and financing activities. This transaction is reported because it could have been accomplished by signing a note payable for cash and then buying the building with the cash. Readers of statements of cash flows should be informed about any significant investing and financing transactions, regardless of whether cash was directly involved. It helps investors understand where financing was obtained and how it was used (i.e., the financial management of the company). Diff: 2 Objective: L.O. 5-4
10) Telder Amusement Park issued common stock for $650,000 on January 1, 2012. The company bought fixed assets for $435,000 cash and inventory for $50,000 cash. Later that same year, the company sold fixed assets for $10,000 more than their book value of $65,000. Half of the inventory was sold for $98,350 during the year. On December 15, cash was used to purchase $49,000 worth of Allen Food Services common stock, which Telder regarded as a long-term investment. Prepare the cash flows from investing activities of the statement of cash flows for Telder Amusement Park. Answer: Cash from Investing Activities: Purchase of fixed assets $(435,000) Sale of fixed assets 75,000 Purchase of long-term investment (49,000) Net cash used by investing activities $(409,000) Diff: 2 Objective: L.O. 5-4
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Learning Objective 5.5 Questions Exhibit 5-1 Cartell Paper Products Balance Sheet December 31, 2012 and 2011
Current Assets: Cash Accounts Receivable Inventory Supplies Prepaid Insurance Total Current Assets Long-term Assets: Fixed Assets Accumulated Depreciation Patent Total Long-term Assets Total Assets Current Liabilities: Accounts Payable Wages Payable Interest Payable Taxes Payable Total Current Liabilities Long-term Liabilities: Bonds Payable Total Liabilities Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities and Stockholders' Equity
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12/31/12
12/31/11
$ 4,600 9,600 17,500 1,200 1,400 34,300
$ 3,100 7,900 18,600 2,100 1,000 32,700
71,000 (30,400) 6,000 46,600 $ 80,900
58,000 (26,500) 7,100 38,600 $ 71,300
$ 6,100 2,200 800 2,300 11,400 20,300 31,700
$ 4,900 2,600 1,000 1,600 10,100 24,000 34,100
22,700 26,500 49,200 $ 80,900
20,000 17,200 37,200 $ 71,300
Cartell Paper Products Income Statement For the Year Ended December 31, 2012 Sales Cost of Goods Sold Gross Profit Less Operating Expenses: Wage Expense Supply Expense Insurance Expense Depreciation Expense Amortization Expense Rent Expense Operating Income Interest Expense Income before Taxes Income Tax Expense Net Income
$147,600 63,800 83,800 $ 40,100 3,600 3,000 3,900 1,100 5,400
57,100 26,700 2,600 24,100 10,800 $ 13,300
1) Referring to Exhibit 5-1, what was the cash collected from customers by Cartell Paper Products in 2012? A) $138,000 B) $145,900 C) $147,600 D) $149,200 E) $157,200 Answer: B Diff: 2 Objective: L.O. 5-5
2) Referring to Exhibit 5-1, how much inventory did Cartell Paper Products purchase in 2012? A) $81,300 B) $63,800 C) $64,900 D) $46,300 E) $62,700 Answer: E Diff: 3 Objective: L.O. 5-5
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3) Referring to Exhibit 5-1, what was the cash paid to suppliers of inventory by Cartell Paper Products in 2012? A) $63,800 B) $61,500 C) $63,700 D) $63,900 E) $66,100 Answer: B Diff: 3 Objective: L.O. 5-5
4) Referring to Exhibit 5-1, what was the cash paid to employees by Cartell Paper Products in 2012? A) $40,500 B) $39,700 C) $40,100 D) $38,000 E) $42,300 Answer: A Diff: 2 Objective: L.O. 5-5
5) Referring to Exhibit 5-1, what was the cash paid for supplies by Cartell Paper Products in 2012? (Assume all purchases of supplies were for cash.) A) $3,600 B) $4,500 C) $2,400 D) $2,700 E) $4,800 Answer: D Diff: 2 Objective: L.O. 5-5
6) Referring to Exhibit 5-1, what was the cash paid for income taxes by Cartell Paper Products in 2012? A) $7,100 B) $11,700 C) $10,100 D) $10,900 E) $8,600 Answer: C Diff: 2 Objective: L.O. 5-5
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7) Referring to Exhibit 5-1, what was the net cash flow from operations for Cartell Paper Products in 2012? A) $18,300 B) $19,500 C) $8,200 D) $14,500 E) $13,000 Answer: B Diff: 3 Objective: L.O. 5-5
8) Referring to Exhibit 5-1, what was the cash paid from the purchase of fixed assets by Cartell Paper Products in 2012? Assume no fixed assets were sold in 2012. A) $(13,000) B) $(9,100) C) $(16,900) D) $9,100 E) Cannot be determined from the information given Answer: A Diff: 3 Objective: L.O. 5-5
9) Referring to Exhibit 5-1, what was the net cash flow from investing activities for Cartell Paper Products in 2012? A) $(9,100) B) $9,100 C) $(13,000) D) $(12,000) E) $2,000 Answer: C Diff: 3 Objective: L.O. 5-5
10) Referring to Exhibit 5-1, what were the dividends paid by Cartell Paper Products in 2012? A) $11,900 B) $0 C) $22,600 D) $4,000 E) $9,300 Answer: D Diff: 3 Objective: L.O. 5-5
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11) Which of the following items will NOT appear in the operating activities section of the statement of cash flows when using the direct method? A) Payments to employees B) Collections from customers C) Net income D) Payments to suppliers E) Income tax payments Answer: C Diff: 2 Objective: L.O. 5-5
12) Which of the following items will NOT appear in the operating activities section of the statement of cash flows when using the direct method? A) Collections from customers B) Depreciation expense C) Cash paid for income taxes D) Payments to employees E) Payments to suppliers Answer: B Diff: 2 Objective: L.O. 5-5
13) When preparing the statement of cash flows under the direct method, all of the following would be an inappropriate procedure except A) add depreciation expense to net income under the operating activities. B) subtract depreciation expense from net income under the operating activities. C) add depreciation expense to net income under the financing activities. D) subtract depreciation expense from net income under the financing activities. E) ignore depreciation expense. Answer: E Diff: 2 Objective: L.O. 5-5
14) When preparing the statement of cash flows under the direct method, an appropriate procedure would be to A) subtract a gain from the sale of a fixed asset to net income. B) subtract an increase in accounts receivable from sales when calculating cash received from customers. C) subtract depreciation expense from net income. D) add a loss from the sale of a fixed asset to net income. E) add depreciation expense to net income. Answer: B Diff: 3 Objective: L.O. 5-5
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15) The direct method of preparing the statement of cash flows A) is preferred by IASB and FASB. B) is the same as the indirect method with the exception of the cash account. C) is an accumulation of net income accounts so that accountants can locate discrepancies in balances. D) omits the financing section of the statement. E) focuses on cash outflows over cash inflows. Answer: A Diff: 1 Objective: L.O. 5-5
16) Under the direct method, a gain from the sale of a fixed asset is added to net income when calculating cash flows from operations. Answer: FALSE Diff: 2 Objective: L.O. 5-5
17) Under the direct method, depreciation is ignored when calculating cash flows from operations. Answer: TRUE Diff: 2 Objective: L.O. 5-5
18) Under the direct method, dividends from investments are included when calculating cash flows from operations. Answer: TRUE Diff: 2 Objective: L.O. 5-5
19) Net income is always used in determining a company's cash flow from operations. Answer: FALSE Diff: 1 Objective: L.O. 5-5
20) Wages and salaries expense plus the increase in wages and salaries payable equals cash paid for wages and salaries. Answer: FALSE Diff: 3 Objective: L.O. 5-5
21) Both the direct and indirect methods yield the same net cash flow from operations. Answer: TRUE Diff: 1 Objective: L.O. 5-5
22) The indirect method is used by the majority of US corporations in preparing the statement of cash flows. Answer: TRUE Diff: 1 Objective: L.O. 5-5
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23) Income tax expense minus the decrease in income taxes payable equals cash paid for income taxes. Answer: FALSE Diff: 3 Objective: L.O. 5-5
24) Stepp Entertainment has the following selected balance sheet and income statement information:
Income Statement Accounts
For the Year Ended December 31, 2012
Income Tax Expense Cost of Goods Sold Sales Wage Expense Balance Sheet Accounts Accounts Payable Cash Income Taxes Payable Accounts Receivable Inventory Wages Payable
$ 15,000 164,000 523,000 88,000 At December 31, 2012 $19,000 19,000 21,000 41,000 12,000 5,000
At December 31, 2011 $17,000 12,000 9,000 36,000 23,000 12,000
Determine the following items for Stepp Entertainment for the year ended December 31, 2012: a. Cash received from customers b. Cash paid to suppliers c. Cash paid for wages d. Cash paid for income taxes Answer: a. Sales $523,000 Less: increase in A/R (5,000) Cash received from customers $518,000 b. Cost of goods sold $164,000 Less: decrease in Inventory (11,000) Less: increase in A/P (2,000) Cash paid to suppliers $151,000 c. Wage expense $88,000 Add: decrease in wages payable 7,000 Cash paid for wages $95,000 d. Income tax expense $15,000 Less: increase in taxes payable (12,000) Cash paid for taxes $ 3,000 Diff: 2 Objective: L.O. 5-5
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25) The following data pertains to Joss Decorating for the year of 2012: a. Salaries and wages: accrued, $175,000; paid in cash $200,000. b. Depreciation, $50,000. c. Interest expense, all paid in cash, $12,500. d. Other expenses, all paid in cash, $112,000. e. Income taxes accrued, $35,000; income taxes paid in cash, $33,000. f. Bought plant and facilities for $365,000 cash. g. Sales of $1,500,000, all on credit. Cash collections from customers, $1,250,000. h. The cost of items sold was $750,000. Purchases of inventory totaled $825,000; inventory and accounts payable were affected accordingly. i. Cash payments on trade accounts payable were $700,000. j. Issued long-term debt for $110,000 cash. k. Paid cash dividends of $45,000. Prepare a statement of cash flows using the direct method for reporting cash flows from operating activities. Omit supporting schedules. Answer: Joss Decorating Statement of Cash Flows For the Year Ended December 31, 2012 Cash from Operating Activities: Cash received from customers Cash paid to suppliers Cash paid to employees Cash paid for interest Cash paid for other expenses Cash paid for income taxes Net cash provided by operating activities
$ 1,250,000 (700,000) (200,000) (12,500) (112,000) (33,000) 192,500
Cash from Investing Activities: Purchased plant and facilities Net cash used by investing activities
(365,000) (365,000)
Cash from Financing Activities: Issued long-term debt Paid cash dividends Net cash provided by financing activities Net decrease in cash
110,000 (45,000) 65,000 $(107,500)
Diff: 3 Objective: L.O. 5-5
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26)
Bearpaw Tours Income Statement For the Year Ended December 31, 2012
Sales Less Expenses: Cost of Goods Sold Wage Expense Depreciation Expense Rent Expense Income Tax Expense Net Income
$624,000 $332,000 211,000 20,000 18,000 16,000
597,000 $ 27,000
Bearpaw Tours Balance Sheet December 31, 2011 and 2012
Current Assets: Cash Accts. Rec. Inventory Prepaid Rent Long-term Assets: Fixed Assets Acc. Depreciation Total Assets
12/31/12
12/31/11
$ 8,100 66,100 27,700 3,000 104,900
$ 10,600 53,400 35,900 4,500 104,400
165,500 (68,800) 96,700 $201,600
147,700 (55,200) 92,500 $196,900
12/31/12
12/31/11
$ 57,200 17,500 7,100 81,800
$59,900 11,300 8,200 79,400
75,000 44,800 119,800
74,000 43,500 117,500
Total Liabilities & Owners' Equity $201,600
$196,900
Current Liabilities: Accounts Payable Wages Payable Taxes Payable Owners' Equity: Common Stock Retained Earnings
Determine the cash flows from operations for Bearpaw Tours assuming the company uses the direct method. Answer: Sales $624,000 Less: increase in accounts rec. (12,700) Cash received from customers $611,300 Cost of goods sold Less: decrease in inventory Add: decrease in accounts payable Cash paid to suppliers
$ 332,000 (8,200) 2,700 $(326,500)
Wage expense Less: increase in wages payable Cash paid for wages
$ 211,000 (6,200) $(204,800)
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Rent expense Less: decrease in prepaid rent Cash paid for rent
$ 18,000 (1,500) $(16,500)
Income tax expense Add: decrease in taxes payable Cash paid for taxes
$ 16,000 1,100 (17,100)
Net cash provided by operations
$ 46,400
Diff: 3 Objective: L.O. 5-5
Learning Objective 5.6 Questions 1) The indirect method of preparing the statement of cash flows A) is seldom used by companies because of the extra effort required to gather cash flow information. B) calculates only the cash effect of each operating activity. C) is the method preferred by the FASB. D) begins with net income, adds back non cash expenses, and adjusts for changes in the current asset and current liability accounts. E) can be used to determine cash flows from operating, investing, and financing activities. Answer: D Diff: 2 Objective: L.O. 5-6
2) When preparing the statement of cash flows under the indirect method, an appropriate procedure would be to A) add a loss from the sale of a fixed asset. B) add an increase in accounts receivable. C) subtract depreciation expense. D) subtract an increase in accounts payable. E) determine cash received from customers. Answer: A Diff: 2 Objective: L.O. 5-6
3) When preparing the statement of cash flows under the indirect method, an appropriate procedure would be to A) subtract an increase in wages payable. B) subtract an increase in accounts receivable. C) subtract amortization expense. D) determine cash paid to suppliers. E) add a gain from the sale of a fixed asset. Answer: B Diff: 2 Objective: L.O. 5-6
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4) When preparing the statement of cash flows under the indirect method, all of the following would be an appropriate procedure except A) adding depreciation expense. B) subtracting a decrease in accounts payable. C) subtracting a decrease in prepaid expenses. D) adding a decrease in inventories. E) subtracting a gain from the sale of a fixed asset. Answer: C Diff: 2 Objective: L.O. 5-6
5) The following selected information is for Porter Handbags at, and for the year ended, December 31, 2012, and 2011: Selected Balance Sheet Accounts Accounts Payable Inventory Prepaid Expense Retained Earnings Wages Payable Accounts Receivable Accumulated Depreciation Cash Fixed Assets
12/31/12 $19,000 26,000 7,000 23,000 2,000 29,000 43,000 19,000 94,000
Selected Income Statement Accounts Depreciation Expense Gain on Sale of Fixed Asset Net Income Sales Wages Expense
$14,000 3,000 23,000 91,000 34,000
12/31/11 $13,000 30,000 5,000 19,000 7,000 22,000 35,000 14,000 79,000
Using the indirect method, what is the net cash flow from operations for Porter Handbags for the year ended December 31, 2012? A) $30,000 B) $33,000 C) $36,000 D) $43,000 E) $44,000 Answer: A Diff: 3 Objective: L.O. 5-6
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6) Which of the following transactions do not affect cash? 1. Convert debt to common stock 2. Credit sales 3. Purchase a fixed asset by issuing debt 4. Accept rental deposit 5. Write-off of prepaid expenses A) 1 and 2 B) 4 and 5 C) 1, 2, and 3 D) 3, 4, and 5 E) 1, 2, 3, and 5 Answer: E Diff: 3 Objective: L.O. 5-6
7) Which of the following transactions do not affect cash? 1. Purchase inventory on credit 2. Accrue operating expenses 3. Collection of accounts receivable 4. Accrue taxes and interest 5. Reclassify long-term debt to short-term debt A) 1 and 2 B) 1, 2, and 4 C) 1, 2, 3, and 5 D) 1, 2, 4, and 5 E) 1, 2, 3, 4, and 5 Answer: D Diff: 2 Objective: L.O. 5-6
8) Which of the following transactions decrease cash? 1. Purchase inventory from cash 2. Pay trade accounts payable 3. Accruing operating expenses 4. Purchase stock in R&D partner with cash 5. Charging depreciation A) 1, 2, and 5 B) 1, 2, and 4 C) 1, 2, 3, and 5 D) 1, 2, 3, and 4 E) 1, 2, 4, and 5 Answer: B Diff: 2 Objective: L.O. 5-6
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9) Which of the following transactions decrease cash? 1. Reduce prepaid expenses 2. Increase treasury stock 3. Lend money to an employee 4. Recognize cost of goods sold 5. Reduce long-term or short-term debt A) 1 and 4 B) 3 and 5 C) 1, 3, and 5 D) 2, 3, and 5 E) 1, 2, 3, 4, and 5 Answer: D Diff: 2 Objective: L.O. 5-6
10) Which of the following transactions increase cash? 1. Convert debt to common stock 2. Credit sales 3. Increase long-term debt 4. Issue common stock A) 1 and 3 B) 2 and 4 C) 3 and 4 D) 1, 2, and 4 E) 1, 2, 3, and 4 Answer: C Diff: 2 Objective: L.O. 5-6
11) Which of the following transactions increase cash? 1. Sales of goods and services for cash 2. Receiving cash dividends 3. Collection of accounts receivable 4. Reclassifying long-term debt to short-term debt 5. Accruing interest revenue A) 1 and 2 B) 1 and 3 C) 1, 2, and 3 D) 1, 2, 3, and 4 E) 1, 2, 3, and 5 Answer: C Diff: 2 Objective: L.O. 5-6
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12) The following selected information is for Barble Gardening Center at, and for the year ended, December 31, 2012, and 2011: Selected Balance Sheet Accounts Fixed Assets Inventory Prepaid Expense Retained Earnings Accounts Payable Accounts Receivable Accumulated Depreciation Cash Wages Payable
12/31/12 $ 188,000 52,000 14,000 46,000 38,000 58,000 86,000 38,000 4,000
Selected Income Statement Accounts Depreciation Expense Gain on Sale of Fixed Asset Net Income Sales Wages Expense
$ 28,000 6,000 43,000 182,000 68,000
12/31/11 $ 158,000 60,000 10,000 38,000 25,000 44,000 70,000 28,000 14,000
Using the indirect method, what is the net cash flow from operations for Barble Gardening Center for the year ended December 31, 2012? A) $63,000 B) $57,000 C) $83,000 D) $58,000 E) $87,000 Answer: D Diff: 3 Objective: L.O. 5-6
13) A decrease in inventory will be added to net income when preparing the operating activities section under the indirect method. Answer: TRUE Diff: 2 Objective: L.O. 5-6
14) Under the indirect method, a loss from the sale of a fixed asset is subtracted from net income. Answer: FALSE Diff: 2 Objective: L.O. 5-6
15) Under the indirect method, a gain from the early extinguishment of long-term debt is subtracted from net income. Answer: TRUE Diff: 2 Objective: L.O. 5-6
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16) A decrease in accounts receivable is added to the financing activities when preparing a statement of cash flows using the indirect method. Answer: FALSE Diff: 2 Objective: L.O. 5-6
17) The indirect method of determining cash from operations is most often used as this method produces larger positive cash flows than the direct method. Answer: FALSE Diff: 1 Objective: L.O. 5-6
18) The Financial Accounting Standards Board (FASB) prefers the indirect method of determining cash flows from operations. Answer: FALSE Diff: 1 Objective: L.O. 5-6
19) In 2012, Jaycox Custom Bikes had net income of $575,000. Jaycox also recorded $215,000 in depreciation. The company also had the following changes in its balance sheet accounts. Accounts Receivable $26,000 increase Inventories 11,000 decrease Accounts Payable 19,000 decrease Compute the net cash provided by operating activities using the indirect method. Answer: Net income $ 575,000 Add: depreciation expense 215,000 Less: increase in accounts receivable (26,000) Add: decrease in inventories 11,000 Less: decrease in accounts payable (19,000) Net cash provided by operating activities $756,000 Diff: 2 Objective: L.O. 5-6
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20)
Bearington Motors Income Statement For the Year Ended December 31, 2012
Sales Less Expenses: Cost of Goods Sold Wage Expense Depreciation Expense Rent Expense Income Tax Expense Net Income
$624,000 $332,000 211,000 20,000 18,000 16,000
597,000 $ 27,000
Bearington Motors Balance Sheet December 31, 2011 and 2012 12/31/12 12/31/11 Current Assets: Cash Accts. Rec. Inventory Prepaid Rent Long-term Assets: Fixed Assets Acc. Depreciation Total Assets
$ 8,100 66,100 27,700 3,000 104,900
12/31/12 12/31/11 Current Liabilities: Accounts Payable Wages Payable Taxes Payable
$ 10,600 53,400 35,900 4,500 104,400
Owners' Equity: Common Stock Retained Earnings
165,500 147,700 (68,800) (55,200) 96,700 92,500 $201,600 $196,900
Total Liabilities & Owners' Equity
$ 57,200 17,500 7,100 81,800
$59,900 11,300 8,200 79,400
75,000 44,800 119,800
74,000 43,500 117,500
$201,600 $196,900
Determine the net cash flow from operations for Bearington Motors, assuming the company uses the indirect method. Answer: Net Income $27,000 Add: depreciation expense 20,000 Less: increase in accounts receivable (12,700) Add: decrease in inventory 8,200 Add: decrease in prepaid rent 1,500 Less: decrease in accounts payable (2,700) Add: increase in wages payable 6,200 Less: decrease in taxes payable (1,100) Net cash provided by operations $46,400 Diff: 2 Objective: L.O. 5-6
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21) After analyzing the following statement of cash flows 1. State the method Pet Halt Services uses to prepare its operating section of the statement of cash flows and explain how you arrived at your answer. 2. Explain why depreciation expense is added back to net income in the operating section of the statement of cash flows. Pet Halt Services Statement of Cash Flows (Partial) For the Month ending January 31, 2012 Cash flows from Operating Activities: Net Income $120,000 Adjustments to reconcile net income to cash provided (used) by operating activities Depreciation expense 18,000 Increase in accounts receivable (29,000) Increase in accounts payable 33,000 Net cash provided by (used for) operating activities $142,000 Answer: 1. The company uses the indirect method of preparing its statement of cash flows because it starts with the net income balance and adjusts for increases and decreases in current assets(excluding cash) and current liabilities in order to arrive at net cash provided by operating activities. 2. Depreciation expense is a noncash expense that was deducted to arrive at net income on the income statement, but since it does not eventually turn into cash it must be added back to net income to arrive at net cash flow from operating activities. Diff: 2 Objective: L.O. 5-6
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Learning Objective 5.7 Questions 1) Which of the following statements is incorrect, regarding the effect of depreciation expense on a statement of cash flows using the indirect method? A) Depreciation expense is not an outflow of cash. B) Depreciation expense represents an inflow of cash. C) Depreciation expense is added in the operating activities section of the statement of cash flows. D) Depreciation expense is not a source of cash. E) Depreciation expense will reduce the net income used in determining net cash flow from operations. Answer: B Diff: 2 Objective: L.O. 5-7
2) If an accountant establishes the sales for the month and adds the beginning balance of accounts receivable and subtracts the accounts receivable balance at the end of the month, this would determine A) cash collections from customers for the month. B) net income for the month C) total assets less liabilities for the month. D) cash payments to vendors for the month. E) total sales in cash for the month. Answer: A Diff: 2 Objective: L.O. 5-7
3) A supplementary schedule reconciling net income to net cash flow from operating activities is A) not needed when using the direct method. B) part of the income statement. C) needed when using the direct method. D) part of the balance sheet. E) used by investors to determine earnings per share. Answer: C Diff: 2 Objective: L.O. 5-7
4) Purchases of inventory minus the increase in accounts payable equals A) cash collected from customers. B) cash collected for sales on credit. C) cash paid to vendors. D) cash paid for inventory. E) none of the above Answer: D Diff: 2 Objective: L.O. 5-7
5) To determine cash collections from customers, we take sales and add the increase in Accounts Receivable. Answer: FALSE Diff: 1 Objective: L.O. 5-7
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6) Depreciation expense is not a source of cash; however, it is added to net income when determining net cash flow from operations under the indirect method. Answer: TRUE Diff: 2 Objective: L.O. 5-7
7) Depreciation expense is not a source of cash; however, it is subtracted from net income when determining net cash flow from operations under the direct method. Answer: FALSE Diff: 2 Objective: L.O. 5-7
8) Cash received from customers is equal to sales plus the increase in accounts receivable. Answer: FALSE Diff: 3 Objective: L.O. 5-7
9) Purchases of inventory minus the increase in accounts payable equals cash paid for inventory. Answer: TRUE Diff: 3 Objective: L.O. 5-7
10) Cost of goods sold plus the increase in inventory equals cash paid for inventory. Answer: FALSE Diff: 3 Objective: L.O. 5-7
11) Molecule Labs, Inc. had sales of $450,000, all received in cash. Total operating expenses were $350,000. All expenses except depreciation were paid in cash. Depreciation of $60,000 was included in the operating expenses. Ignore income taxes. Calculate net income and net cash provided by operating activities using the direct method. Answer: Sales revenue $450,000 Less: operating expenses 350,000 Net income $100,000 Cash received from customers Less: cash operating expenses Net cash provided by operating activities
$450,000 290,000 $160,000
Diff: 3 Objective: L.O. 5-7
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Learning Objective 5.8 Questions 1) The balance sheet equation provides the conceptual basis for all financial statements and can be rearranged to incorporate the statement of cash flows as follows: A) Cash + Noncash assets = Liabilities + Stockholders' equity B) Cash - Noncash assets = Liabilities + Stockholders' equity C) Assets = Liabilities - Noncash assets + Stockholders' equity D) Assets = Liabilities + Noncash assets + Stockholders' equity E) Liabilities - Noncash assets = Cash + Stockholders' equity Answer: A Diff: 2 Objective: L.O. 5-8
2) Increases in cash stem from 1. increases in liabilities. 2. increases in stockholders' equity. 3. increases in noncash assets. 4. decreases in liabilities. 5. decreases in stockholders' equity. 6. decreases in noncash assets. A) 1, 2, and 3 B) 2, 3, and 4 C) 1, 2, and 6 D) 2, 3, and 5 E) 3, 4, and 5 Answer: C Diff: 2 Objective: L.O. 5-8
3) An increase in stockholders' equity can be calculated as A) new issuance of stock plus net income plus cash dividends declared. B) new issuance of stock plus net income less cash dividends declared. C) new issuance of stock less net income less cash dividends declared. D) new issuance of stock less net income plus cash dividends declared. E) Cannot be determined from the information provided Answer: B Diff: 2 Objective: L.O. 5-8
4) The indirect method and the direct method of preparing the statement of cash flows A) always produce the same totals for net cash from operating activities. B) sometimes produce the same totals for net cash from operating activities. C) have different totals for net cash from financing activities. D) have different totals for net cash from investing activities. E) have different answers for the change in cash. Answer: A Diff: 2 Objective: L.O. 5-8
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5) Increases in liabilities, owners' equity, and noncash assets increase cash. Answer: FALSE Diff: 2 Objective: L.O. 5-8
6) Even though assets must always equal the sum of liabilities and owners' equity, the net cash flow from operations does not have to equal the sum of the net cash flow from investing activities and the net cash flow from financing activities. Answer: TRUE Diff: 2 Objective: L.O. 5-8
7) Net cash provided by operating activities is always equal to net income. Answer: FALSE Diff: 1 Objective: L.O. 5-8
8) Losses and gains on the disposal of assets are essentially nonoperating items that are adjustments to net income under the direct method. Answer: FALSE Diff: 2 Objective: L.O. 5-8
Learning Objective 5.9 Questions 1) Caltrac Company had net cash used by operating activities of $(150,000), had proceeds from the sale of a stock investment of $100,000, and incurred capital expenditures of $50,000. What is Caltrac Company's free cash flow? A) $100,000 B) $(50,000) C) $(200,000) D) $0 E) $50,000 Answer: C Diff: 2 Objective: L.O. 5-9
2) Supporting Therapy has a negative free cash flow. What is Supporting Therapy most likely going to do assuming they are not able to obtain financing? A) Sell its assets B) Hire new employees C) Buy a new patent D) Buy additional inventory E) Pay dividends Answer: A Diff: 2 Objective: L.O. 5-9
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3) Since both the income statement and the statement of cash flows report on company changes, A) an income statement is not necessary if a statement of cash flows is prepared. B) a statement of cash flows is not necessary if an income statement is prepared. C) a statement of cash flows and an income statement are prepared regardless. D) a balance sheet is not necessary if an income statement and a statement of cash flows is prepared. E) a balance sheet is not necessary if either an income statement or a statement of cash flows is prepared. Answer: C Diff: 2 Objective: L.O. 5-9
4) What does a positive free cash flow tell investors about a company's ability to produce cash flows from operations and make necessary investments? Answer: A positive free cash flow tells investors that the company has cash left over after undertaking the company's operations and making the necessary investments to ensure its continued operations. Diff: 2 Objective: L.O. 5-9
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Introduction to Financial Accounting, 11e (Horngren) Chapter 6 Accounting for Sales Learning Objective 6.1 Questions 1) A long term contract to provide services for New York City was awarded to Mason Technology on December 30, 20X1. The 4-year contract is set for $160 million and payment is certain. Services are to be provided evenly over 20X2 through 20X5. Progress measures are dependable, the contract obligations are explicit and the buyer and seller are expected to meet their obligations. A) In 20X2, Mason should recognize no revenue. B) In 20X2, Mason should recognize $160 million in revenue. C) In 20X3, Mason should recognize no revenue. D) In 20X3, Mason should recognize $40 million in revenue. E) In 20X3, Mason should recognize $160 million in revenue. Answer: D Diff: 1 Objective: L.O. 6-1
2) In order for revenue to be recognized, A) goods or services must be delivered to the customer only. B) cash or an asset virtually assured of being converted into cash must be received from the customer only. C) goods or services must be delivered to the customer and cash or an asset virtually assured of being converted into cash must be received. D) cash must be received from the customer only. E) goods or services must be delivered to the customer and cash must be received from the customer. Answer: C Diff: 1 Objective: L.O. 6-1
3) Why is the timing of revenue recognition important? A) Revenues increase net income. B) Revenues reduce net income by triggering the recognition of certain expenses. C) Revenues increase the declaration of dividends. D) Increases in revenues result in higher retained earnings. E) both A and B Answer: E Diff: 1 Objective: L.O. 6-1
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4) Quizno Contracting would like to utilize the percentage of completion method to recognize a building under construction for Balto Veterinary. However, the accountant is not sure whether Quizno Contracting is meeting GAAP expectations. It is appropriate for Quizno Contracting to apply the percentage of completion method EXCEPT when A) progress measures are dependable. B) contract obligations are precise and clear. C) the buyer has agreed to use the completed contract method of revenue recognition. D) both buyer and seller are expected to meet their obligations. E) little or no uncertainty exists regarding payment by the buyer. Answer: C Diff: 2 Objective: L.O. 6-1
5) If the criteria to use the percentage of completion method are not met, a company must A) use the completed contract method to recognize revenue. B) use the completion revenue principle to recognize revenue. C) confer with their client about cash collection expectations. D) refer to IFRS and choose between one of the five available revenue recognition principles. E) determine whether they are permitted to conduct business with a client. Answer: A Diff: 2 Objective: L.O. 6-1
6) Joint discussions between the FASB and IASB regarding accounting for revenues A) are ongoing and may result in a new standard for revenue recognition. B) have resulted in a 4 step process for revenue recognition. C) have resulted in a 3 step process for revenue recognition. D) were undertaken for the benefit of stockholders so that stock prices retain stability during unstable economic times. E) have not been conducted and no discussions are in the foreseeable future. Answer: A Diff: 2 Objective: L.O. 6-1
7) For a magazine company, subscription revenues are recognized when cash is received from the customer before delivery of the magazine. Answer: FALSE Diff: 1 Objective: L.O. 6-1
8) Revenue is generally recognized at the point of sale. Answer: TRUE Diff: 1 Objective: L.O. 6-1
9) The revenue recognition principle relies only on the principle of receiving cash or an asset virtually assured of being converted into cash. Answer: FALSE Diff: 1 Objective: L.O. 6-1
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10) Name the five steps for revenue recognition proposed by the joint discussions between the FASB and IASB. Answer: Step 1: Identify the contract with a customer. Step 2: Identify the separate performance obligations in the contract. Step 3: Determine the transaction price. Step 4: Allocate the transaction price to the separate performance obligations in the contract. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. Diff: 3 Objective: L.O. 6-1
Learning Objective 6.2 Questions 1) Lazareth Machine Metals sold inventory to Talla Manufacturing for $5,000 cash. Which of the following is the journal entry made by Lazareth Machine Metals? Assume the periodic inventory system is used. A) Cost of Goods Sold 5,000 Sales 5,000 B) Cash 5,000 Inventory 5,000 C) Accounts Receivable 5,000 Sales 5,000 D) Cash 5,000 Sales 5,000 E) Cash 5,000 Accounts Payable 5,000 Answer: D Diff: 1 Objective: L.O. 6-2
2) Assume the periodic inventory system is used. Karton Company sold inventory to Rabell Company for $3,400 with agreement from Rabell that payment will be made at the end of the month. Which of the following is the journal entry to be made by Karton Company? A) Cost of Goods Sold 3,400 Sales 3,400 B) Cash 3,400 Inventory 3,400 C) Accounts Receivable 3,400 Sales 3,400 D) Cash 3,400 Sales 3,400 E) Cash 3,400 Accounts Payable 3,400 Answer: C Diff: 1 Objective: L.O. 6-2
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3) Flores Materials gave inventory to Jared Industries to settle short-term credit for $4,000. Which of the following is the journal entry to be made by Flores Materials? A) Accounts Payable 4,000 Sales 4,000 B) Cash 4,000 Sales 4,000 C) Accounts Receivable 4,000 Sales 4,000 D) Sales 4,000 Accounts Payable 4,000 E) Accounts Payable 4,000 Inventory 4,000 Answer: E Diff: 2 Objective: L.O. 6-2
4) When a company sells goods and receives non-cash items in return, A) the seller estimates the fair market value of the non-cash item or the cash equivalent of the noncash item. B) the seller receiving the non-cash item estimates its value as the original cost of the inventory sold. C) the seller uses the buyers' cost for the non-cash item. D) the seller uses one-half of the fair market value of the non-cash item. E) both parties must realize that they are conducting a transaction that is not in accordance with GAAP. Answer: A Diff: 2 Objective: L.O. 6-2
5) A company reports revenue on its income statement using A) gross sales less sales returns and allowances. B) net sales less sales returns and allowances. C) gross sales plus trade discounts. D) net sales plus trade discounts. E) gross sales less trade discounts plus sales returns and allowances. Answer: A Diff: 2 Objective: L.O. 6-2
6) Sales returns and allowances A) are accounted for by deducting the total amount from gross sales. B) are accounted for by deducting the total amount from net sales. C) are accounted for using a contra account called Trade Discounts. D) are accounted for using a reduction account. E) are not accounted for on the financial statements. Answer: A Diff: 1 Objective: L.O. 6-2
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7) Ganes Computing sold $70,000 of inventory on account to Markel Company on April 1, 20X3. The company uses a periodic inventory system. Markel Company returned $2,000 of the inventory on April 20, 20X3 because it did not fit the company's needs. Which of the following is the journal entry to be made by Ganes Computing for the return of inventory? A) Cash $2,000 Accounts Receivable $2,000 B) Accounts Receivable $2,000 Revenue $2,000 C) Revenue $2,000 Accounts Receivable $2,000 D) Revenue $2,000 Sales Returns and Allowances $2,000 E) Sales Returns and Allowances $2,000 Accounts Receivable $2,000 Answer: E Diff: 2 Objective: L.O. 6-2
8) Cash Discounts on Sales are A) a contra account to Accounts Receivable. B) a contra account to Accounts Payable. C) a contra account to gross sales. D) an adjunct account to gross sales. E) neither an addition nor a deduction to gross sales. Answer: C Diff: 2 Objective: L.O. 6-2
9) The difference between gross sales and net sales may include A) Cash Discounts on Sales. B) Sales Returns and Allowances. C) Trade Discounts. D) both A and B E) both A and C Answer: D Diff: 1 Objective: L.O. 6-2
10) Trade discounts are journalized by A) decreasing returns and allowances. B) increasing returns and allowances. C) decreasing gross sales. D) increasing gross sales. E) decreasing net sales. Answer: C Diff: 1 Objective: L.O. 6-2
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11) Neslund Ornamentals offered a 2% trade discount to Parsons Retail Outlet for all purchases over $200,000. Parsons Retail Outlet purchased $300,000 from Neslund Ornamentals on account. Neslund uses the periodic inventory system. Which of the following is the journal entry made by Neslund Ornamentals to recognize the sale and the 2% trade discount? A) Accounts Receivable $294,000 Sales $294,000 B) Accounts Receivable $300,000 Sales Returns and Allowances $6,000 Sales $294,000 C) Sales Returns and Allowances $294,000 Sales $294,000 D) Sales $294,000 Accounts Receivable $300,000 Trade Discounts $6,000 E) Sales $294,000 Accounts Receivable $294,000 Answer: A Diff: 2 Objective: L.O. 6-2
12) A company offers a 2% discount on payments received within 10 days of the invoice date. Otherwise full payment must be received within 30 days of the invoice date. If the invoice date is January 5, the payment date is January 13, and the company received the invoice on January 7, what is the amount that should be remitted assuming a gross sale of $1,000? A) $200 B) $1,000 C) $1,020 D) $980 E) $196 Answer: D Diff: 1 Objective: L.O. 6-2
13) Companies that offer cash discounts for prompt payment and use the gross method to account for them journalize the discount by A) deducting the discount from the gross accounts receivable account. B) using a separate account called Cash Discounts on Sales. C) using a separate account called Trade Discounts on Sales. D) adding the discount to the gross accounts receivable account. E) deducting the discount from the revenue account. Answer: B Diff: 2 Objective: L.O. 6-2
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14) In contrast to the gross method, the net method of accounting for cash discounts uses an ________ account. A) Interest Revenue B) Interest Expense C) Cash Discounts on Sales D) Cash Discounts for Bank Card E) None of the above Answer: A Diff: 1 Objective: L.O. 6-2
15) Casper Company sold inventory of $5,000 and accepted payment with a credit card. The credit card charges Casper Company a 2% fee on credit card sales. Casper uses the periodic inventory system. Which of the following journal entries reflects the sale made by Casper Company? A) Cash $5,000 Sales $5,000 B) Cash $4,900 Cash discounts for credit cards $100 Sales $5,000 C) Cash discounts for credit cards $4,900 Sales $4,900 D) Accounts receivable $5,000 Sales $5,000 E) Accounts receivable $4,900 Trade discounts for credit cards $100 Sales $5,000 Answer: B Diff: 2 Objective: L.O. 6-2
16) What is one possible reason why the account Sales Returns and Allowances needs to be established as a contra account? A) So that managers can keep a running balance of returned goods in order to be able to sell the damaged goods to the employees of the organization as an incentive B) So that managers can produce more goods when goods get returned in order to hit monthly bonus levels C) So that managers can make adjustments to the manufacturing process when goods are returned for defective reasons D) So that factory foremen can manage when invoices are paid E) So that factory foremen can control the amount of credit they grant customers Answer: C Diff: 2 Objective: L.O. 6-2
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17) Assume the periodic inventory system is used. Madison Manufacturing gave a 4% trade discount to Tristan Company when it sold inventory for cash that normally sells for $12,000. Which of the following is the journal entry to be made by Madison Manufacturing? A) Cash 11,520 Sales 11,520 B) Cash 11,520 Trade Discount 480 Sales 12,000 C) Cash 11,520 Trade Discount Payable 480 Sales 12,000 D) Cash 12,000 Trade Discount 480 Sales 11,520 E) Cash 12,000 Trade Discount Receivable 480 Sales 11,520 Answer: A Diff: 2 Objective: L.O. 6-2
18) Assume the periodic inventory system is used. Krinkle Company sold inventory on account for $500 on May 8, 20X3, with terms of 2/10, n/30. On May 16, 20X3 the appropriate payment was received from the customer. Which of the following is the journal entry to record the May 16 transaction on Krinkle's books? A) Cash 500 Accounts Receivable 500 B) Cash 490 Cash Discounts on Sales 10 Accounts Receivable 500 C) Cash 490 Sales 10 Accounts Receivable 500 D) Cash 500 Cash Discounts on Sales 10 Accounts Receivable 490 E) Cash 500 Sales 10 Accounts Receivable 490 Answer: B Diff: 1 Objective: L.O. 6-2
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19) Trade discounts A) apply one or more reductions to the gross selling price for a particular class of customers in accordance with a company's policies. B) are offered in order to be competitive. C) are offered to encourage certain customer behavior (to encourage early orders). D) are not reported on the income statement E) All of the above statements are true regarding trade discounts. Answer: E Diff: 2 Objective: L.O. 6-2
20) Assume the periodic inventory system is used. Sammy Company sold inventory on account for $300. A week later, the inventory was returned and a full credit was given to the customer. Which of the following would be Sammy's journal entry to record the return of the inventory? A) Cash 300 Accounts Receivable 300 B) Sales 300 Accounts Receivable 300 C) Sales Discounts 300 Accounts Receivable 300 D) Sales Returns & Allowances 300 Sales 300 E) Sales Returns & Allowances 300 Accounts Receivable 300 Answer: E Diff: 2 Objective: L.O. 6-2
21) Assume the periodic inventory system is used. Nicolla Company sold inventory for cash of $6,000. A week later, the inventory was returned and a cash refund was given to the customer. Nicolla's journal entry to record the return of the inventory would be which of the following? A) Cash 6,000 Accounts Receivable 6,000 B) Sales 6,000 Accounts Receivable 6,000 C) Sales Discounts 6,000 Cash 6,000 D) Sales Returns & Allowances 6,000 Sales 6,000 E) Sales Returns & Allowances 6,000 Cash 6,000 Answer: E Diff: 2 Objective: L.O. 6-2
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22) Wayne Company just purchased merchandise costing $700, which has payment terms of 2/10, n/45. Wayne Company is uncertain whether to take advantage of the discount. What is the annual interest rate implicit in the cash discount, assuming a 365-day year? A) 2.0% B) 3.0% C) 16.2% D) 20.9% E) 21.3% Answer: E Diff: 3 Objective: L.O. 6-2
23) Payne Industries can borrow money from the local bank at 14%. The company just acquired inventory costing $2,900, which has terms of 2/10, n/30. Assuming a 365-day year, which of the following statements is true? A) Do not pay within the discount period since the effective annual rate of the discount is 37.2%, while the cost to borrow money is 14%. B) Pay within the discount period since the effective annual rate of the discount is 37.2%, while the cost to borrow money is 14%. C) Do not pay within the discount period since the effective annual rate of the discount is 24%, while the cost to borrow money is 14%. D) Pay within the discount period since the effective annual rate of the discount is 24%, while the cost to borrow money is 14%. E) Do not pay within the discount period since the 2% discount is less than the 14% cost to borrow money. Answer: B Diff: 3 Objective: L.O. 6-2
24) Which of the following statements is true? A) Trade discounts and sales returns and allowances are listed on the income statement as deductions from gross sales. B) Reports to shareholders often omit the details of revenue and show only net revenue. C) Cash Discounts on Sales are listed on the income statement as an expense of doing business. D) "Turnover" is commonly used in the United States to refer to net sales revenue. E) Cash discounts must appear on cash flow statements. Answer: B Diff: 3 Objective: L.O. 6-2
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25) Higgins Company accepts bank cards, which charge a fee of 4% on sales. The company had gross sales of $60,000, of which 25% were cash sales and the remainder was credit sales that are solely attributable to bank cards. The company uses the periodic inventory system. Which of the following is the journal entry for Higgins Company? A) Cash 58,200 Sales 58,200 B) Cash 15,000 Accounts Receivable 43,200 Sales 58,200 C) Cash 57,600 Cash discounts for Bank Cards 2,400 Sales 60,000 D) Cash 58,200 Cash Discounts for Bank Cards 1,800 Sales 60,000 E) Cash 15,000 Accounts Receivable 43,200 Cash Discounts on Bank Cards 1,800 Sales 60,000 Answer: D Diff: 2 Objective: L.O. 6-2
26) Thompson Manufacturing sold inventory to a customer for $400. The customer used a VISA bank card, which charges Thompson a 3% fee. The company uses the periodic inventory system. What asset results from this sale? A) Accounts Receivable of $388 B) Cash of $400 C) Cash of $388 D) Sales of $388 E) Accounts Receivable of $400 Answer: C Diff: 2 Objective: L.O. 6-2
27) White Enterprises sold $100,000 of sales in January, but customers returned $10,000 of goods to White Enterprises during the month. In addition, White Enterprises gave cash discounts of $1,000 to its customers. The beginning balance of the allowance for uncollectible accounts was $2,000 and the company uses the aging of accounts receivable to account for uncollectible accounts. What is the net sales figure for the month of January for White Enterprises? A) $89,000 B) $90,000 C) $92,000 D) $91,000 E) $100,000 Answer: A Diff: 2 Objective: L.O. 6-2
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28) For a newspaper subscription, subscription revenue is always credited when cash is received from the customer. Answer: FALSE Diff: 1 Objective: L.O. 6-2
29) Revenue is generally recognized at the point of sale with a debit. Answer: FALSE Diff: 1 Objective: L.O. 6-2
30) A sales return occurs when a buyer returns merchandise to the seller, and a sales allowance is when the seller allows a lower price to be charged to the customer. Answer: TRUE Diff: 1 Objective: L.O. 6-2
31) There are no contra accounts on the income statement. Answer: FALSE Diff: 1 Objective: L.O. 6-2
32) Net sales is always equal to total sales revenue less sales returns and allowances. Answer: FALSE Diff: 1 Objective: L.O. 6-2
33) Net sales is equal to total sales revenue plus sales returns and allowances and sales discounts. Answer: FALSE Diff: 1 Objective: L.O. 6-2
34) If a company normally sells merchandise for $5,000, but allows a $200 trade discount, then the company would state that its revenue on this transaction was $4,800. Answer: TRUE Diff: 2 Objective: L.O. 6-2
35) The credit terms 2/4, n/30 means that the customers may take a 4% cash discount if they pay within 30 days. Answer: FALSE Diff: 1 Objective: L.O. 6-2
36) The credit terms 2/10, n/30 means that the customers may take a 2% cash discount if they pay within 10 days. Answer: TRUE Diff: 1 Objective: L.O. 6-2
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37) Companies should always take advantage of cash discounts even if they have to borrow money from the bank to do so. Answer: FALSE Diff: 2 Objective: L.O. 6-2
38) Retailers accept bank cards such as VISA and Master Card in order to get cash immediately rather than waiting for the customers to pay in due course. Answer: TRUE Diff: 2 Objective: L.O. 6-2
39) A retailer accepting a bank card such as VISA or Master Card does not have the responsibility of collecting cash on account. Answer: TRUE Diff: 2 Objective: L.O. 6-2
40) On February 27, 20X9, Best Appliances Ever agreed to sell 60 refrigerators to a local home construction company. The sales contract stated that the normal selling price of the refrigerators was $500 each, but a 4% trade discount was given due to the size of the order. The terms of the sales are 2/10, n/30. The refrigerators are to be delivered on March 20, 20X9. The invoice was dated March 20, 20X9. The customer paid the appropriate amount on March 28. A. What is the gross revenue that Best Appliances Ever should recognize for the month ending March 31, 20X9? B. What is the net revenue that Best Appliances Ever should recognize for the month ending March 31, 20X9? Answer: A. Trade discount is $500 × 4% = $20 per refrigerator 60 × ($500 - $20) = $28,800 B. $28,800 × (1 - .02) = $28,224 Diff: 2 Objective: L.O. 6-2
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41) The following information pertains to results obtained during the month of October 20X9 for Hawkins Hearing Center: Sales Returns and Allowances $ 21,000 Gross Sales 720,000 Cash Discounts on Sales 15,000 Of the gross sales, $245,000 were sales made to customers who used their bank cards. The bank card company charged Hawkins Hearing Center a 3% fee. Prepare the revenue section of the income statement for Hawkins Hearing Center for the month ended October 31, 20X9. Answer: Sales $720,000 Less: Sales Returns & Allowances (21,000) Cash Discount on Sales (15,000) Cash Discount on Bank Cards (7,350) Net Sales $ 676,650 Diff: 2 Objective: L.O. 6-2
42) Our House is a manufacturer of furniture. On June 16, 20X9, Our House received an order from Old Fashioned, Inc., for 15 living room sets at $1,500 per set. The furniture was delivered by Our House to Old Fashioned, Inc., on June 30, 20X9, at which time Our House billed Old Fashioned under the terms 2/30, n/60. Old Fashioned, Inc., paid Our House on July 25. Assume Our House uses a periodic inventory system. Prepare the appropriate journal entries for Our House as of the following dates: a. June 16 b. June 30 c. July 25 Answer: a. No entry b. Accounts Receivable 22,500 Sales 22,500 c. Cash 22,050 Cash Discounts on Sales 450 Accounts Receivable 22,500 Diff: 2 Objective: L.O. 6-2
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Learning Objective 6.3 Questions 1) Martin Optical has found that 2% of credit sales turn into bad debts and it costs the company $2,000 in administration expenses per year to manage the bad debts. Martin Optical obtains $30,000 of credit sales each year that it would not otherwise obtain if it did not offer credit. In addition, the $30,000 of credit sales earns Martin Optical $12,000 per year. What is the net gain (loss) of continuing to offer credit to its customers? A) $10,000 B) $12,000 C) $2,000 D) $9,400 E) $2,600 Answer: D Diff: 2 Objective: L.O. 6-3
2) Brandon Corporation generated $98,000 in credit sales during 20X2. In February 20X3, Brandon realized that $13,500 of the accounts receivable generated from the 20X2 credit sales were uncollectible. Brandon seldom experiences bad debts losses; therefore, it used the specific write-off method. Using the matching principle, what is the effect on 20X3 and 20X2 net income as a result of the write-off? A) 20X3 net income is understated by $13,500, while 20X2 net income is overstated by $13,500. B) 20X3 net income is overstated by $13,500, while 20X2 net income is understated by $13,500. C) 20X3 net income is neither overstated nor understated, but 20X2 net income is understated by $13,500. D) 20X3 net income is overstated by $13,500, but 20X2 net income is neither overstated nor understated. E) There is no effect on either year's net income as revenues and expenses are properly matched. Answer: A Diff: 3 Objective: L.O. 6-3
3) Axle Motors Inc. has a December 31 year-end. On November 28, 20X2, the company sold inventory for $600 on account with the terms 2/10, n/30. On February 28, 20X3, the company recognized the account as uncollectible. If Axle Motors Inc. uses the specific write-off method, what can be said with respect to the matching principle? A) The matching principle is not violated using the specific write-off method. B) 20X2 earnings are overstated by $600, and 20X3 earnings are understated by $600. C) 20X2 earnings are understated by $600, and 20X3 earnings are overstated by $600. D) 20X2 earnings are overstated by $600, and 20X3 earnings are overstated by $600. E) 20X2 earnings are understated by $600, and 20X3 earnings are understated by $600. Answer: B Diff: 3 Objective: L.O. 6-3
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4) Axle Motors Inc. has a December 31 year-end. On November 28, 20X2, the company sold inventory for $600 on account with the terms 2/10, n/30. On February 28, 20X3, the company recognized the account as uncollectible. What is the journal entry for Axle Motors, Inc. on February 28, 20X3, if the company uses the specific write-off method? A) Accounts Receivable 600 Bad Debts Expense 600 B) Allowance for Uncollectible Accounts 600 Accounts Receivable 600 C) Bad Debts Expense 600 Allowance for Uncollectible Accounts 600 D) Accounts Receivable 600 Allowance for Uncollectible Accounts 600 E) Bad Debts Expense 600 Accounts Receivable 600 Answer: E Diff: 2 Objective: L.O. 6-3
5) Which of the following is NOT an attribute of the Allowance for Uncollectible Accounts? A) The balance in the account increases when an uncollectible account is written off. B) It is on the asset side of the balance sheet. C) It is a contra account. D) It reduces Accounts Receivable. E) It normally has a credit balance. Answer: A Diff: 1 Objective: L.O. 6-3
6) Selia Sewage Systems has sales of $900,000, of which 25% are cash sales and the remainder is on credit. As of year-end, but before the bad debts adjustment, the Allowance for Uncollectible Accounts has a credit balance of $300, and Accounts Receivable has a debit balance of $60,000. If bad debts are estimated to be 1.5% of credit sales, what journal entry will Selia Sewage Systems need to prepare in order to estimate bad debts? A) Allowance for Uncollectible Accounts 10,125 Accounts Receivable 10,125 B) Bad Debts Expense 9,525 Allowance for Uncollectible Accounts 9,525 C) Bad Debts Expense 10,425 Allowance for Uncollectible Accounts 10,425 D) Bad Debts Expense 10,125 Allowance for Uncollectible Accounts 10,125 E) Bad Debts Expense 13,500 Accounts Receivable 13,500 Answer: D Diff: 2 Objective: L.O. 6-3
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7) Selia Sewage Systems has sales of $900,000, of which 25% are cash sales and the remainder is on credit. As of year-end, but before the bad debts adjustment, the Allowance for Uncollectible Accounts has a credit balance of $300, and Accounts Receivable has a debit balance of $60,000. If it is determined that the company will not collect from Colltor and from Mortana for the amounts of $330 and $680, respectively, what journal entry would Selia prepare? A) Allowance for Uncollectible Accounts 1,010 Accounts Receivable, Colltor 330 Accounts Receivable, Mortana 680 B) Bad Debts Expense 1,010 Accounts Receivable, Colltor 330 Accounts Receivable, Mortana 680 C) Bad Debts Expense 1,010 Allowance for Uncollectible Accounts 1,010 D) Accounts Receivable, Colltor 330 Accounts Receivable, Mortana 680 Allowance for Uncollectible Accounts 1,010 E) Accounts Receivable, Colltor 330 Accounts Receivable, Mortana 680 Bad Debts Expense 1,010 Answer: A Diff: 2 Objective: L.O. 6-3
8) Which of the following statements associated with the allowance method for bad debts is false? A) The write-off of an uncollectible account does not affect the accounts receivable subsidiary ledger. B) The write-off of an uncollectible account does not affect the total amount of current assets. C) The write-off of an uncollectible account does not affect current liabilities. D) The write-off of an uncollectible account does not affect the income statement. E) The write-off of an uncollectible account does not affect stockholders' equity. Answer: A Diff: 3 Objective: L.O. 6-3
9) The estimation of bad debts expense, using the allowance method, has what effect on the balance sheet? A) It has no effect on assets and decreases stockholders' equity. B) It decreases assets and decreases stockholders' equity. C) It increases assets and increases stockholders' equity. D) It decreases assets and increases stockholders' equity. E) It increases assets and decreases stockholders' equity. Answer: B Diff: 3 Objective: L.O. 6-3
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10) The write-off of a specific account for bad debts has what effect on the balance sheet under the allowance method? A) It has no effect on total assets or stockholders' equity. B) It decreases assets and decreases stockholders' equity. C) It increases assets and decreases stockholders' equity. D) It decreases assets and has no effect on stockholders' equity. E) It has no effect on assets and decreases owner's equity. Answer: A Diff: 3 Objective: L.O. 6-3
11) A bad debts recovery has what effect on the balance sheet under the allowance method for bad debts? A) It has no effect on total assets or stockholders' equity. B) It decreases assets and decreases stockholders' equity. C) It increases assets and decreases stockholders' equity. D) It decreases assets and has no effect on stockholders' equity. E) It has no effect on assets and decreases owner's equity. Answer: A Diff: 3 Objective: L.O. 6-3
12) The accounts receivable subsidiary ledger A) is not effected by the write-off of individual accounts. B) provides the supporting detail (i.e., individual customer names and amounts owed) for the general ledger account "Accounts Receivable." C) is kept for both the "Accounts Receivable" and the "Allowance for Uncollectible Accounts" accounts. D) is only kept by companies that use the allowance method of estimating bad debts. E) All of the above are true statements. Answer: B Diff: 2 Objective: L.O. 6-3
13) Emerz Corporation had sales of $850,000, of which 20% were cash sales. As of year-end, the balance in the Allowance for Uncollectible Accounts before adjusting for bad debts was a $400 debit. The company estimates bad debts as 10% of ending accounts receivable or 1.5% of credit sales. What is the journal entry that Emerz Corporation will make if it estimates bad debts by using a percentage of credit sales? A) Bad Debts Expense 9,800 Allowance for Uncollectible Accounts 9,800 B) Bad Debts Expense 10,200 Allowance for Uncollectible Accounts 10,200 C) Bad Debts Expense 10,600 Allowance for Uncollectible Accounts 10,600 D) Bad Debts Expense 12,350 Allowance for Uncollectible Accounts 12,350 E) Bad Debts Expense 12,750 Allowance for Uncollectible Accounts 12,750 Answer: B Diff: 3 Objective: L.O. 6-3
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14) Emerz Corporation had sales of $850,000, of which 20% were cash sales. As of year-end, the balance in the Allowance for Uncollectible Accounts before adjusting for bad debts was a $400 debit. The company estimates bad debts as 10% of ending accounts receivable or 1.5% of credit sales. What is the balance in the Allowance for Uncollectible Accounts after Emerz Corporation estimates bad debts using a percentage of credit sales? A) $9,800 B) $10,200 C) $10,600 D) $12,350 E) $12,750 Answer: A Diff: 3 Objective: L.O. 6-3
15) Emerz Corporation had sales of $850,000, of which 20% were cash sales. As of year-end, the balance in the Allowance for Uncollectible Accounts before adjusting for bad debts was a $400 debit. The company estimates bad debts as 10% of ending accounts receivable or 1.5% of credit sales. The ending balance in Accounts Receivable is $72,000. What is the balance in the Allowance for Uncollectible Accounts if Emerz Corporation estimates bad debts using a percentage of ending accounts receivable? A) $6,800 B) $7,200 C) $7,600 D) $85,000 E) $84,600 Answer: B Diff: 3 Objective: L.O. 6-3
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16) Nolan Company had total credit sales for the past year of $800,000. As of year-end, but before estimating bad debts, the company had a $70,000 debit balance in accounts receivable and a $600 debit balance in the Allowance for Uncollectible Accounts. Upon examination of the accounts receivable, it was found that 55% of the balance was 1-30 days old, 30% was 31-60 days old, 9% were 61-90 days old, and 6% were over 90 days old. Nolan Company estimates the following bad debts percentages: 1-30 days 10% 31-60 days 25% 61-90 days 40% Over 90 days 80% Which of the following is the journal entry necessary to estimate bad debts using the aging method? A) Bad Debts Expense 14,380 Accounts Receivable 14,380 B) Bad Debts Expense 14,380 Allowance for Uncollectible Accounts 14,380 C) Bad Debts Expense 14,980 Allowance for Uncollectible Accounts 14,980 D) Bad Debts Expense 15,580 Allowance for Uncollectible Accounts 15,580 E) Bad Debts Expense 16,180 Allowance for Uncollectible Accounts 16,180 Answer: D Diff: 3 Objective: L.O. 6-3
17) Assume Credit Categories uses the allowance method for bad debts. Credit Categories wrote off the $400 account of P. Miller on February 19, 20X3. On October 8, 20X3 Credit Categories received a check for $400 from P. Miller. Which of the following is(are) the journal entry(ies) that Credit Categories will make on October 8, 20X3? A) Bad Debts Expense 400 Accounts Receivable 400 B) Cash 400 Bad Debts Expense 400 C) Accounts Receivable 400 Allowance for Uncollectible Accounts 400 Cash 400 Accounts Receivable 400 D) Cash 400 Accounts Receivable 400 E) No journal entry is required on October 8, 20X3. Answer: C Diff: 2 Objective: L.O. 6-3
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18) Reporting Standards, Inc. recovered a bad debt from Plodding, Inc. in October 20X3 in the amount of $350 that was previously written off by Reporting Standards, Inc. in November 20X2. Reporting Standards, Inc. utilizes the percentage of sales method to estimate bad debts. What journal entry is required in October 20X3? A) Bad debt expense 350 Allowance for uncollectible accounts 350 B) Allowance for uncollectible accounts 350 Bad debt expense 350 C) Bad debt expense 350 Accounts receivable 350 D) Accounts receivable 350 Allowance for uncollectible accounts 350 E) Accounts receivable 350 Allowance for uncollectible accounts 350 Cash 350 Accounts receivable 350 Answer: E Diff: 2 Objective: L.O. 6-3
19) When an organization sells on credit, it is essentially reducing the risk that a portion of the accounts receivable balance will never be collected. Answer: FALSE Diff: 2 Objective: L.O. 6-3
20) The allowance method has two basic elements: (1) an estimate of the amount of accounts receivable that will ultimately be uncollectible and (2) a contra account that contains the estimate and is deducted from the accounts receivable. Answer: TRUE Diff: 2 Objective: L.O. 6-3
21) A contra asset account is created under the allowance method because of the inability to write down a specific customer's account at the time bad debts expense is recognized. Answer: TRUE Diff: 2 Objective: L.O. 6-3
22) The accounts used in the journal entry for the estimation of bad debts is the same whether a firm uses the percentage of sales, percentage of accounts receivable, or the aging method to estimate bad debts expense. Answer: TRUE Diff: 2 Objective: L.O. 6-3
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23) In the aging of accounts receivable method, one would expect the bad debts percentages to increase as the age of the accounts receivable increases. Answer: TRUE Diff: 1 Objective: L.O. 6-3
24) When bad debts recoveries occur, the write-off should be reversed and the collection handled as a normal receipt on account. Answer: TRUE Diff: 2 Objective: L.O. 6-3
25) The specific write-off method assumes all sales are fully collectible until proved otherwise. Answer: TRUE Diff: 2 Objective: L.O. 6-3
26) Accountants generally do not use the specific write-off method because it violates the matching principle. Answer: TRUE Diff: 1 Objective: L.O. 6-3
27) The Allowance for Uncollectible Accounts may have a debit balance before the adjusting entry is prepared. Answer: TRUE Diff: 2 Objective: L.O. 6-3
28) An aging schedule reveals $6,500 of uncollectible accounts. The Allowance for Uncollectible Accounts currently has a credit balance of $250. The adjusting entry amount should be $6,250. Answer: TRUE Diff: 3 Objective: L.O. 6-3
29) An aging schedule reveals $6,500 of uncollectible accounts. The Allowance for Uncollectible Accounts account currently has a debit balance of $250. The adjusting entry amount should be $6,750. Answer: TRUE Diff: 3 Objective: L.O. 6-3
30) Oxhaven Company has determined that 2% of $50,000 credit sales are uncollectible. The Allowance for Uncollectible Accounts currently has a credit balance of $250. The adjusting entry amount for bad debts should be $1,000. Answer: TRUE Diff: 3 Objective: L.O. 6-3
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31) Morland Company has determined that 2% of $50,000 credit sales are uncollectible. The Allowance for Uncollectible Accounts currently has a debit balance of $250. The adjusting entry for bad debts should be prepared for $1,250. Answer: FALSE Diff: 3 Objective: L.O. 6-3
32) In its first year of operations, 20X2, Flow Crafts, Inc., had credit sales of $420,000 to many different customers. Of this amount, P. Walker purchased $400 and J. Jocke purchased $180 on account. During the year, cash collections of $389,000 were made, of which P. Walker paid $360 and J. Jocke paid $60. At the end of 20X2, bad debts expense was estimated to be 5% of ending accounts receivable. At December 31, 20X2, the Allowance for Uncollectible Accounts is $0. On February 23, 20X3, the balance in J. Jocke's account was written off as uncollectible. Prepare the appropriate journal entry on the books of Flow Crafts, Inc. for a. the $420,000 in credit sales. b. the collection of $389,000 from credit customers. c. the estimation of bad debts expense. d. the write-off of J. Jocke's account. Answer: a. Accounts Receivable 420,000 Sales 420,000 b. Cash 389,000 Accounts Receivable 389,000 c. Bad Debts Expense 1,550 Allowance for Uncollectible Accounts 1,550 d. Allowance for Uncollectible Accounts 120 Accounts Receivable, J. Jocke 120 Diff: 2 Objective: L.O. 6-3
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33) Sequential, Inc. has the following information available as of December 31, 20X3: Total Accounts 1-30 31-60 61-90 Over 90 Receivable Days Days Days Days $60,000 $46,500 $7,400 $3,700 $2,400 Total credit sales for the year ended December 31, 20X3, were $825,000. The balance in the Allowance for Uncollectible Accounts at December 31, 20X3, is a $500 debit. The estimated bad debts percentages are as follows: as a percentage of credit sales 1% as a percentage of ending accounts receivable 10% as a percentage of aging accounts receivable: 1-30 days 3% 31-60 days 15% 61-90 days 35% Over 90 days 75% Given the previous information, prepare the journal entry on December 31, 20X3, to estimate bad debts under the allowance method using the a. percentage of credit sales method. b. percentage of ending accounts receivable method. c. aging of accounts receivable method. Answer: a. Bad Debts Expense 8,250* Allowance for Uncollectible Accounts 8,250 b. Bad Debts Expense 6,500** Allowance for Uncollectible Accounts 6,500 c. Bad Debts Expense 6,100*** Allowance for Uncollectible Accounts 6,100 * **
($825,000 × .01)= $8,250 ($60,000 × .10) = $6,000 ($6,000 + $500) = $6,500 *** ($46,500 × .03) + ($7,400 × .15) + ($3,700 × .35) + ($2,400 × .75) = $5,600 ($5,600 + $500) = $6,100 Diff: 3 Objective: L.O. 6-3
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34) Direct Rentals has many accounts receivable. Direct Rentals' balance sheet as of December 31, 20X2, showed Accounts Receivable of $36,000 and an Allowance for Uncollectible Accounts of $3,400 credit. In early 20X3, write-offs of customer accounts of $2,800 were made. In late 20X3, a customer named Jeremy, whose $1,000 debt had been written off earlier, won a $1 million promotion cash prize. He immediately remitted $1,000 to Direct Rentals. Prepare the journal entries for the a. $2,800 write-off in early 20X3. b. receipt from Jeremy in late 20X3. Answer: a. Allowance for Uncollectible Accounts 2,800 Accounts Receivable 2,800 b. Accounts Receivable 1,000 Allowance for Uncollectible Accounts 1,000 Cash 1,000 Accounts Receivable 1,000 Diff: 2 Objective: L.O. 6-3
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Learning Objective 6.4 Questions 1) Consider the following information: Cash sales Credit sales Beginning Cash Ending Cash Beginning Retained Earnings Ending Retained Earnings Beginning Accounts Receivable Ending Accounts Receivable Net Income
$ 59,000 510,000 18,000 11,500 32,300 41,700 40,000 50,000 64,000
What is the accounts receivable turnover? A) 1.20 B) 2.92 C) 11.33 D) 12.64 E) 13.78 Answer: C Diff: 2 Objective: L.O. 6-4
2) Consider the following information: Cash sales Credit sales Beginning Cash Ending Cash Beginning Retained Earnings Ending Retained Earnings Beginning Accounts Receivable Ending Accounts Receivable Net Income
$ 59,000 510,000 18,000 11,500 32,300 41,700 40,000 50,000 64,000
Assuming a 365-day year, determine the days to collect accounts receivable. A) 304.2 days B) 125.0 days C) 31.9 days D) 32.22 days E) 28.4 days Answer: D Diff: 2 Objective: L.O. 6-4
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3) Why is it difficult to compare accounts receivable turnover across companies? A) companies do not typically differentiate credit sales from total sales B) companies do not typically differentiate net sales from total sales C) companies do not typically differentiate beginning retained earnings from total retained earnings D) it violates SEC regulation to calculate accounts receivable turnover for public companies E) it is not difficult to compare accounts receivable turnover across companies Answer: A Diff: 1 Objective: L.O. 6-4
4) Typically, the more credit sales a company has A) the lower the days to collect accounts receivable B) the higher the days to collect accounts receivable C) the lower the accounts receivable turnover rate D) the higher the accounts receivable yield E) none of the above Answer: B Diff: 2 Objective: L.O. 6-4
5) All else equal, the lower the accounts receivable turnover ratio and the higher the days to collect accounts receivable, the better. Answer: FALSE Diff: 2 Objective: L.O. 6-4
6) The accounts receivable turnover ratio indicates how rapidly customers pay their bills. Answer: TRUE Diff: 1 Objective: L.O. 6-4
7) The days to collect accounts receivable is calculated by dividing credit sales by the average accounts receivable. Answer: FALSE Diff: 1 Objective: L.O. 6-4
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8) Heal of Approval Spa reports the following information for the years ended December 31, 20X2 and 20X3:
Sales Accounts Receivable
20X3 $ 640,000 40,000
20X2 $720,000 60,000
Sales consisted of 80% credit sales and 20% cash sales during 20X2 and 20X3. From the information given previously for Heal of Approval Spa, determine the a. accounts receivable turnover for 20X3. b. days to collect accounts receivable for 20X3. Answer: a. The accounts receivable turnover for 20X3 is (80% × $640,000)/[($40,000 + $60,000)/2] = 10.24 b. The days to collect accounts receivable for 20X3 is 365 days/10.24 = 35.6 days Diff: 2 Objective: L.O. 6-4
Learning Objective 6.5 Questions 1) Heintz Corporation wishes to borrow $83,000 at 11% interest from the local bank. However, the bank requires a compensating balance of 10%. The effective interest rate that Heintz Corporation will pay on the loan is which of the following? A) 10.1% B) 12.2% C) 13.2% D) 16.4% E) 14.1% Answer: B Diff: 2 Objective: L.O. 6-5
2) Which of the following is not a procedure used to safeguard cash? A) The serial numbers on the money are recorded and maintained. B) The individuals who receive cash do not also disburse cash. C) The individuals who handle cash do not have access to the accounting records. D) Cash receipts are immediately recorded and deposited and are not used directly to make payments. E) Disbursements are made by serially numbered checks and only upon proper authorization by someone other than the person writing the check. Answer: A Diff: 1 Objective: L.O. 6-5
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3) Internal controls are often implemented to guard against theft of cash. To conceal the theft of $1,500 cash, which journal entry might an accountant perform to best conceal the theft? A) Cash $1,500 Inventory $1,500 B) Petty Cash $1,500 Cash $1,500 C) Wage and Salary Expense $1,500 Cash $1,500 D) Cash $1,500 Wage and Salary Expense $1,500 E) Accounts Receivable $1,500 Cash $1,500 Answer: C Diff: 2 Objective: L.O. 6-5
4) Office Supply Space has several assets on its balance sheet. The accountant is trying to decipher which assets belong in the Cash account. From the list of assets below, which asset should NOT be included in the Cash account? A) Checks made payable to Office Supply Space B) Money orders made payable to Office Supply Space C) The company's savings account D) U.S. Treasury bond with a 5 year maturity E) The company's checking account Answer: D Diff: 2 Objective: L.O. 6-5
5) A compensating balance is the required minimum cash balance on deposit when money is borrowed from the bank. Answer: TRUE Diff: 1 Objective: L.O. 6-5
6) Cash equivalents are highly liquid long-term investments that can easily be converted into cash. Answer: FALSE Diff: 1 Objective: L.O. 6-5
7) Deposits in the bank are assets to the depositor but they are liabilities to the bank. Answer: TRUE Diff: 1 Objective: L.O. 6-5
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8) Name four internal controls specific to the cash account. Answer: Four internal controls specific to the cash account include the following: 1. The receipt and disbursement of cash should be separated. 2. All receipts should be deposited intact every day. 3. All major cash disbursements should be made by serially numbered checks and require proper authorization. 4. Bank accounts should be reconciled monthly. 5. Different individuals should handle cash and have access to the accounting records. Diff: 2 Objective: L.O. 6-5
Learning Objective 6.6 Questions 1) Good accounting controls A) include all methods and procedures that facilitate management's planning and control of operations. B) help maximize efficiency and minimize waste, unintentional errors, and fraud. C) are not concerned with the accuracy of the financial records. D) are not concerned with safeguarding assets. E) All of the above statements are true concerning accounting controls. Answer: B Diff: 2 Objective: L.O. 6-6
2) Which statement is FALSE? A) Administrative controls consider the organization plan. B) Accounting controls include procedures that facilitate management's planning and control of operations. C) Accounting controls include the methods and procedures for authorizing transactions and safeguarding assets. D) Accounting controls are present to ensure the accuracy of the financial records. E) Accounting controls minimize waste, errors, and fraud within an organization. Answer: B Diff: 2 Objective: L.O. 6-6
3) The internal accounting control that provides reasonable assurance that all authorized transactions are recorded in the correct amounts, periods, and accounts is A) authorization. B) recording. C) safeguarding. D) reconciliation. E) valuation. Answer: B Diff: 1 Objective: L.O. 6-6
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4) Which of the following internal accounting control objectives relate to establishing the system of accountability and are aimed at the prevention of errors and irregularities? 1. Authorization 2. Promoting operating efficiency 3. Reconciliation 4. Recording 5. Safeguarding 6. Valuation A) 3 and 4 B) 4 and 5 C) 1, 3, and 4 D) 1, 4, and 5 E) 2, 3, and 5 Answer: D Diff: 2 Objective: L.O. 6-6
5) Which of the following statements describes the Sarbanes-Oxley required attributes of a management report? A) A management report usually includes a statement on the adequacy of internal controls. B) A management report includes information with respect to management's compensation, including the salaries and bonuses received by the top executives of the company. C) A management report lists the executives of the company and states what changes have been made in management personnel since the prior period and why those changes were made. D) A management report states how well or poorly the company performed during the most recent period. E) A management report states the acquisitions and divestitures that a company has made during the current period. Answer: A Diff: 2 Objective: L.O. 6-6
6) Which of the following is NOT a typical attribute of an audit committee? A) Audit committees are being used more and more throughout the world. B) The audit committee is employed by the external auditors. C) Audit committees are comprised solely of outside board members. D) Audit committees act as a liaison among the full board of directors, internal auditors, external auditors, and management. E) The audit committee oversees the internal accounting controls, financial statements and financial affairs of a corporation. Answer: B Diff: 3 Objective: L.O. 6-6
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7) Which of the following items from the checklist of internal control is most important? A) Proper authorization B) Separation of duties C) Honest, reliable personnel D) Adequate documents E) Physical safeguards Answer: C Diff: 1 Objective: L.O. 6-6
8) The primary goal of the separation of duties is A) to provide greater training to employees by allowing them to work on different tasks. B) to make sure that one person, acting alone, cannot defraud the company. C) to ensure that no one in management accumulates too much organizational power and control. D) to provide clear promotion tracks within one's discipline. E) to provide a work environment where no one person is overloaded with work or does so many things that he or she becomes indispensable to the company. Answer: B Diff: 1 Objective: L.O. 6-6
9) A policy stating that the board of directors must approve all expenditures for capital assets in excess of $50,000 is an example of A) specific authorization. B) general authorization. C) adequate documentation. D) proper procedures. E) an independent check. Answer: A Diff: 2 Objective: L.O. 6-6
10) A policy that forces clerks to make change by pricing items at $1.99, $2.99, and $3.99 rather than at $2, $3, and $4 is an example of A) adequate documentation. B) general authorization. C) specific authorization. D) proper procedures. E) an independent check. Answer: A Diff: 2 Objective: L.O. 6-6
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11) A policy that requires organizations to use procedures manuals to specify the flow of documents and provide information and instructions to facilitate adequate record-keeping is an example of A) adequate documentation. B) general authorization. C) specific authorization. D) proper procedures. E) an independent check. Answer: D Diff: 2 Objective: L.O. 6-6
12) Which of the following tasks is not commonly performed by an external auditor? A) External auditors examine transactions, but the number examined is dependent on the strength or weakness of the internal control system. B) External auditors evaluate the system of internal controls. C) External auditors test whether the internal control system is being followed. D) External auditors assume responsibility for the total accuracy of the financial statements. E) External auditors inspect a sample of the transactions that are entered into the records of a company. Answer: D Diff: 2 Objective: L.O. 6-6
13) Internal accounting controls include administrative, financial statement, and accounting controls. Answer: FALSE Diff: 1 Objective: L.O. 6-6
14) Accounting controls include the methods and procedures for authorizing transactions, safeguarding assets, and ensuring the accuracy of the financial records. Answer: TRUE Diff: 1 Objective: L.O. 6-6
15) Since auditors provide an opinion as to the fairness of the financial statements, auditors have the primary responsibility for the preparation of the company's financial statements. Answer: FALSE Diff: 1 Objective: L.O. 6-6
16) Audit committees perform the internal audits of a company. Answer: FALSE Diff: 2 Objective: L.O. 6-6
17) The most important element of internal control is reliable personnel with clear responsibilities. Answer: TRUE Diff: 1 Objective: L.O. 6-6
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18) A main goal of the separation of duties is to make sure that one person, acting alone, cannot defraud the company. Answer: TRUE Diff: 1 Objective: L.O. 6-6
19) The goal of the internal control that calls for adequate documentation is the immediate, complete, and tamper-proof recording of all transactions. Answer: TRUE Diff: 2 Objective: L.O. 6-6
20) Wells, Inc., manufactures lawn mowers. Materials are purchased by the purchasing agent from information sent to him by the line manager. The line manager details how much to purchase as well as whom to purchase the materials from. When materials arrive at the factory, they are sent immediately to the stockroom without warehouse personnel checking on quantity or quality of the goods. Invoices are received by the accounts payable department, which compares the invoice to the purchase order. If the documents agree, payment is generated in the accounts payable department and sent to the vendor. Propose improvements in the internal control procedures for Wells, Inc. Answer: 1. All materials should be counted and quality checked to ensure the correct number of materials have been received and that faulty materials are sent back to the vendor. A receiving report should be prepared by the warehouse personnel. 2. Vendors should be chosen by the purchasing department using an approved vendor list. 3. The invoice should be compared to the receiving report as well as the purchase order to verify that invoices are paid to materials actually received, not materials ordered. 4. Checks should be prepared by the treasurer's department. Diff: 2 Objective: L.O. 6-6
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Learning Objective 6.7 Questions 1) The following represent common reconciling items within a bank reconciliation: 1. Bank service charges 2. Deposits in transit 3. Outstanding checks Which of the above items will be an adjustment to the balance per books? A) 1 only B) 2 only C) 3 only D) 1 and 2 E) 2 and 3 Answer: A Diff: 2 Objective: L.O. 6-7
2) In a bank reconciliation, company errors are adjustments to ________. Bank errors are adjustments to ________. A) balance per bank; balance per bank B) balance per company; balance per company C) balance per bank; balance per company D) balance per company; balance per bank E) balance per company; balance per IRS Answer: D Diff: 2 Objective: L.O. 6-7
3) The bank reconciliation is A) only required when a company suspects fraud. B) supplied as a bank courtesy. C) needed because the IRS requires it for cash-basis companies. D) an important part of internal control. E) usually reported in a company footnote. Answer: D Diff: 2 Objective: L.O. 6-7
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4) Novak Industries had a check returned to it labeled "NSF." What journal entry should Novak Industries make to recognize the $200 NSF check? A) Accounts receivable 200 Service charges 200 B) Bad debt expense 200 Accounts receivable 200 C) Accounts receivable 200 Bad debt expense 200 D) Allowance for uncollectible accounts 200 Accounts receivable 200 E) Accounts receivable 200 Cash 200 Answer: E Diff: 3 Objective: L.O. 6-7
5) Deposits in transit are added to the balance per books when preparing a bank reconciliation. Answer: FALSE Diff: 1 Objective: L.O. 6-7
6) Outstanding checks should be added to the balance per bank when preparing a bank reconciliation. Answer: FALSE Diff: 2 Objective: L.O. 6-7
7) Bank service charges not recorded on the books should be added to the balance per books when preparing a bank reconciliation. Answer: FALSE Diff: 2 Objective: L.O. 6-7
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8) The following information is associated with the bank reconciliation of Tall Hills Ski Resort as of October 31, 20X4: Balance per bank Balance per books Bank service charge Deposits in transit NSF check from a credit customer Outstanding checks
$ 956 538 31 108 57 614
a. Prepare a bank reconciliation for Tall Hills Ski Resort dated October 31, 20X4. b. Prepare the adjusting entries needed by Tall Hills Ski Resort as a result of the bank reconciliation. Answer: a. Balance per books $ 538 Balance per bank $ 956 Less: bank service charge (31) Add: deposits in transit 108 Less: NSF check (57) Less: outstanding checks (614) Adjusted balance per books $ 450 Adjusted balance per bank $ 450 b. Bank Service Charge Expense Cash Accounts Receivable Cash
31 31 57 57
Diff: 2 Objective: L.O. 6-7
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9) Corbin Catering prepares monthly bank reconciliations of its checking account balance. The bank statement received by Corbin Catering for February 20X9 follows: Corbin Catering 54 Windsong Drive BANK STATEMENT
First Fifth Bank PO Box 22 DATE OF STATEMENT: February 28, 20X9 Credit
Balance, February 1, 20X9 Interest earned Service charge Account collected on behalf of Corbin Checks: #310 #312 #313 #314 #316 #317 Deposits: February 15, 20X9
Debit $ 29,500
$100 $40 1,600 120 260 180 215 80 110 5,000
Ending Balance -----------------------------------------------------------------------------Corbin Catering's books disclosed the following additional information: -----------------------------------------------------------------------------Checking account balance, February 1, 20X9 $ 29,500 Checks written: #310 $120 #311 40 #312 260 #313 180 #314 215 #315 200 #316 80 #317 110 Deposits: February 15, 20X9 $5,000 February 28, 20X9 2,500 Ending balance $35,795 ------------------------------------------------------------------------------Required: Prepare a bank reconciliation for Corbin Catering at February 28, 20X9.
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$ 35,195
Answer:
Corbin Catering Bank Reconciliation February 28, 20X9
Balance per bank Add: Deposit in transit Less: Outstanding checks #311 #315 Adjusted balance per bank
$35,195 2,500
Balance per books Add: interest earned Add: Account collected by bank Less: service charges Adjusted balance per books
$35,795 100 1,600 (40) $37,455
(40) (200) $37,455
Diff: 3 Objective: L.O. 6-7
10) When and why are adjustments made to the books after the reconciliation of the bank account? Answer: Adjustments occur when items are entered by the bank and not entered on the books. The adjustments are prepared as journal entries so that the books have the exact balance as the adjusted bank balance. The adjusting entries are prepared after the bank reconciliation is prepared. Diff: 2 Objective: L.O. 6-7
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Introduction to Financial Accounting, 11e (Horngren) Chapter 7 Inventories and Cost of Goods Sold Learning Objective 7.1 Questions 1) Given the following data, what is cost of goods sold? Sales revenue $730,000 Beginning inventory 80,000 Ending inventory 95,000 Purchases of inventory 160,000 A) $585,000 B) $145,000 C) $570,000 D) $175,000 E) $555,000 Answer: B Diff: 2 Objective: L.O. 7-1
2) Given the following data, what is cost of goods sold? Sales revenue $10,000 Beginning inventory 3,000 Ending inventory 7,000 Purchases of inventory 5,000 A) $12,000 B) $ 9,000 C) $ 8,000 D) $ 7,000 E) $ 1,000 Answer: E Diff: 2 Objective: L.O. 7-1
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3) Given the following information, determine the gross profit. Accounts Receivable $ 14,000 Administrative Expenses 31,000 Cost of Goods Sold 142,000 Depreciation Expense 8,000 Income Tax Expense 4,000 Inventory 26,000 Sales 312,000 Selling Expenses 36,000 Wage Expense 75,000 A) $20,000 B) $ 16,000 C) $ 184,000 D) $156,000 E) $170,000 Answer: E Diff: 1 Objective: L.O. 7-1
4) When comparing two companies with regard to profitability, it is not important to distinguish differences arising from accounting practices from differences caused by real economic conditions. Answer: FALSE Diff: 2 Objective: L.O. 7-1
5) The cost of goods available for sale is determined by taking the cost of inventory purchased during the year combined with the cost of goods sold. Answer: FALSE Diff: 2 Objective: L.O. 7-1
6) Inventory valuation is linked to gross profit because the inventory valuation involves allocating the cost of goods available for sale between cost of goods sold and ending inventory as of the balance sheet date. Answer: TRUE Diff: 1 Objective: L.O. 7-1
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7) Galvanized Piping purchased 80 pumps during the month of March, 20X9. When the company purchased the pumps, they had 10 pumps in inventory. At the end of March, 20X9, Galvanized Piping had 50 pumps left in inventory. Pumps have been purchased from Costfo Warehouse for $2.50 per pump since Galvanized Piping began operations in January, 20X9. Required: 1) Calculate the cost valuation for ending inventory. 2) Calculate cost of goods sold. Answer: 1) Ending inventory: 50 pumps × $2.50 each = $125.00 2) Cost of goods sold: 10 units (beginning inventory) + 80 units (purchased) - 50 units (ending inventory) = 40 units sold × $2.50 per unit = $100 Diff: 3 Objective: L.O. 7-1
Learning Objective 7.2 Questions 1) The calculation of cost of goods sold under the periodic system is A) beginning inventory + purchases. B) beginning inventory + ending inventory - purchases. C) beginning inventory + ending inventory + purchases. D) beginning inventory + purchases - ending inventory. E) ending inventory + purchases - beginning inventory. Answer: D Diff: 2 Objective: L.O. 7-2
2) Which of the following statements is FALSE? A) Historically, the periodic system has been associated with low volume, high value items. B) Historically, the perpetual system has been considered more expensive and cumbersome to maintain. C) The perpetual system is better able to aid management in pricing and ordering inventory. D) Computerized inventory systems and optical scanning equipment are examples of ways to implement a perpetual inventory system. E) The perpetual inventory system is more likely than the periodic inventory system to isolate inventory shrinkage due to breakage, loss, or theft. Answer: A Diff: 2 Objective: L.O. 7-2
3) A perpetual inventory system offers all of the following characteristics except: A) it is less expensive than a periodic system. B) inventory balances are always current. C) it helps salespeople determine whether there is a sufficient supply on hand to fill the customer orders. D) it enhances internal control. E) All of the above are characteristics of a perpetual inventory system. Answer: A Diff: 2 Objective: L.O. 7-2
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4) If a company uses a perpetual inventory system, it will maintain all the following accounts except: A) cost of goods sold. B) inventory. C) sales. D) purchases. E) All of the above accounts are used with a perpetual inventory system. Answer: D Diff: 2 Objective: L.O. 7-2
5) In a periodic inventory system the quantity of ending inventory is determined by A) subtracting units sold from units purchased. B) a physical inventory count. C) looking at the balance in the inventory account. D) subtracting cost of goods sold from the beginning inventory balance. E) adding units sold to the beginning inventory balance. Answer: B Diff: 2 Objective: L.O. 7-2
6) If a company is using a periodic inventory system, the balance in its inventory account three-quarters of the way through an accounting period would be equal to the A) amount of inventory on hand at that date. B) inventory on hand at the beginning of the period. C) total of the beginning inventory plus goods purchased during the accounting period. D) amount of goods purchased during the period. E) inventory on hand at the beginning of the period multiplied by 75%. Answer: B Diff: 3 Objective: L.O. 7-2
7) The journal entry to purchase merchandise under a periodic inventory system includes a debit to A) Cost of Goods Sold. B) Inventory. C) Purchases. D) Accounts Receivable. E) Accounts Payable. Answer: C Diff: 2 Objective: L.O. 7-2
8) The journal entry to sell merchandise on account under a periodic inventory system includes a A) debit to Cost of Goods Sold. B) debit to Inventory. C) credit to Purchases. D) credit to Sales. E) credit to Accounts Receivable. Answer: D Diff: 2 Objective: L.O. 7-2
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9) If a company using a periodic inventory system has beginning inventory of 15 units, purchases an additional 40 units, has ending inventory of 10 units, and sells 45 units, what is the company's number of units available for sale? A) 55 units B) 45 units C) 65 units D) 60 units E) 15 units Answer: A Diff: 2 Objective: L.O. 7-2
10) In regards to physical inventory counts and valuations, it is not unusual A) to use inventory counts to be able to journalize sales. B) for firms to choose fiscal accounting periods to end when inventory levels are high. C) to count inventory when inventory levels are high. D) to count inventory twice per week. E) for external auditors to use experts. Answer: E Diff: 2 Objective: L.O. 7-2
11) The two main types of inventory systems are the periodic system and the gross margin method. Answer: FALSE Diff: 1 Objective: L.O. 7-2
12) Under a periodic inventory system, a business maintains a continual record of inventory on hand. Answer: FALSE Diff: 1 Objective: L.O. 7-2
13) When using a perpetual inventory system, a business will debit inventory and credit cost of goods sold each time a sale is recorded. Answer: FALSE Diff: 2 Objective: L.O. 7-2
14) Under a periodic inventory system, cost of goods available for sale is ending inventory plus purchases. Answer: FALSE Diff: 2 Objective: L.O. 7-2
15) A physical inventory count is required under both the perpetual and periodic inventory systems. Answer: TRUE Diff: 2 Objective: L.O. 7-2
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16) Historically, periodic inventory systems have been used for low value, high volume items, whereas the perpetual inventory system has been used for high value, low volume items. Answer: TRUE Diff: 2 Objective: L.O. 7-2
Learning Objective 7.3 Questions 1) In a transaction where the merchandise invoice indicates F.O.B. shipping point, who pays the cost of shipping? A) The buyer B) The seller C) The common carrier D) The freight forwarder E) None of the above Answer: A Diff: 2 Objective: L.O. 7-3
2) On March 1, 20X3, Environmental Impacts acquired inventory on account. The cost of the inventory was $85,000. The terms of the purchase were 2/10, n/30. Upon inspection of the inventory on March 2, $4,800 worth of inventory was returned. Environmental Impacts paid for the inventory on March 8. The company uses a periodic inventory system. What journal entry will Environmental Impacts make on March 1, 20X3? A) Inventory 83,300 Accounts Payable 83,300 B) Inventory 85,000 Accounts Payable 85,000 C) Inventory 85,000 Cash Discounts on Purchases 1,700 Accounts Payable 83,300 D) Purchases 85,000 Accounts Payable 85,000 E) Purchases 85,000 Cash Discounts on Purchases 1,700 Accounts Payable 83,300 Answer: D Diff: 2 Objective: L.O. 7-3
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3) On March 1, 20X3, Environmental Impacts acquired inventory on account. The cost of the inventory was $85,000. The terms of the purchase were 2/10, n/30. Upon inspection of the inventory on March 2, $4,800 worth of inventory was returned. Environmental Impacts paid for the inventory on March 8. The company uses a periodic inventory system. What journal entry will Environmental Impacts make on March 2, 20X3? A) Accounts Payable 4,704 Inventory 4,704 B) Accounts Payable 4,800 Inventory 4,800 C) Accounts Payable 4,800 Purchases 4,800 D) Accounts Payable 4,800 Purchase Returns and Allowances 4,800 E) Accounts Payable 4,704 Cash Discounts on Purchases 96 Purchase Returns and Allowances 4,800 Answer: D Diff: 2 Objective: L.O. 7-3
4) On March 1, 20X3, Environmental Impacts acquired inventory on account. The cost of the inventory was $85,000. The terms of the purchase were 2/10, n/30. Upon inspection of the inventory on March 2, $4,800 worth of inventory was returned. Environmental Impacts paid for the inventory on March 8. The company uses a periodic inventory system. What journal entry will Environmental Impacts make on March 8, 20X3? A) Accounts Payable 80,200 Cash 80,200 B) Accounts Payable 80,200 Cash Discounts on Purchases 1,604 Cash 78,596 C) Accounts Payable 80,200 Cash Discounts on Purchases 802 Cash 79,398 D) Accounts Payable 80,200 Inventory 1,604 Cash 78,596 E) Accounts Payable 80,200 Purchases 1,604 Cash 78,596 Answer: B Diff: 2 Objective: L.O. 7-3
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5) Which of the following statements is incorrect? A) Both freight-in and freight-out affect gross profit. B) Freight-in appears as part of cost of goods sold under the periodic inventory system. C) Freight-out is a shipping expense. D) Freight-in for the purchaser occurs when the terms of the invoice are FOB shipping point. E) When the seller bears the shipping cost, the invoice is stated as FOB destination. Answer: A Diff: 2 Objective: L.O. 7-3
6) Which of the following statements is correct? A) The perpetual inventory system uses a separate account for Purchase Returns and Allowances. B) The periodic inventory system continually updates the Inventory and Cost of Goods Sold accounts. C) The perpetual inventory system requires a closing entry in order to determine Cost of Goods Sold. D) The Purchases account is used under both the periodic and perpetual inventory systems. E) Under the periodic inventory system, neither the Cost of Goods Sold account nor the Inventory account is updated on a daily basis. Answer: E Diff: 2 Objective: L.O. 7-3
7) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using the perpetual inventory system, what is the journal entry for May 2? A) Inventory 5,000 Accounts Payable 5,000 B) Purchases 4,900 Accounts Payable 4,900 C) Purchases 5,000 Accounts Payable 5,000 D) Inventory 4,900 Cash Discounts on Purchases 100 Accounts Payable 5,000 E) Purchases 4,900 Cash Discounts on Purchases 100 Accounts Payable 5,000 Answer: A Diff: 2 Objective: L.O. 7-3
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8) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses Inc. were using the periodic inventory system, what is the journal entry for May 2? A) Inventory 4,900 Accounts Payable 4,900 B) Inventory 5,000 Accounts Payable 5,000 C) Purchases 5,000 Accounts Payable 5,000 D) Inventory 4,900 Cash Discounts on Purchases 100 Accounts Payable 5,000 E) Purchases 4,900 Cash Discounts on Purchases 100 Accounts Payable 5,000 Answer: C Diff: 2 Objective: L.O. 7-3
9) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using the perpetual inventory system, what is the journal entry for May 3? A) Accounts Payable 1,000 Inventory 1,000 B) Accounts Payable 1,000 Purchases 1,000 C) Accounts Payable 1,000 Purchase Returns and Allowances 1,000 D) Accounts Payable 1,000 Cash Discounts on Purchases 20 Inventory 980 E) Accounts Payable 1,000 Cash Discounts on Purchases 20 Purchases 980 Answer: A Diff: 2 Objective: L.O. 7-3
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10) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using the periodic inventory system, what is the journal entry on May 3? A) Accounts Payable 1,000 Inventory 1,000 B) Accounts Payable 1,000 Purchases 1,000 C) Accounts Payable 1,000 Purchase Returns and Allowances 1,000 D) Accounts Payable 1,000 Cash Discounts on Purchases 20 Inventory 980 E) Accounts Payable 1,000 Cash Discounts on Purchases 20 Purchases 980 Answer: C Diff: 2 Objective: L.O. 7-3
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11) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using the perpetual inventory system, what is the journal entry for May 9? A) Accounts Payable 4,000 Inventory 100 Cash 3,900 B) Accounts Payable 4,000 Inventory 80 Cash 3,920 C) Accounts Payable 5,000 Inventory 100 Cash 4,900 D) Accounts Payable 4,000 Cash Discounts on Purchases 100 Cash 3,900 E) Accounts Payable 4,000 Cash Discounts on Purchases 80 Cash 3,920 Answer: B Diff: 2 Objective: L.O. 7-3
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12) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using the periodic inventory system, what is the journal entry for May 9? A) Accounts Payable 4,000 Inventory 100 Cash 3,900 B) Accounts Payable 4,000 Inventory 80 Cash 3,920 C) Accounts Payable 5,000 Inventory 100 Cash 4,900 D) Accounts Payable 4,000 Cash Discounts on Purchases 100 Cash 3,900 E) Accounts Payable 4,000 Cash Discounts on Purchases 80 Cash 3,920 Answer: E Diff: 2 Objective: L.O. 7-3
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13) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using a perpetual inventory system, what is the journal entry for May 15? A) Accounts Receivable 3,800 Sales 3,800 B) Accounts Receivable 3,800 Sales 3,800 Cost of Goods Sold 2,134 Cash Discounts on Sales 66 Inventory 2,200 C) Accounts Receivable 3,800 Sales 3,800 Cost of Goods Sold 2,200 Inventory 2,200 D) Accounts Receivable 3,686 Cash Discount on Sales 114 Sales 3,800 E) Accounts Receivable 3,686 Cash Discount on Sales 114 Sales 3,800 Cost of Goods Sold 2,200 Inventory 2,200 Answer: C Diff: 2 Objective: L.O. 7-3
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14) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using a periodic inventory system, what is the journal entry on May 15? A) Accounts Receivable 3,800 Sales 3,800 B) Accounts Receivable 3,800 Sales 3,800 Cost of Goods Sold 2,134 Cash Discounts on Sales 66 Inventory 2,200 C) Accounts Receivable 3,800 Sales 3,800 Cost of Goods Sold 2,200 Inventory 2,200 D) Accounts Receivable 3,686 Cash Discount on Sales 114 Sales 3,800 E) Accounts Receivable 3,686 Cash Discount on Sales 114 Sales 3,800 Cost of Goods Sold 2,200 Inventory 2,200 Answer: A Diff: 2 Objective: L.O. 7-3
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15) Queen Mattresses, Inc. had the following transactions occur during May 20X3. Assume there is no beginning inventory. May 2 Inventory was purchased on account for $5,000, terms 2/10, n/30. May 3 Inventory costing $1,000 was returned. May 9 Paid for the inventory. May 15 Inventory costing $2,200 was sold on account for $3,800, terms 3/10, n/45. May 31 Closing entries are prepared for the month-end financial statements. If Queen Mattresses, Inc. were using a periodic inventory system, what is the journal entry to close sales on May 31? A) Sales 3,800 Cost of Goods Sold 3,800 B) Cost of Goods Sold 3,800 Sales 3,800 C) Income Summary 3,800 Sales 3,800 D) Sales 3,800 Income Summary 3,800 E) No entry is necessary on a monthly basis. Answer: D Diff: 2 Objective: L.O. 7-3
16) At the year-end, the perpetual inventory system of Horran Company indicated an ending inventory level of 190 units at a cost of $5 each. A physical count performed at year-end resulted in 184 units being on hand at a cost of $5 each. What journal entry, if any, is necessary at year-end? A) No journal entry is necessary. B) Inventory Shrinkage Expense 30 Inventory 30 C) Cost of Goods Sold 30 Inventory Shrinkage Expense 30 D) Inventory Shrinkage Expense 30 Cost of Goods Sold 30 E) Inventory 30 Cost of Goods Sold 30 Answer: B Diff: 2 Objective: L.O. 7-3
17) When the seller bears the cost of shipping, the sales invoice is stated as FOB destination. When the buyer bears the cost of shipping, the sales invoice is stated as FOB shipping point. Answer: TRUE Diff: 2 Objective: L.O. 7-3
18) The purchaser bears the transportation cost when the terms are FOB destination. Answer: FALSE Diff: 1 Objective: L.O. 7-3
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19) Under the periodic inventory system, freight-in is an additional part of cost of goods sold. Answer: TRUE Diff: 1 Objective: L.O. 7-3
20) Inventory Shrinkage Expense decreases cost of goods sold. Answer: FALSE Diff: 1 Objective: L.O. 7-3
21) The cost of merchandise acquired is the invoice price of the goods plus directly identifiable inbound transportation costs less any cash or quantity discounts and less any returns or allowances. Answer: TRUE Diff: 2 Objective: L.O. 7-3
22) Silver Line Transportation purchased inventory on account for $20,000 on April 2, 20X3. They use a periodic inventory system. The terms of the purchase were 3/10, n/45. Shipping was $800, FOB destination. On April 4, the inventory was inspected, and it was discovered that some was damaged. The seller granted Silver Line Transportation a $600 allowance. On April 11, Silver Line Transportation paid the appropriate amount. Prepare the journal entries for each of the events noted above. Answer: Apr 2 Purchases 20,000 Accounts Payable 20,000 Apr 4 Accounts Payable 600 Purchase Returns and Allowances 600 Apr 11 Accounts Payable 19,400 Cash Discounts on Purchases 582 Cash 18,818 Diff: 2 Objective: L.O. 7-3
23) Dexter Warehouse had inventory of $200 on June 1. The company had the following transactions during June. June 2 Purchased inventory on account for $2,000, terms 2/10, n/30. June 3 Returned $350 worth of inventory from the June 2 purchase. June 9 Paid the appropriate amount for the inventory purchased on June 2. Prepare the appropriate journal entry for each of the above transactions assuming Dexter Warehouse uses a perpetual inventory system. Answer: June 2 Inventory 2,000 Accounts Payable 2,000 June 3 Accounts Payable 350 Inventory 350 June 9 Accounts Payable 1,650 Inventory 33 Cash 1,617 Diff: 2 Objective: L.O. 7-3
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24) Morrill Manufacturing had inventory of $350 on March 1. The company had the following transactions during March. March 2 Purchased inventory on account for $1,800, terms 2/10, n/30. March 3 Returned $150 worth of inventory from the Mar. 2 purchase. March 9 Paid the appropriate amount for the inventory purchased on Mar. 2. March 17 Sold inventory costing $1,000 for $1,920 in cash. March 28 Prepared closing entries for the month (prepare entries only for sales and cost of goods sold) Prepare the appropriate journal entry for each of the above transactions assuming Morrill Manufacturing uses the perpetual inventory method. Answer: March 2 Inventory 1,800 Accounts Payable 1,800 March 3 Accounts Payable 150 Inventory 150 March 9 Accounts Payable 1,650 Inventory 33 Cash 1,617 March 17 Cash 1,920 Sales 1,920 Cost of Goods Sold 1,000 Inventory 1,000 March 28 Sales 1,920 Income Summary 1,920 Income Summary 1,000 Cost of Goods Sold 1,000 Diff: 2 Objective: L.O. 7-3
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25) Fill in the appropriate blank figures in the income statement below. Gross sales $7,500 Sales returns and allowances A Less: Cash discounts on sales 250 B _______________________ Cost of goods sold Inventory, January 1, 2X10 200 Purchases (gross) $3,210 C _______________________ 275 Less: Cash discounts on purchases 280 Net Purchases D Add: Freight In 50 Total cost of merchandise acquired 2,705 Cost of goods available for sale 2,905 Inventory, December 31, 2X10 280 Cost of goods sold Gross Profit Answer: A $150 ($7,500 - $7,100 - $250 = $150) B Net Sales C Less: Purchase returns and allowances D $2,655 ($3,210 - $275 - $280) E $2,625 ($2,905 - $280) F $4,475 ($7,100 - $2,625)
$7,100
E $F
Diff: 2 Objective: L.O. 7-3
26) Polltok Pools & Spas had cost of goods sold for July, 20X3 totaling $670,000. Purchase Discounts used by Polltok Pools & Spas totaled $4,500 and discounts used by customers totaled $3,000. Sales returns were $2,000 while purchase returns were $ 3,800. Total purchases amounted to $700,000. The inventory balance on July 1, 20X3 was $ 70,000. The company uses the periodic inventory system. Determine Polltok Pools & Spas' ending inventory. Answer: $91,700 Ending inventory = Beginning inventory + Purchases - Purchase returns - Cash Discounts on Purchases - Cost of goods sold = $70,000 + $700,000 - $3,800 - $4,500 - $670,000 = $91,700 Diff: 2 Objective: L.O. 7-3
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27) Color Images, Inc. started March 1, 20X3 with an inventory balance of 20 pieces of lumber originally purchased for $2.00 per piece. During the month, the company purchased 100 pieces of lumber for $2.00 per piece for cash and sold 50 pieces of lumber on account to one contractor for $5.00 per piece. At the end of March, 20X3, Color Images, Inc. conducted a physical inventory of its lumber and accounted for 66 pieces of lumber. The company uses a perpetual inventory system. Make the necessary journal entries for the month of March, 20X3. Answer: Purchase: Inventory 200 Cash 200 Sale: Accounts Receivable 250 Sales Revenue 250 Cost of Goods Sold 100 Inventory 100 Shrinkage: Inventory Shrinkage Expense Inventory
8 8
Diff: 2 Objective: L.O. 7-3
Learning Objective 7.4 Questions 1) Using the LIFO method, the earliest purchases of inventory are assumed to be contained A) on the balance sheet as part of ending inventory. B) on the income statement as part of cost of goods sold. C) equally split between the income statement and the balance sheet. D) Impossible to determine from the given data E) The earliest purchases of inventory under LIFO are not shown on any financial statement. Answer: A Diff: 2 Objective: L.O. 7-4
2) Using the FIFO method, the earliest purchases of inventory are assumed to be contained A) on the balance sheet as part of ending inventory. B) on the income statement as part of cost of goods sold. C) equally split between the income statement and the balance sheet. D) Impossible to determine from the given data E) The earliest purchases of inventory under FIFO are not shown on any financial statement. Answer: B Diff: 2 Objective: L.O. 7-4
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3) Which of the following inventory methods physically links the particular items sold with the actual cost of goods sold for the items sold? A) FIFO B) LIFO C) Weighted-average D) Specific identification E) FIFO and LIFO Answer: D Diff: 2 Objective: L.O. 7-4
4) When inventory prices are rising, all of the following are reasons for choosing the LIFO method versus the FIFO method except: A) LIFO generally results in lower income taxes paid. B) LIFO uses more current costs in calculating cost of goods sold. C) LIFO permits management to influence income by the timing of inventory purchases. D) LIFO reports the most up-to-date inventory values on the balance sheet. E) None of the above is correct. Answer: D Diff: 2 Objective: L.O. 7-4
5) When inventory prices are rising, the ending inventory balance reported on a LIFO basis is generally A) lower than on a FIFO basis. B) equal to a FIFO basis. C) greater than on a FIFO basis. D) equal to a weighted-average basis. E) greater than a weighted-average basis. Answer: A Diff: 3 Objective: L.O. 7-4
6) When inventory prices are rising, the FIFO method will generally yield a gross profit that is A) less than the LIFO method. B) equal to the gross profit of the LIFO method. C) FIFO does not generally cause a gross profit that is different from that of any other costing method. D) higher than the LIFO method. E) All of the above are correct. Answer: D Diff: 3 Objective: L.O. 7-4
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7) Assuming inflation, if a company wanted to maximize net income, it would select which of the following inventory valuation methods? A) FIFO B) LIFO C) Weighted-average D) The selection of an inventory valuation method does not affect the net income. E) Specific identification Answer: A Diff: 3 Objective: L.O. 7-4
8) Which of the following statements best describes how management selects an inventory valuation method? A) If a company generally sells its oldest inventory first, it must use the FIFO inventory valuation method. B) If a company generally sells its oldest inventory first, it must use the LIFO inventory valuation method. C) If a company generally sells its newest inventory first, it must use the FIFO inventory valuation method. D) If a company sometimes sells its newest inventory and sometimes sells its oldest inventory, then it must use the weighted average inventory valuation method. E) A company may choose any inventory valuation method even if it is contradictory to the physical flow of inventory. Answer: E Diff: 2 Objective: L.O. 7-4
9) Assuming inflation, which of the following relationships among inventory valuation methods is incorrectly stated? A) FIFO has a higher ending inventory balance and a higher net income than LIFO. B) FIFO has a higher ending inventory balance and a higher net income than weighted-average. C) LIFO has a higher ending inventory balance and a higher net income than weighted-average. D) Weighted-average has a higher ending inventory balance and a lower cost of goods sold than LIFO. E) LIFO has a lower ending inventory balance and a higher cost of goods sold than FIFO. Answer: C Diff: 3 Objective: L.O. 7-4
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10) Assuming inflation, which of the following statements incorrectly describes an attribute of, or the relationship among, inventory valuation methods? A) Specific identification is used primarily when ending inventory consists of a relatively few but very expensive and distinctive items. B) Given inflation and in order to minimize taxes, most firms have tended to switch to LIFO if they had been using FIFO. C) LIFO tends to provide ending inventory valuations that closely approximate the actual market value of the inventory at the balance sheet date. D) LIFO tends to report current acquisition costs of inventory through cost of goods sold. E) Weighted average provides less extreme balance sheet and income statement results than either FIFO or LIFO. Answer: C Diff: 3 Objective: L.O. 7-4
11) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the ending inventory balance at August 31, 20X3, for Biscuit Bakery if the company uses perpetual FIFO as its inventory valuation method? A) $198.00 B) $270.00 C) $294.00 D) $297.50 E) $358.00 Answer: C Diff: 2 Objective: L.O. 7-4
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12) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the cost of goods sold for the month ended August 31, 20X3, for Biscuit Bakery if the company uses periodic FIFO as its inventory valuation method? A) $424.00 B) $485.00 C) $488.00 D) $500.00 E) $584.00 Answer: C Diff: 2 Objective: L.O. 7-4
13) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the ending inventory at August 31, 20X3, for Biscuit Bakery if the company uses periodic weighted average as its inventory valuation method (round all calculations to the nearest penny)? A) $281.70 B) $285.60 C) $290.22 D) $290.70 E) $294.00 Answer: A Diff: 2 Objective: L.O. 7-4
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14) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the ending inventory balance at August 31, 20X3, for Biscuit Bakery if the company uses perpetual LIFO as its inventory valuation method? A) $240 B) $270 C) $288 D) $300 E) $438 Answer: C Diff: 2 Objective: L.O. 7-4
15) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the cost of goods sold for the month ended August 31, 20X3, for Biscuit Bakery if the company uses perpetual LIFO as its inventory valuation method? A) $344 B) $482 C) $494 D) $502 E) $542 Answer: C Diff: 3 Objective: L.O. 7-4
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16) Biscuit Bakery had the following activity in its inventory account during August 20X3. Cost per Date Activity Units Unit Cost Total August 1 Beginning inventory 100 $3.00 $300 August 3 Purchase 40 3.10 124 August 7 Sale 50 August 12 Purchase 50 3.20 160 August 16 Sale 70 August 23 Sale 40 August 30 Purchase 60 3.30 198 What is the ending inventory balance at August 31, 20X3, for Biscuit Bakery if the company uses periodic LIFO as its inventory valuation method? A) $240 B) $270 C) $288 D) $300 E) $438 Answer: B Diff: 3 Objective: L.O. 7-4
17) FIFO tends to decrease taxes when A) costs are increasing. B) costs are decreasing. C) costs are constant. D) FIFO will always yield the lowest possible taxes. E) Impossible to determine without specific cost data Answer: B Diff: 2 Objective: L.O. 7-4
18) LIFO tends to decrease taxes when A) costs are declining. B) costs are constant. C) costs are increasing. D) LIFO will always yield the lowest possible taxes. E) Impossible to determine without specific cost data Answer: C Diff: 2 Objective: L.O. 7-4
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19) IFRS prohibits the use of the ________ method of inventory valuation. A) FIFO B) weighted-average C) moving average D) specific identification E) LIFO Answer: E Diff: 2 Objective: L.O. 7-4
20) There is no difference in the value of ending inventory if a company uses perpetual FIFO as opposed to periodic FIFO. Answer: TRUE Diff: 3 Objective: L.O. 7-4
21) If unit costs and prices did not fluctuate, specific identification, LIFO, FIFO, and weighted-average would show the same ending inventory and cost of goods sold balances. Answer: TRUE Diff: 2 Objective: L.O. 7-4
22) The specific identification method is frequently used for items with common characteristics, such as tons of coal. Answer: FALSE Diff: 2 Objective: L.O. 7-4
23) Under the FIFO method, ending inventory is valued based on the oldest unit costs. Answer: FALSE Diff: 2 Objective: L.O. 7-4
24) When prices are rising, LIFO generally results in the lowest taxable income, and therefore helps reduce taxes paid. Answer: TRUE Diff: 2 Objective: L.O. 7-4
25) FIFO will report the highest cost of goods sold on the income statement when prices are falling. Answer: TRUE Diff: 3 Objective: L.O. 7-4
26) LIFO results in a more accurate valuation of ending inventory on the balance sheet than does FIFO. Answer: FALSE Diff: 3 Objective: L.O. 7-4
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27) LIFO matches cost of goods sold to sales on the income statement more accurately than does FIFO. Answer: TRUE Diff: 3 Objective: L.O. 7-4
28) Assuming inflation, FIFO will result in a higher net income than LIFO. Answer: TRUE Diff: 3 Objective: L.O. 7-4
29) Assuming inflation, the weighted-average method will result in a net income that is higher than LIFO. Answer: TRUE Diff: 3 Objective: L.O. 7-4
30) The consistency convention requires a company to use LIFO from year to year. Answer: TRUE Diff: 2 Objective: L.O. 7-4
31) An attribute associated with inventory valuation methods is that the lower the cost of goods sold the higher the ending inventory. Answer: TRUE Diff: 2 Objective: L.O. 7-4
32) U.S. tax law contains a conformity requirement that allows companies to use LIFO for tax purposes only if the companies use LIFO for financial reporting purposes. Answer: TRUE Diff: 2 Objective: L.O. 7-4
33) The LIFO costing method can result in misleading inventory costs on the balance sheet because the oldest costs are left in ending inventory. Answer: TRUE Diff: 2 Objective: L.O. 7-4
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34) Tall Trees Gear uses the periodic inventory method and recorded the following inventory and purchase transactions for the month of August, 20X3. Date Aug 1 Aug 3 Aug 10 Aug 17 Aug 24
Transaction Beginning inventory Purchases Purchases Purchases Purchases
Units 2,800 units 500 units 300 units 400 units 700 units
Unit Cost @ $1.10 @ $1.20 @ $1.30 @ $1.40 @ $1.55
Determine the ending inventory balance at August 31 and the cost of goods sold for the month of August, 20X3 for Tall Trees Gear. Tall Trees Gear sold 3,200 units during August, 20X3. On August 31, a physical inventory count was conducted, and 1,500 units were on hand. Assume the company uses the first-infirst-out (FIFO) cost flow assumption. Answer: FIFO ending inventory Aug. 24 Purchase 700 units @ $1.55 $ 1,085 Aug. 17 Purchase 400 units @ $1.40 560 Aug. 10 Purchase 300 units @ $1.30 390 Aug. 3 Purchase 100 units @ $1.20 120 1,500 $2,155 FIFO periodic cost of goods sold Aug. 3 Purchase 400 units @ $1.20 Aug. 1 B.I. 2,800 units @ $1.10 3,200
$ 480 3,080 $3,560
Diff: 2 Objective: L.O. 7-4
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35) Tall Trees Gear uses the periodic inventory method and recorded the following inventory and purchase transactions for the month of August, 20X3. Date Aug 1 Aug 3 Aug 10 Aug 17 Aug 24
Transaction Beginning inventory Purchases Purchases Purchases Purchases
Units 2,800 units 500 units 300 units 400 units 700 units
Unit Cost @ $1.10 @ $1.20 @ $1.30 @ $1.40 @ $1.55
Determine the ending inventory balance at August 31 and the cost of goods sold for the month of August, 20X3 for Tall Trees Gear. Tall Trees Gear sold 3,200 units during August, 20X3. On August 31, a physical inventory count was conducted, and 1,500 units were on hand. Assume the company uses the last-infirst-out (LIFO) cost flow assumption. Answer: LIFO ending inventory Aug. 1 B.I. 1,500 units @ $1.10 $1,650 LIFO periodic cost of goods sold Aug. 24 Pur. 700 units @ $1.55 Aug. 17 Pur. 400 units @ $1.40 Aug. 10 Pur. 300 units @ $1.30 Aug. 3 Pur. 500 units @ $1.20 Aug. 1 B.I. 1,300 units @ $1.10 3,200
$ 1,085 560 390 600 1,430 $4,065
Diff: 2 Objective: L.O. 7-4
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36) Gabby Company operates under a perpetual inventory system. It began operations on March 1, 20X9, and had the following transactions affecting inventory during March, 20X9. March 1 March 5 March 10 March 15 March 20 March 25
Purchase Sale Purchase Sale Purchase Sale
500 units @ $5.00 200 units 300 units @ $5.20 320 units 400 units @ $5.40 230 units
$2,500 $1,560 $2,160
Determine the cost of goods sold for the month of March, 20X9 and the ending inventory balance at March 31, 20X9. Assume the company uses the first-in-first-out (FIFO) cost flow assumption. Answer: Note that 750 units were sold, 450 units are in ending inventory, and the total dollar amount of ending inventory and cost of goods sold must equal $6,220. Cost of goods sold March 5 Sale 200 units @ $5.00 $1,000 March 15 Sale 300 units @ $5.00 1,500 20 units @ $5.20 104 March 25 Sale 230 units @ $5.20 1,196 $3,800 Ending inventory
50 units @ $5.20 400 units @ $5.40
$ 260 2,160 $2,420
Diff: 2 Objective: L.O. 7-4
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37) Gabby Company operates under a perpetual inventory system. It began operations on March 1, 20X9, and had the following transactions affecting inventory during March, 20X9. March 1 March 5 March 10 March 15 March 20 March 25
Purchase Sale Purchase Sale Purchase Sale
500 units @ $5.00 200 units 300 units @ $5.20 320 units 400 units @ $5.40 230 units
$2,500 $1,560 $2,160
Assume the company is trying to decide between the periodic method and the perpetual method. Gabby has decided to use the last-in-first-out cost flow assumption. Determine the cost of goods sold for the month of March, 20X9 and the ending inventory balance at March 31, 20X9, using both the perpetual method and the periodic method. Answer: The perpetual focuses upon sales, periodic focuses upon purchases. This problem demonstrates this to the student. Note that 750 units were sold, 450 units are in ending inventory, and the total dollar amount of ending inventory and cost of goods sold must equal $6,220. LIFO perpetual method Cost of goods sold March 5 sale 200 units @ $5.00 March 15 sale 300 units @ $5.20 20 units @ $5.00 March 25 sale 230 units @ $5.40
Ending inventory 280 units @ $5.00 170 units @ $5.40
LIFO periodic inventory method Cost of goods sold March 20 purchase 400 units @ $5.40 March 10 purchase 300 units @ $5.20 March 1 purchase 50 units @ $5.00
LIFO ending inventory March 1 purchase 450 units @ $5.00
$1,000 1,560 100 1,242 $3,902
$1,400 918 $2,318
$2,160 1,560 250 $3,970
$2,250
Diff: 3 Objective: L.O. 7-4
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Learning Objective 7.5 Questions 1) The lower-of-cost-or-market practice is based on the A) consistency principle. B) entity concept. C) reliability principle. D) conservatism principle. E) historical cost concept. Answer: D Diff: 1 Objective: L.O. 7-5
2) The replacement costs have increased from $5.60 per unit to $6.20 per unit from the time 200 units of inventory were purchased. The year-end audit found 120 units remaining in stock. What entry is required? A) Cost of goods sold 72 Inventory 72 B) Inventory 72 Cost of goods sold 72 C) Cost of goods sold 48 Inventory 48 D) Inventory 48 Cost of goods sold 48 E) Make no entry. Answer: E Diff: 2 Objective: L.O. 7-5
3) Panel Install has 200 units of inventory that have a replacement cost of $4.90 per unit. The net realizable value of the inventory also declined. Originally this inventory cost $5.50 per unit from an order of 400. What entry is required? A) Loss on inventory write-down 120 Inventory 120 B) Inventory 120 Loss on inventory write-down 120 C) Loss on inventory write-down 240 Inventory 240 D) Inventory 240 Loss on inventory write-down 240 E) Make no entry. Answer: A Diff: 2 Objective: L.O. 7-5
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4) Compared with a pure cost method, the lower-of-cost-or-market method reports less net income in the period of decline in the market value of the inventory and more net income in the period of sale. Answer: TRUE Diff: 3 Objective: L.O. 7-5
5) The lower-of-cost-or-market method affects how much income is reported in each year but not the total income over the company's life. Answer: TRUE Diff: 3 Objective: L.O. 7-5
6) If replacement costs rise after the inventory is written down, then the inventory value must be increased. Answer: FALSE Diff: 1 Objective: L.O. 7-5
7) Holton Automotive computed gross profit for the month ended January 31, 20X3 as follows: Sales $5,200 Cost of goods available for sale 4,800 Ending inventory (200 units) 1,900 Cost of goods sold 2,900 Gross profit $2,300 Holton Automotive experienced a sudden decline in the replacement cost of its inventory during the month of January with per unit costs declining to $6.00 per unit and net realizable values falling to $7.00 per unit on January 31. On February 28, 20X3 replacement costs rose to $11.00 per unit. Required: 1) Prepare the appropriate journal entry under U.S. GAAP regulations on January 31, 20X3. 2) Prepare the appropriate journal entry under IFRS on January 31, 20X3. 3) Prepare the appropriate journal entry under U.S. GAAP regulations for February 28, 20X3. 4) Prepare a revised gross profit statement for Holton Automotive for the month ended January 31, 20X3 under U.S. GAAP regulations. Answer: 1) Cost of goods sold 700 Inventory 700 2) Cost of goods sold 500 Inventory 500 3) There is no journal entry required 4) Sales $5,200 Cost of goods available for sale $4,800 Ending inventory 1,200 Cost of goods sold 3,600 Gross profit $1,600 Diff: 2 Objective: L.O. 7-5
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8) Payton Industries had the following purchases as of September 30, 20X3. September 3 order of 400 units @ $10.50 September 8 order of 100 units @ $11.00 September 19 order of 200 units @ $11.50
$ 4,200 1,100 2,300 $ 7,600
On September 20, 20X3, the company sold 240 units at $16.00 per unit. On September 30, 20X3, a competitor announced a new model which resulted in the cost of Payton's inventory dropping to the new replacement cost, which was $10.75 per unit. The net realizable value also declined. Payton Industries uses a perpetual inventory system. 1. What is the balance in the inventory account on September 30, 20X3, if Payton Industries uses: a. FIFO? b. LIFO? 2. What journal entry is necessary on September 30, 20X3, if Payton Industries uses lower-of-cost-ormarket, where cost is defined as: a. FIFO? b. LIFO? Answer: 1a. FIFO 160 units @ $10.50 $1,680 100 units @ $11.00 1,100 200 units @ $11.50 2,300 $5,080 1b. LIFO 400 units @ $10.50 60 units @ $11.00
$4,200 660 $4,860
2a. FIFO Loss on Write-down of Inventory 175 Inventory 175 [200 units × ($11.50 - $10.75)] + [100 units × ($11 - $10.75)] 2b. LIFO. Loss on Write-down of Inventory Inventory (60 units × ($11.00 - $10.75))
15 15
Diff: 3 Objective: L.O. 7-5
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Learning Objective 7.6 Questions 1) If the ending inventory is overstated by $18,000 in 20X3, and assuming a constant 30% tax rate, then what will be the effect on net income in 20X4? A) Net income will be understated by $5,400 in 20X4. B) Net income will be overstated by $5,400 in 20X4. C) Net income will be understated by $12,600 in 20X4. D) Net income will be overstated by $12,600 in 20X4. E) Net income will not be overstated or understated in 20X4. Answer: C Diff: 3 Objective: L.O. 7-6
2) If ending inventory is understated by $8,000 in 20X3, and assuming a constant 30% tax rate, then what will be the effect on retained earnings on December 31, 20X4? A) The 20X4 ending retained earnings will be understated by $2,400. B) The 20X4 ending retained earnings will be overstated by $2,400. C) The 20X4 ending retained earnings will be understated by $5,600. D) The 20X4 ending retained earnings will be overstated by $5,600. E) The 20X4 ending retained earnings will not be understated or overstated. Answer: E Diff: 3 Objective: L.O. 7-6
3) If ending inventory is understated by $7,000 in 20X3, and assuming a constant 30% tax rate, then what will be the effect on gross profit in 20X3? A) 20X3 gross profit will be understated by $2,100. B) 20X3 gross profit will be understated by $4,900. C) 20X3 gross profit will be overstated by $4,900. D) 20X3 gross profit will be understated by $7,000. E) 20X3 gross profit will be overstated by $7,000. Answer: D Diff: 3 Objective: L.O. 7-6
4) Two separate errors affected Source Documenting in 20X3. The beginning inventory was overstated by $17,000 and the ending inventory was overstated by $23,000. Ignoring taxes, net income in 20X3 will be: A) overstated by $40,000. B) understated by $23,000. C) overstated by $23,000. D) overstated by $6,000. E) understated by $40,000. Answer: D Diff: 3 Objective: L.O. 7-6
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5) If ending inventory is overstated by $5,000 in 20X3, retained earnings will be overstated in 20X3. Answer: TRUE Diff: 3 Objective: L.O. 7-6
6) If beginning inventory is overstated by $2,000 in 20X3, net income in 20X4 will be overstated. Answer: FALSE Diff: 3 Objective: L.O. 7-6
7) If ending inventory is understated by $3,000 in 20X3, net income in 20X4 will be overstated. Answer: TRUE Diff: 3 Objective: L.O. 7-6
8) If ending inventory is overstated by $3,000 in 20X3, retained earnings at the end of 20X4 will be correctly stated. Answer: TRUE Diff: 3 Objective: L.O. 7-6
9) Cutoff errors are failures to record transactions in the correct time period. Answer: TRUE Diff: 1 Objective: L.O. 7-6
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10) Presented below are the income statements for Saldron Manufacturing for the years ended December 31, 20X3, 20X2, and 20X1. Saldron Manufacturing Comparative Income Statements For years ending December 31
Sales Less: Cost of Goods Sold: Beginning Inventory Purchases Cost of Goods Available for Sale Less: Ending Inventory Cost of Goods Sold Gross Profit Less: Operating Expenses Income Before Taxes Income Tax Expense (40%) Net Income
20X3 $910
20X2 $790
20X1 $620
90 550 640 80 560 350 70 280 112 $168
70 510 580 90 490 300 60 240 96 $144
60 420 480 70 410 210 50 160 64 $ 96
In 20X4 it was discovered that the 20X1 ending inventory was understated by $20, and the 20X3 ending inventory was overstated by $10. The 20X1 beginning inventory and the 20X2 ending inventory were correctly stated. Identify the accounts which are incorrect on the 20X1, 20X2, and 20X3 income statements. State the dollar error (by how much they are incorrect) and whether the amounts overstate or understate balances. Answer: Saldron Manufacturing Comparative Income Statements For years ending December 31
Sales Less: Cost of goods sold Beginning inventory Purchases Cost of Gds. Avail. For Sale Less: Ending inventory Cost of goods sold Gross profit Less: Operating expenses Income before taxes Income tax expense (40%) Net income
20X3 $910
20X2 $790
20X1 $620
70 ($20 under) 510 580 ($20 under)
60 420 480
80 ($10 over) 90 560 ($10 under) 490 ($20 under) 350 ($10 over) 300 ($20 over) 70 60 280 ($10 over) 240 ($20 over) 112 ($ 4 over) 96 ($ 8 over) $168 ($ 6 over) $144 ($12 over)
70 410 210 50 160 64 $ 96
90 550 640
Diff: 3 Objective: L.O. 7-6
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($20 under) ($20 over) ($20 under) ($20 under) ($ 8 under) ($12 under)
Learning Objective 7.7 Questions 1) Fortune Company had sales during July 20X3 of $29,000. During the month, the company had purchases of $17,000. At July 1, 20X3, the company had inventory of $4,500. Assuming the company has a gross profit percentage of 40%, what is the estimated ending inventory for Fortune Company at July 31, 20X3? A) $ 4,100 B) $ 4,900 C) $ 7,300 D) $ 7,500 E) $ 9,900 Answer: A Diff: 2 Objective: L.O. 7-7
2) Video Company had sales during July 20X3 of $30,000. During the month, the company had purchases of $10,000. At July 1, 20X3, the company had inventory of $10,000. Assuming the company has a gross profit percentage of 40%, what is the estimated ending inventory for Video Company at July 31, 20X3? A) $ 2,000 B) $ 16,000 C) $ 18,000 D) $ 20,000 E) none of the above Answer: A Diff: 2 Objective: L.O. 7-7
3) Resale Sports had inventory of $8,000 on Jan 1, 20X3, and $12,000 on Dec 31, 20X3. Sales for 20X3 were $250,000 and the company's gross profit percentage was 35%. What was the inventory turnover for Resale Sports for 20X3? A) 7.29 times B) 8.75 times C) 13.54 times D) 16.25 times E) 25.00 times Answer: D Diff: 2 Objective: L.O. 7-7
4) The gross profit percentage is calculated as sales divided by gross profit. Answer: FALSE Diff: 1 Objective: L.O. 7-7
5) Inventory turnover is calculated as cost of goods sold divided by average inventory. Answer: TRUE Diff: 1 Objective: L.O. 7-7
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6) Financial analysts and managers use the gross profit percentage as a measure of profitability and inventory turnover as a measure of efficient asset use. Answer: TRUE Diff: 2 Objective: L.O. 7-7
7) Catskill Company uses a periodic inventory system. On January 1, 20X3, the company had beginning inventory of $979,000. From January 1 to April 27, the company purchased $285,000 of inventory and had sales revenue of $840,000. On the morning of April 28, an earthquake occurred which resulted in the total loss of all inventory. The company's gross profit percentage has averaged 40%. What is the estimated inventory loss due to the earthquake? Answer: Sales $840,000 Less: Cost of goods sold 504,000 (60% × $840,000) Gross Profit $336,000 (40% × $840,000) Beginning inventory Plus: Purchases Cost of Goods available for sale Less: Cost of goods sold (from above) Equals Estimated ending inventory
$979,000 285,000 1,264,000 504,000 $760,000
Diff: 2 Objective: L.O. 7-7
Learning Objective 7.8 Questions 1) An increase in the replacement cost of the inventory held during the current period is called a A) holding gain. B) holding loss. C) unusual gain. D) operating gain. E) operating loss. Answer: A Diff: 3 Objective: L.O. 7-8
2) With inflation, a LIFO liquidation will A) decrease net income. B) increase cost of goods sold. C) increase gross profit. D) increase inventory. E) increase the current ratio. Answer: C Diff: 2 Objective: L.O. 7-8
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3) When prices and costs are rising, most companies that use LIFO A) have a higher inventory value than they would under FIFO. B) report their LIFO reserve on the balance sheet or in the footnotes. C) have higher total assets than they would under FIFO. D) have higher stockholders' equity than they would under FIFO. E) are very rare. Answer: B Diff: 3 Objective: L.O. 7-8
4) LIFO liquidation refers to the relatively higher profits generated under LIFO when reductions in inventory levels occur because older, lower inventory costs are used in calculating cost of goods sold. Answer: TRUE Diff: 2 Objective: L.O. 7-8
5) An increase in the replacement cost of the inventory held during the current period is referred to as a holding gain. Answer: TRUE Diff: 2 Objective: L.O. 7-8
6) The difference between a company's inventory valued at LIFO and what it would be under FIFO is known as a FIFO reserve. Answer: FALSE Diff: 1 Objective: L.O. 7-8
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Learning Objective 7.9 Questions 1) What order does inventory typically travel in an organization? A) Raw materials, customer, finished goods, work in process B) Raw materials, work in process, customer, finished goods C) Raw materials, work in process, finished goods, customer D) Work in process, raw materials, finished goods, customer E) Work in process, finished goods, raw materials, customer Answer: C Diff: 1 Objective: L.O. 7-9
2) Arko, Inc., manufactures tables. During the month of March, 20X9, Arko purchased 100 table tops of wood costing $3 per piece, 400 table legs of wood costing $1 per leg, 100 bottles of glue costing $2.50 per bottle, and 800 nails costing $.20 per nail. All raw materials were put into production during March, 20X9, and production wages related to the production of tables amounted to $300. At the end of March, 20X9, ending work in process inventory had 20 table tops of wood, 80 table legs of wood, 20 bottles of glue, and 160 nails. Required: Prepare journal entries for the purchase of raw materials on account, production activity, and completion of production. Answer: Purchase of raw materials Raw materials inventory 1,110 Accounts payable 1,110 Production activity Work in process inventory Raw materials inventory Work in process inventory Wages payable Completion of production Finished goods inventory Work in process inventory
1,110 1,110 300 300
1,188 1,188
Diff: 3 Objective: L.O. 7-9
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3) Arko, Inc., manufactures tables. During the month of March, 20X9, Arko purchased 100 table tops of wood costing $3 per piece, 400 table legs of wood costing $1 per leg, 100 bottles of glue costing $2.50 per bottle, and 800 nails costing $.20 per nail. All raw materials were put into production during March, 20X9, and production wages related to the production of tables amounted to $300. At the end of March, 20X9, ending work in process inventory had 20 table tops of wood, 80 table legs of wood, 20 bottles of glue, and 160 nails. Required: What will be the inventory balances for Arko, Inc., on March, 31, 20X9? Assume that the beginning balances on March 1, 20X9, in the Raw Materials Inventory account was $400, the Work in Process Inventory account was $200, and the Finished Goods Inventory was $0. Answer: Raw materials inventory = $400 + $1,110 - $1,110 = $400 Work in process inventory = $200 + $1,110 + $300 - $1,188 = $422 Finished goods inventory = $1,188 Diff: 3 Objective: L.O. 7-9
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Introduction to Financial Accounting, 11e (Horngren) Chapter 8 Long-Lived Assets Learning Objective 8.1 Questions 1) Repairs made to equipment as part of yearly maintenance would be recorded in the journal by A) debiting equipment. B) debiting repairs expense. C) debiting depreciation expense. D) debiting accumulated depreciation. E) crediting accumulated depreciation. Answer: B Diff: 2 Objective: L.O. 8-1
2) Treating a capital expenditure as repairs and maintenance expense A) understates expenses and overstates owners' equity. B) understates expenses and understates assets. C) overstates expenses and understates net income. D) overstates assets and overstates owners' equity. E) overstates assets and overstates revenue. Answer: C Diff: 3 Objective: L.O. 8-1
3) Expenditures for long-lived assets are expensed when they A) add new assets. B) increase capacity. C) improve efficiency. D) provide benefits lasting one year or less. E) lengthen an asset's useful life. Answer: D Diff: 3 Objective: L.O. 8-1
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4) The decision whether to expense or capitalize expenditures for plant assets depends on many factors. Which of the following is NOT a factor for a company choosing to expense or capitalize an expenditure? A) The decision of whether to expense or capitalize an expenditure is based on management's judgment. B) The decision of whether to expense or capitalize an expenditure is influenced by cost-benefit and materiality tests. C) The decision of whether to expense or capitalize an expenditure is not based on management's judgment since U.S. GAAP provides clear rules on specific types of assets. D) The decision of whether to expense or capitalize an expenditure has the potential to cause ethical issues for companies. E) The decision of whether to expense or capitalize an expenditure is influenced by the principle of conservatism causing accountants to expense an expenditure as opposed to capitalize it when faced with contradictory evidence. Answer: C Diff: 2 Objective: L.O. 8-1
5) All of the following are tangible assets except A) tow motor used to relocate inventory. B) office portion of a building. C) patent on manufacturing equipment used to make company products. D) land that will potentially be used by a company in the future. E) drill press used to manufacture company products. Answer: C Diff: 1 Objective: L.O. 8-1
6) An operating expense is the cost that is added to an asset account. Answer: FALSE Diff: 1 Objective: L.O. 8-1
7) Long-lived assets include accounts receivable and inventory. Answer: FALSE Diff: 1 Objective: L.O. 8-1
8) Expenditures are purchases of goods or services, whether for cash or on credit. Answer: TRUE Diff: 1 Objective: L.O. 8-1
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9) For each of the following items, identify whether they are a capital expenditure or an expense: a. Built a new elevator in the office building. b. Acquired a trademark. c. Incurred research and development expense to develop a patent. d. Modified a machine, thus extending its useful life and capabilities. e. Paid wages for the janitorial workers. f. Paid for a new roof on the building. g. Paid for a month's utilities in the office building. h. Replaced the furnace in the office building. i. Replaced the carpeting in the office building. Answer: a. capital expenditure b. capital expenditure c. expense d. capital expenditure e. expense f. capital expenditure g. expense h. capital expenditure i. capital expenditure Diff: 2 Objective: L.O. 8-1
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10) For each of the following items, identify whether they are a tangible or intangible asset. In addition, if the asset is long-lived, identify whether it is depreciated, amortized, or depleted. If the asset is not a longlived asset, identify it as a current asset.
1) Natural gas reserves 2) Warehouse forklift 3) Computers held for resale 4) Copyrights 5) Land 6) Delivery truck 7) Trademarks 8) Oil and coal 9) Building 10) Building owned by a real estate company; Building for sale 11) Accounts receivable Answer: 1) Natural gas reserves 2) Warehouse forklift 3) Computers held for resale 4) Copyrights 5) Land 6) Delivery truck 7) Trademarks 8) Oil and coal 9) Building 10) Building owned by a real estate company 11) Accounts receivable
Tangible/ Intangible /Current __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________
Depreciated/ Amortized/Depleted __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________ __________________
__________________ __________________
__________________ __________________
tangible tangible current intangible tangible tangible intangible tangible tangible current current
Diff: 2 Objective: L.O. 8-1
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depleted depreciated n/a amortized not depreciated depreciated amortized depleted depreciated n/a n/a
Learning Objective 8.2 Questions 1) Kolonial Township acquired a building and the 3 acres of land on which it is located. The total purchase price was $2,500,000. For valuation purposes, the company contacted three local commercial real estate agents, who gave the following valuation estimates:
M. Mulhan H. Ivan T. Grasso
Land $ 900,000 $ 300,000 $ 600,000
Building $2,100,000 $2,700,000 $2,400,000
If Kolonial Township used the valuation made by T. Grasso, and assuming it paid cash for the land and building, what journal entry would Kolonial Township make to record the purchase? A) Land 600,000 Building 2,400,000 Cash 3,000,000 B) Land 500,000 Building 2,000,000 Cash 2,500,000 C) Land 300,000 Building 2,700,000 Cash 3,000,000 D) Land 250,000 Building 2,250,000 Cash 2,500,000 E) Land 900,000 Building 2,100,000 Cash 2,500,000 Gain on Purchase of Assets 500,000 Answer: B Diff: 2 Objective: L.O. 8-2
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2) Kolonial Township acquired a building and the 3 acres of land on which it is located. The total purchase price was $2,500,000. For valuation purposes, the company contacted three local commercial real estate agents, who gave the following valuation estimates:
M. Mulhan H. Ivan T. Grasso
Land $ 900,000 $ 300,000 $ 600,000
Building $2,100,000 $2,700,000 $2,400,000
If Kolonial Township used the valuation made by H. Ivan, and assuming it paid cash for the land and building, what journal entry would Kolonial Township make to record the purchase? A) Land 750,000 Building 1,750,000 Cash 2,500,000 B) Land 500,000 Building 2,000,000 Cash 2,500,000 C) Land 300,000 Building 2,700,000 Cash 3,000,000 D) Land 250,000 Building 2,250,000 Cash 2,500,000 E) Land 300,000 Building 2,750,000 Cash 2,500,000 Gain on Purchase of Assets 500,000 Answer: D Diff: 2 Objective: L.O. 8-2
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3) Kolonial Township acquired a building and the 3 acres of land on which it is located. The total purchase price was $2,500,000. For valuation purposes, the company contacted three local commercial real estate agents, who gave the following valuation estimates:
M. Mulhan H. Ivan T. Grasso
Land $ 900,000 $ 300,000 $ 600,000
Building $2,100,000 $2,700,000 $2,400,000
If Kolonial Township used the valuation made by M. Mulhan and assuming it paid cash for the land and building, what journal entry would Kolonial Township make to record the purchase? A) Land 750,000 Building 1,750,000 Cash 2,500,000 B) Land 500,000 Building 2,000,000 Cash 2,500,000 C) Land 900,000 Building 2,100,000 Cash 3,000,000 D) Land 833,250 Building 830,750 Cash 2,500,000 E) Land 900,000 Building 2,100,000 Cash 2,500,000 Gain on Purchase of Assets 500,000 Answer: A Diff: 2 Objective: L.O. 8-2
4) Equipment is acquired for $100,000. Freight costs are $1,800, sales tax amounted to $1,000. Maintenance during the first year of use cost $6,000. What is the cost of the equipment? A) $102,800 B) $100,000 C) $108,800 D) $101,000 E) $101,800 Answer: A Diff: 2 Objective: L.O. 8-2
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5) The removal of an old building to make land suitable for its intended use is charged to A) repairs expense. B) land. C) buildings. D) land improvements. E) None of the above Answer: B Diff: 2 Objective: L.O. 8-2
6) Goetz Construction Company constructed a shed for Paramount Industries. Instead of giving cash, Paramount Industries, gave Goetz Construction Company a used delivery truck originally costing Paramount Industries, $52,000. The book value for the delivery truck on the financial statements of Paramount Industries showed the delivery truck with a value of $40,000. A new delivery truck is currently selling for $44,000, and an independent appraiser said the fair value of the used delivery truck is $48,000. What value should Paramount Industries assign to the shed on its financial statements? A) $39,000 B) $52,000 C) $40,000 D) $44,000 E) $48,000 Answer: E Diff: 2 Objective: L.O. 8-2
7) All of the following are included in the acquisition cost of land except A) costs of clearing land to construct a building. B) transfer taxes. C) attorney's fees to prepare closing documents. D) cost of land survey. E) architect fee for new building. Answer: E Diff: 2 Objective: L.O. 8-2
8) All of the following are included in the acquisition cost of equipment except A) maintenance costs one year after purchase. B) installation costs. C) transportation costs. D) sales tax. E) cost to unbox and repair prior to use. Answer: A Diff: 2 Objective: L.O. 8-2
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9) Nonmonetary assets are A) permitted to be exchanged in lieu of cash when a company's stock exceeds 20% of its fair value. B) permitted to be exchanged in lieu of cash when a company's stock exceeds 50% of its fair value. C) assets with a price in terms of units of currency that could change over time. D) assets with a price that are fixed in terms of units of currency. E) assets that are sold to an independent third party. Answer: C Diff: 2 Objective: L.O. 8-2
10) If a company acquires a new machine, the cost of rewiring the building to accommodate the machine, and the cost to reinforce the floor to support the weight of the machine, are all considered a part of the total cost of the machine. Answer: TRUE Diff: 1 Objective: L.O. 8-2
11) The cost of equipment shall include all costs of acquisition and preparation for use. Answer: TRUE Diff: 1 Objective: L.O. 8-2
12) Delta Company acquired land and a building on March 1, 20X3, paying a total of $1,400,000. Separately, the land had an estimated fair market value of $750,000 and the building had an estimated fair market value of $1,125,000. In order to use the property, land improvements of $20,000 were incurred. Additionally, the building needed to be rewired, at a cost of $65,000. Also, certain walls had to be knocked down, while others were constructed. The cost to remove and replace walls was $80,000. The company took occupancy of the building on August 1, 20X3. For all of items noted above, determine how much will be incorporated into the land account, the building account, or expensed as of Delta Company's year end of December 31, 20X3. Answer: Fair Market Values: Percent Land $ 750,000 .4 Building 1,125,000 .6 Total $1,875,000 1.0 Land: Allocated purchase price
$560,000
($1,400,000 × .4)
Building: Allocated purchase price Cost of rewiring Cost of wall removal and construction Total cost of building
$840,000 65,000
($1,400,000 × .6)
Land Improvements(depreciable)
$20,000
80,000 $985,000
Diff: 2 Objective: L.O. 8-2
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13) Key Company purchased land for $350,000 with intentions to construct an office building on the site. At the time of the closing, Key Company paid closing costs of $5,000, title fees of $800, and attorney's fees of $3,200. When Key Company purchased the land, removal of an old building was completed in preparation for the new building at a cost of $8,000. However, Key Company was able to sell a portion of the building materials retrieved from the old, demolished building to a local contractor for $2,000. After $21,000 was paid to grade the property, a building was constructed at a total cost of $600,000. Required: Based on the previous information, identify the total acquisition costs for the land and the building. Answer: Land Purchase price $ 350,000 Closing costs 5,000 Title fees 800 Attorney's fees 3,200 Removal of old building 8,000 Sale of building material (2,000) Grading 21,000 Total cost of land $386,000 Building Construction cost Total cost of building
$600,000 $600,000
Diff: 2 Objective: L.O. 8-2
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Learning Objective 8.3 Questions 1) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. What is the depreciable value of the machine acquired by Compatibility Services? A) $4,000 B) $76,000 C) $80,000 D) $8,000 E) Cannot be determined without additional data Answer: B Diff: 1 Objective: L.O. 8-3
2) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses straight-line depreciation, what is the depreciation expense in 20X4? A) $6,686 B) $ 9,500 C) $ 10,000 D) $ 8,000 E) $12,500 Answer: B Diff: 2 Objective: L.O. 8-3
3) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses straight-line depreciation, what is the balance in the accumulated depreciation account on January 1, 20X5? A) $19,000 B) $20,000 C) $28,500 D) $21,600 E) $30,000 Answer: A Diff: 2 Objective: L.O. 8-3
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4) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. Compatibility Services uses units-ofproduction depreciation, and the company produces 40,000 units in 20X3, what will be the depreciation expense for 20X3? A) $5,760 B) $6,400 C) $15,200 D) $8,000 E) $7,600 Answer: E Diff: 2 Objective: L.O. 8-3
5) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses units-ofproduction depreciation and the company produces 40,000 units in 20X3; 60,000 units in 20X4; and 50,000 units in 20X5; what is the depreciation expense in 20X5? A) $ 28,500 B) $12,000 C) $10,000 D) $9,500 E) $11,400 Answer: D Diff: 2 Objective: L.O. 8-3
6) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses units-ofproduction depreciation, and the company produces 40,000 units in 20X3; 60,000 units in 20X4; 50,000 units in 20X5; and 30,000 units in 20X6; what is the net book value of the machine at December 31, 20X6? A) $40,000 B) $48,000 C) $42,000 D) $45,800 E) $49,600 Answer: D Diff: 2 Objective: L.O. 8-3
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7) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses doubledeclining-balance depreciation, what is the depreciation expense in 20X3? A) $14,400 B) $20,000 C) $17,600 D) $25,000 E) $27,776 Answer: B Diff: 2 Objective: L.O. 8-3
8) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses doubledeclining-balance depreciation, what is the depreciation expense in 20X4? A) $ 19,000 B) $ 10,000 C) $15,000 D) $9,500 E) $16,000 Answer: C Diff: 3 Objective: L.O. 8-3
9) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. What is the balance in the accumulated depreciation account on December 31, 20X4, if Compatibility Services uses double-declining-balance depreciation? A) $40,000 B) $35,000 C) $18,750 D) $37,500 E) $32,000 Answer: B Diff: 3 Objective: L.O. 8-3
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10) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses doubledeclining-balance depreciation, what is the depreciation expense in 20X5? A) $ 5,184 B) $ 5,760 C) $11,250 D) $14,400 E) $16,000 Answer: C Diff: 3 Objective: L.O. 8-3
11) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. What is the balance in the accumulated depreciation account on December 31, 20X5, if Compatibility Services uses double-declining-balance depreciation? A) $11,250 B) $15,000 C) $20,000 D) $46,250 E) $15,312 Answer: D Diff: 3 Objective: L.O. 8-3
12) Compatibility Services acquired an $80,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $4,000. For units-of-production depreciation purposes, the machine is expected to produce 400,000 units. If Compatibility Services uses doubledeclining-balance depreciation, what is the net book value of the machine on December 31, 20X5? A) $ -0B) $ 30,000 C) $ 33,750 D) $40,000 E) $46,250 Answer: C Diff: 3 Objective: L.O. 8-3
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13) Compatibility Services acquired a $100,000 machine on January 1, 20X3. The machine is estimated to have a useful life of 8 years, and a residual value of $10,000. Assume Compatibility Services was considering the use of double-declining-balance depreciation. What is the depreciation expense in 20X3 and 20X4? 20X3 20X4 A) $12,500 $12,500 B) $20,000 $20,000 C) $22,500 $16,875 D) $25,000 $18,750 E) $25,000 $15,000 Answer: D Diff: 3 Objective: L.O. 8-3
14) To determine depreciation expense for a plant asset, all of the following must be known except: A) estimated useful life. B) current market value. C) estimated residual value. D) historical cost. E) All of the above must be known to determine depreciation expense for a plant asset. Answer: B Diff: 1 Objective: L.O. 8-3
15) Ganley Rental Cars recently acquired several new cars for their fleet. The cars have an estimated life of 4 years and should be driven 80,000 miles. What is the most appropriate method of depreciation to properly match revenues and expenses? A) Double-declining balance B) Straight line C) Units-of-production D) Revenue recognition E) Expense deferral Answer: C Diff: 2 Objective: L.O. 8-3
16) Book value is defined as A) cost less salvage value. B) current market value less accumulated depreciation. C) cost less accumulated depreciation. D) cost plus accumulated depreciation. E) cost plus salvage value. Answer: C Diff: 1 Objective: L.O. 8-3
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17) The double-declining-balance method of depreciation A) causes less depreciation in the early years of an asset's use as compared to other depreciation methods. B) causes the same amount of depreciation in the early years of an asset's use as compared to other depreciation methods. C) causes more depreciation in the early years of an asset's use as compared to other depreciation methods. D) is not an acceptable depreciation method according to generally accepted accounting principles. E) None of the above Answer: C Diff: 2 Objective: L.O. 8-3
18) Machiel Manufacturing acquired a $60,000 machine on January 1, 20X9. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. What is the depreciable value of the machine acquired by Machiel Manufacturing? A) $10,000 B) $50,000 C) $60,000 D) $15,000 E) Cannot be determined without additional data Answer: B Diff: 1 Objective: L.O. 8-3
19) Machiel Manufacturing acquired a $60,000 machine on January 1, 20X9. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing used straight-line depreciation, what will be the depreciation expense in 20X9? A) $ 7,200 B) $ 8,000 C) $ 8,800 D) $12,500 E) $13,888 Answer: D Diff: 1 Objective: L.O. 8-3
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20) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing uses straight-line depreciation, what is the depreciation expense in 2011? A) $ 3,686 B) $ 7,200 C) $ 8,000 D) $ 8,800 E) $12,500 Answer: E Diff: 1 Objective: L.O. 8-3
21) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing uses straight-line depreciation, what is the balance in the accumulated depreciation account on January 1, 2011? A) $14,400 B) $16,000 C) $17,600 D) $21,600 E) $25,000 Answer: E Diff: 2 Objective: L.O. 8-3
22) Machiel Manufacturing acquired a $60,000 machine on January 1, 20X9. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing uses units-ofproduction depreciation, and the company produces 80,000 units in 20X9, what will be the depreciation expense for 20X9? A) $5,760 B) $6,400 C) $7,200 D) $8,000 E) $8,800 Answer: D Diff: 2 Objective: L.O. 8-3
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23) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. Machiel Manufacturing uses units-ofproduction depreciation and the company produces 80,000 units in 2009; 130,000 units in 2010; and 160,000 units in 2011. What is the depreciation expense in 2011? A) $ 8,000 B) $13,000 C) $12,800 D) $16,000 E) $37,000 Answer: D Diff: 2 Objective: L.O. 8-3
24) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. Machiel Manufacturing uses units-ofproduction depreciation, and the company produces 80,000 units in 2009; 130,000 units in 2010; 160,000 units in 2011 and 70,000 units in 2012; what is the net book value of the machine at December 31, 2012? A) $ 8,000 B) $13,000 C) $12,800 D) $16,000 E) $37,000 Answer: D Diff: 2 Objective: L.O. 8-3
25) Machiel Manufacturing acquired a $60,000 machine on January 1, 20X9. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing uses doubledeclining-balance depreciation, what is the depreciation expense in 20X9? A) $12,500 B) $16,000 C) $17,500 D) $25,000 E) $30,000 Answer: E Diff: 2 Objective: L.O. 8-3
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26) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. If Machiel Manufacturing uses doubledeclining-balance depreciation, what is the depreciation expense in 2010? A) $ 8,640 B) $ 9,600 C) $12,500 D) $15,000 E) $25,000 Answer: D Diff: 3 Objective: L.O. 8-3
27) Machiel Manufacturing acquired a $60,000 machine on January 1, 2009. The machine is estimated to have a useful life of 4 years, and a residual value of $10,000. For units-of-production depreciation purposes, the machine is expected to produce 500,000 units. What is the balance in the accumulated depreciation account on December 31, 2010, if Machiel Manufacturing uses double-declining-balance depreciation? A) $25,000 B) $30,000 C) $40,000 D) $45,000 E) $50,000 Answer: D Diff: 3 Objective: L.O. 8-3
28) Which of the following statements is TRUE? A) The depreciable value of a tangible asset is the total acquisition cost of the asset. B) The residual value of a tangible asset is the estimated amount to be received for an asset upon its disposal at the end of its useful life. C) The useful life of a tangible asset is the time period over which the company believes it will own the asset. D) The estimation of useful lives is almost always based upon when the tangible asset will physically wear out. E) Depreciation attempts to measure the deteriorating market value of an asset. Answer: B Diff: 1 Objective: L.O. 8-3
29) Depreciation expense computed under double-declining-balance will decrease each year because the A) book value used in the computation each year increases. B) book value used in the computation each year decreases. C) rate used in the computation each year increases. D) rate used in the computation each year decreases. E) All the above are correct. Answer: B Diff: 2 Objective: L.O. 8-3
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30) Component depreciation is A) required by IFRS B) required by GAAP C) permissible if a small portion of an asset has separate, depreciable components D) utilized heavily by publicly traded corporations in the U.S. E) utilized heavily by privately held corporations in the U.S. Answer: A Diff: 1 Objective: L.O. 8-3
31) The accumulated depreciation account represents a growing amount of cash to be used to replace the asset. Answer: FALSE Diff: 1 Objective: L.O. 8-3
32) In order to calculate depreciation, the current market value of the equipment, the salvage value, and the estimated useful life must be known. Answer: FALSE Diff: 1 Objective: L.O. 8-3
33) Book value is determined by adding salvage value to the cost of the asset. Answer: FALSE Diff: 1 Objective: L.O. 8-3
34) Regardless of the depreciation method used, accumulated depreciation will be the same when the asset is fully depreciated. Answer: TRUE Diff: 3 Objective: L.O. 8-3
35) The depreciable value is the difference between the total acquisition cost and the predicted residual value. Answer: TRUE Diff: 2 Objective: L.O. 8-3
36) Residual value is computed as cost less depreciation expense. Answer: FALSE Diff: 2 Objective: L.O. 8-3
37) Depreciation is not intended to track the decreasing current market value of a tangible asset. Answer: TRUE Diff: 2 Objective: L.O. 8-3
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38) Both straight-line depreciation and units-of-production depreciation will generate the same depreciation expense during every year of an asset's life. Answer: FALSE Diff: 2 Objective: L.O. 8-3
39) Double-declining-balance depreciation may be referred to as accelerated depreciation. Answer: TRUE Diff: 2 Objective: L.O. 8-3
40) Most companies use accelerated depreciation for financial reporting purposes and straight-line depreciation for income tax purposes. Answer: FALSE Diff: 1 Objective: L.O. 8-3
41) Units-of-production depreciation is the most popular form of accelerated depreciation. Answer: FALSE Diff: 1 Objective: L.O. 8-3
42) Double-declining-balance depreciation computes annual depreciation by multiplying the asset's book value at the beginning of the year by two times the straight-line rate. Answer: TRUE Diff: 2 Objective: L.O. 8-3
43) Land is always depreciated using double-declining-balance depreciation. Answer: FALSE Diff: 1 Objective: L.O. 8-3
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44) Hartman Manufacturing acquired a vehicle on January 1, 20X2, for $78,000. The machine is estimated to have a 6-year life, with a residual value of $6,000. Hartman Manufacturing is not certain whether to use the straight-line or double-declining-balance method of depreciation. Prepare the following depreciation schedule:
Date 01/01/2X02 12/31/2X02 12/31/20X3 12/31/20X4 12/31/20X5 12/31/20X6 12/31/20X7 Answer: Date 01/01/2X02 12/31/20X2 12/31/20X3 12/31/20X4 12/31/20X5 12/31/20X6 12/31/20X7
Straight-Line Depreciation Book Expense Value $78,000
Double-Declining-Balance Depreciation Book Expense Value $78,000
Straight-Line Depreciation Book Expense Value $78,000 $ 12,000 66,000 12,000 54,000 12,000 42,000 12,000 30,000 12,000 18,000 12,000 6,000
Double-Declining-Balance Depreciation Book Expense Value $78,000 $26,000 52,000 17,333 34,667 11,556 23,111 7,704 15,407 5,136 10,271 4,271 6,000
Diff: 3 Objective: L.O. 8-3
45) For each of the independent situations below, determine the age of the asset in question. All assets were acquired at the beginning of the years. a. The balance in the buildings account is $400,000; while the balance sheet shows the book value of the buildings at $217,600. The notes to the financial statements indicate that straight-line depreciation is used for all plant assets and that residual values are estimated at 5% of cost. The estimated life of the buildings is 25 years. b. The book value of delivery equipment is $51,520. The cost of the delivery equipment was $80,500. The company uses the straight-line method of depreciation for delivery equipment and estimates life at 5 years or 50,000 units. So far, 27,000 units have been produced. Residual value is 10% of cost. Answer: a. $400,000 × .95 = $380,000 depreciable value $380,000/25 = $15,200 annual depreciation $400,000 - $217,600 = $182,400 balance in accumulated depreciation $182,400/$15,200 = 12 years old b. $80,500 × .90 = $72,450 depreciable value $72,450/5 = $14,490 annual depreciation $80,500 - $51,520 = $28,980 balance in accumulated depreciation $28,980/$14,490 = 2 years old Diff: 3 Objective: L.O. 8-3
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46) On January 1, 2009, Elicir Technologies purchased lawn mowers for $60,000. The lawn mowers have an estimated life of 8 years or 40,000 hours and an estimated residual value of $4,000. Elicir Technologies must choose the depreciation method that appropriately allocates depreciation over the lawn mowers' useful life and would like the following items calculated. 1) Depreciation expense for 2009 and 2010 using the units-of-production depreciation method. The lawn mowers were operated for 4,000 hours in 2009 and 6,000 hours in 2010. 2) Straight-line depreciation for 2009 and 2010. 3) Accumulated depreciation at December 31, 2010 using the straight-line method 4) Accumulated depreciation at December 31, 2010 using the units-of-production method. 5) Book value of the lawn mowers using the straight-line depreciation method and the book value using the units-of-production method of depreciation as of December 31, 2010. Answer: 1) 2009 = $5,600 ($60,000 - $4,000 = $56,000/40,000 = $1.4 × 4,000 = $5,600) 2010 = $8,400 ($60,000 - $4,000 = $56,000/40,000 = $1.4 × 6,000 = $8,400) 2) 2009 = $7,000 2010 = $7,000 ($60,000 - $4,000 = $56,000/8 = $7,000) 3) $7,000 × 2 years = $14,000 4) $5,600 + $8,400 = $14,000 5) Straight-line book value = $60,000 - $7,000 - $7,000 = $46,000 Units-of-production book value = $60,000 - $5,600 - $8,400 = $46,000 Diff: 3 Objective: L.O. 8-3
47) Explain the concept of depreciation. Include in your discussion one common misconception regarding what depreciation represents. Answer: Depreciation is the process of allocating a plant asset's cost to expense over the period the asset is used. This process is designed to match the asset's expense against the revenue generated over the asset's life. The primary purpose of depreciation is to help measure income properly. Depreciation is not a process of valuation, and depreciation does not mean that the business sets aside cash to replace assets as they become fully depreciated. Depreciation is also a noncash expense. Depreciation does impact cash flows from operations via the tax savings it generates. It is a tax-deductible expense, thus decreasing the income tax payment. Diff: 2 Objective: L.O. 8-3 & 8-6
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Learning Objective 8.4 Questions 1) Dugger Excavating bought a machine for $24,000 on January 1, 20X3, with a useful life of 5 years and a salvage value of $4,000. At the beginning of 20X4, Dugger finds the residual value will be zero. Assuming Dugger employs straight-line depreciation, what will be the depreciation expense in 20X4? A) $4,000 B) $5,000 C) $6,000 D) $4,750 E) $8,500 Answer: B Diff: 2 Objective: L.O. 8-4
2) Dugger Excavating bought a machine for $24,000 on January 1, 20X3, with a useful life of 5 years and a salvage value of $4,000. At the beginning of 20X4, Dugger finds the residual value will be zero. Assuming Dugger employs double-declining-balance depreciation, what will be the depreciation expense in 20X4? A) $5,250 B) $8,000 C) $4,160 D) $9,600 E) $5,760 Answer: E Diff: 2 Objective: L.O. 8-4
3) Dugger Excavating bought a machine for $24,000 on January 1, 20X3, with a useful life of 5 years and a salvage value of $4,000. At the beginning of 20X4, Dugger finds the residual value will be zero. Assume Dugger employs straight-line depreciation. Additionally assume that at the beginning of 20X4 Dugger finds a $200 attachment that extends the life of the equipment 2 years beyond the original estimate. What will be the depreciation expense in 20X4? A) $4,800 B) $4,667 C) $3,367 D) $4,000 E) $4,200 Answer: C Diff: 2 Objective: L.O. 8-4
4) Accounting for changes in useful life is prospective in nature. Answer: TRUE Diff: 1 Objective: L.O. 8-4
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5) Accounting for changes in residual value must be prospective and retrospective. Answer: FALSE Diff: 1 Objective: L.O. 8-4
6) Depreciation is recomputed starting in the period that a change in estimate is known. Answer: TRUE Diff: 1 Objective: L.O. 8-4
7) MLJ Manufacturing has prepared the following depreciation schedule: Straight-line depreciation schedule of snow blowers Annual depreciation Year 1 Year 2 Year 3 Year 4
$21,250 21,250 21,250 21,250
Book value $85,000 63,750 42,500 21,250 0
Suppose at the beginning of year 3, MLJ Manufacturing no longer believes the snow blowers will last 4 years, but instead decides the snow blowers will last 6 total years. Assume the residual value of the snow blowers is $0. Required: 1) What is the new depreciation expense for Year 3 and Year 4? 2) What is the new book value after Year 4 records depreciation expense? 3) What is the accumulated depreciation amount after Year 6 records depreciation expense? Answer: 1) $42,500 left to depreciate / 4 years left = $10,625 2) $42,500 book value at the beginning of Year 3 - $10,625 depreciation expense for Year 3 - $10,625 depreciation expense for Year 4 = $21,250 3) $85,000 Diff: 2 Objective: L.O. 8-4
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Learning Objective 8.5 Questions 1) Which of the following statements is TRUE? A) For most assets, MACRS approximates straight-line depreciation. B) MACRS depreciates assets over a longer useful life than would be expected from the asset. C) MACRS allows for greater depreciation expense in the later years of an asset's life, thus reducing the taxes a company will have to pay during those years. D) The purpose of MACRS is to increase a company's income tax liability in the early years of a fixed asset's life. E) None of the above Answer: E Diff: 2 Objective: L.O. 8-5
2) The MACRS allows depreciable assets to have A) longer lives than economic lives resulting in higher income taxes in the early years of an asset's life than the straight-line method. B) longer lives than economic lives resulting in lower income taxes in the early years of an asset's life than the straight-line method. C) shorter lives than economic lives resulting in higher income taxes in the early years of an asset's life than the straight-line method. D) shorter lives than economic lives resulting in lower income taxes in the early years of an asset's life than the straight-line method. E) useful lives equivalent to economic lives. Answer: D Diff: 2 Objective: L.O. 8-5
3) Useful lives for depreciable assets for tax purposes are frequently shorter than the useful lives used for financial reporting purposes. Because of this, taxable net income would be A) lower and lower income taxes payable in the early years of an asset's life than the straight-line method. B) lower and higher income taxes payable in the early years of an asset's life than the straight-line method. C) higher and lower income taxes payable in the early years of an asset's life than the straight-line method. D) higher and higher income taxes payable in the early years of an asset's life than the straight-line method. E) undeterminable from the information given. Answer: A Diff: 3 Objective: L.O. 8-5
4) The MACRS of depreciation is used for income tax purposes and financial reporting purposes. Answer: FALSE Diff: 1 Objective: L.O. 8-5
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5) Financial reports for the Internal Revenue Service must abide by generally accepted accounting principles. Answer: FALSE Diff: 1 Objective: L.O. 8-5
6) Depreciation is a noncash expense and therefore not tax-deductible. Answer: FALSE Diff: 2 Objective: L.O. 8-5
Learning Objective 8.6 Questions 1) Which of the following statements is considered incorrect? A) Depreciation methods provide a systematic way to expense the cost of an asset, although this expense is not a negative cash flow. B) Depreciation is an allocation of the original cost of an asset to the periods in which the asset is used. C) Accumulated depreciation is the summation of the amount of the original cost of an asset already written off to expense in prior periods. D) Accumulated depreciation is not a pile of cash waiting to be used. E) Depreciation expense provides a means of setting aside cash for the replacement of an asset. Answer: E Diff: 2 Objective: L.O. 8-6
2) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the cash balance before taxes on December 31, 20X3, if Useful Organizing uses straight-line depreciation? A) $72,000 B) $76,900 C) $79,000 D) $81,100 E) $86,000 Answer: C Diff: 2 Objective: L.O. 8-6
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3) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the cash balance before taxes on December 31, 20X3, if Useful Organizing uses double-declining- balance depreciation? A) $64,000 B) $74,500 C) $79,000 D) $83,500 E) $94,000 Answer: C Diff: 2 Objective: L.O. 8-6
4) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the net cash provided by operating activities before taxes for 20X3, if Useful Organizing uses straight-line depreciation? A) $(74,000) B) $(67,000) C) $ 22,000 D) $ 25,000 E) $ 29,000 Answer: E Diff: 2 Objective: L.O. 8-6
5) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the net cash provided by operating activities before taxes for 20X3, if Useful Organizing uses double-declining-balance depreciation? A) $(81,000) B) $(67,000) C) $ 14,000 D) $ 25,000 E) $ 29,000 Answer: E Diff: 2 Objective: L.O. 8-6
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6) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the cash balance after taxes on December 31, 20X3, if Useful Organizing uses straight-line depreciation? A) $55,300 B) $72,400 C) $72,550 D) $94,050 E) $94,400 Answer: B Diff: 3 Objective: L.O. 8-6
7) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the cash balance after taxes on December 31, 20X3, if Useful Organizing uses double-declining-balance depreciation? A) $59,800 B) $74,500 C) $74,800 D) $88,800 E) $89,500 Answer: C Diff: 3 Objective: L.O. 8-6
8) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the net cash provided by operating activities after taxes for 20X3, if Useful Organizing uses straight-line depreciation? A) $ 6,600 B) $15,050 C) $15,400 D) $22,400 E) $22,550 Answer: D Diff: 3 Objective: L.O. 8-6
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9) Useful Organizing began operations on January 1, 20X3, when the owners invested $80,000 cash in the company. Also on January 1, the company paid for a $30,000 machine. The machine has a useful life of 4 years and a $2,000 residual value. During its first year of operations, the company had sales of $96,000 and operating expenses except depreciation of $67,000. All sales were cash sales and all non-depreciation operating expenses were paid in cash. Useful Organizing has a 30% tax rate and pays all taxes on December 31. What is the net cash provided by operating activities after taxes for 20X3, if Useful Organizing uses double-declining-balance depreciation? A) $ 6,860 B) $ 9,800 C) $10,500 D) $24,500 E) $24,800 Answer: E Diff: 3 Objective: L.O. 8-6
10) Depreciation expense generates cash. Answer: FALSE Diff: 1 Objective: L.O. 8-6
11) Using accelerated depreciation instead of straight-line depreciation results in a lower net income but a higher cash balance in the initial years of a fixed asset's life. Answer: TRUE Diff: 3 Objective: L.O. 8-6
12) Depreciation does not generate cash, but it does have a cash benefit if it results in lower taxes. Answer: TRUE Diff: 2 Objective: L.O. 8-6
13) On an after-tax basis, the choice of using accelerated or straight-line depreciation affects income but does not affect cash. Answer: FALSE Diff: 3 Objective: L.O. 8-6
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14) Tullot Industries began operations on January 1, 20X9. On that date, the owners invested $140,000 in the company, and acquired a $90,000 machine. The machine has a useful life of 5 years, and a residual value of $4,000. The company intends to depreciate the machine on a straight-line basis for financial reporting purposes. During 20X9, revenues, which were all in cash, totaled $630,000. All operating expenses, other than depreciation and all paid in cash, were $510,000. Tullot Industries has a 45% income tax rate. Given the above information, determine the following (round all answers to the nearest dollar): a. 20X9 Net income using straight-line depreciation b. 20X9 Net cash provided by operations using straight-line depreciation Answer: a. Sales $630,000 Operating expenses 510,000 Depreciation expense 17,200 Income tax expense 46,260 Net income $ 56,540 b. Collections from customers Operating expenses paid Income taxes paid Net cash provided by operating activities
$630,000 (510,000) (46,260) $ 73,740
Diff: 3 Objective: L.O. 8-6
Learning Objective 8.7 Questions 1) A major expenditure made to equipment that extends its useful life beyond the original estimate is journalized by A) debiting repairs expense. B) debiting depreciation expense. C) debiting equipment. D) crediting depreciation expense. E) crediting accumulated depreciation. Answer: C Diff: 2 Objective: L.O. 8-7
2) Which of the following activities can be classified as a betterment? A) waxing a car B) oil change on a car C) rotating tires on a car D) overhauling engine of a car E) changing windshield wipers on a car Answer: D Diff: 1 Objective: L.O. 8-7
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3) The expenditure for an improvement to equipment that would increase output is journalized by A) crediting accumulated depreciation. B) crediting depreciation expense. C) debiting depreciation expense. D) debiting equipment. E) debiting repair expense. Answer: D Diff: 2 Objective: L.O. 8-7
4) Suppose Hyton, Inc. purchases a $50,000 vehicle and estimates its useful life to be 8 years with a $2,000 salvage value. After 2 full years of use, Hyton, Inc. puts in a new engine costing $6,000 in the vehicle extending its life from a total of 8 years to a total of 10 years. The company uses straight-line depreciation. What is the depreciation expense in year 4? A) $5,500 B) $5,250 C) $4,750 D) $4,500 E) $5,000 Answer: B Diff: 2 Objective: L.O. 8-7
5) An improvement or betterment is an expenditure that is intended to add to the future benefits from an existing fixed asset. Answer: TRUE Diff: 2 Objective: L.O. 8-7
6) Businesses do not capitalize improvements. Answer: FALSE Diff: 1 Objective: L.O. 8-7
7) If an improvement increases operating efficiency, then the depreciation schedule is revised. Answer: TRUE Diff: 2 Objective: L.O. 8-7
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8) Elton Enterprises has recently upgraded its delivery truck. The various expenditures related to the upgrades occurred at the end of year 2 and are as follows: Item and amounts Capital expenditure/Operating expense 1) Oil changes, $20 _______________________ 2) All four tires on truck replaced, $800 _______________________ 3) Engine replacement, $900 _______________________ 4) Changed truck colors from blue to green, $500 _______________________ 5) Replaced brakes, $400 _______________________ Required: 1) Determine whether the expenditure is a capital improvement or ordinary operating expense. 2) Suppose the delivery truck with an original cost of $35,000 was being depreciated using straight line depreciation over 5 years and was expected to have a $3,000 residual value, however the upgrades are expected to increase the useful life from 5 years to 7 years. Based on the upgrades above, what is the revised depreciation expense for years 3 through 7? Answer: 1) Item and amounts Capital expenditure/Operating expense 1) Oil changes, $20 Operating expenses 2) All four tires on truck replaced, $800 Operating expenses 3) Engine replacement, $900 Capital expenditure 4) Changed truck colors from blue to green, $500 Operating expenses 5) Replaced brakes, $400 Operating expenses 2) Book value change = $35,000 - $12,800 = $22,200 (book value at the end of year 2) + $900 expenditures) = $23,100 - $3,000 = $20,100/5 years = $4,020 Diff: 2 Objective: L.O. 8-7
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(capital
Learning Objective 8.8 Questions 1) Appott Technologies recently sold some equipment for $6,800 cash. The equipment cost $23,000 and had accumulated depreciation through the date of sale totaling $17,250. The journal entry to record the sale of the equipment will include a A) credit to accumulated depreciation of $17,250. B) credit to equipment for $5,750. C) debit to gain on sale of equipment for $1,050. D) credit to gain on sale of equipment for $1,050. E) debit to depreciation expense for $17,250. Answer: D Diff: 2 Objective: L.O. 8-8
2) Equipment costing $20,000 with $17,800 of accumulated depreciation is sold for $2,500 cash. The journal entry will involve a A) debit to depreciation expense for $17,800. B) credit to depreciation expense for $17,800. C) credit to accumulated depreciation for $17,800. D) debit to accumulated depreciation for $17,800. E) debit to accumulated depreciation for $2,200. Answer: D Diff: 2 Objective: L.O. 8-8
3) Equipment costing $45,000 with a book value of $12,000 is sold for $21,500. The journal entry will involve a A) credit to accumulated depreciation for $14,900. B) debit to accumulated depreciation for $22,000. C) debit to accumulated depreciation for $33,000. D) credit to equipment for $22,000. E) credit to accumulated depreciation for $22,000. Answer: C Diff: 2 Objective: L.O. 8-8
4) AC Heating & Cooling uses the indirect method to prepare the statement of cash flows. During 2X03, AC Heating & Cooling had $100,000 in net income, which included a gain of $10,000 from the sale of a plant asset. To calculate operating cash flows, AC Heating & Cooling must A) deduct $10,000 from net income in the operating activities section of the statement of cash flows. B) add $10,000 to net income in the operating activities section of the statement of cash flows. C) deduct $10,000 from net income in the investing section of the statement of the statement of cash flows. D) add $10,000 to net income in the investing section of the statement of cash flows. E) deduct $10,000 from net income in the financing section of the statement of cash flows. Answer: A Diff: 2 Objective: L.O. 8-8
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5) The sale of a plant asset may result in a gain but not a loss. Answer: FALSE Diff: 2 Objective: L.O. 8-8
6) A gain will result when the cash received from the sale of a plant asset exceeds the book value of the asset. Answer: TRUE Diff: 2 Objective: L.O. 8-8
7) A loss will result on the sale of a plant asset when the book value of the asset exceeds the cash received. Answer: TRUE Diff: 2 Objective: L.O. 8-8
8) Gains or losses on sales of tangible plant assets are usually measured by the difference between the cash received and the net book value of the asset given up. Answer: TRUE Diff: 2 Objective: L.O. 8-8
9) Gains on disposal of plant assets are generally shown as "other income" on the income statement. Answer: TRUE Diff: 2 Objective: L.O. 8-8
10) Exam Laboratories gathered the following data for the year ended December 31, 20X3, related to its equipment. Accumulated Equipment Depreciation, Equipment January 1, 20X3, balance $85,000 $40,000 Total debits to the account 55,000 ? Total credits to the account ? 51,000 December 31, 20X3, balance 92,000 56,000 Based on the above data, prepare the journal entry to record the sale of equipment during the year for $11,500 cash. Answer: Cash 11,500 Loss on Sale of Equipment 1,500 Accumulated Depreciation, Equipment 35,000 Equipment 48,000 Diff: 2 Objective: L.O. 8-8
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11) On January 1, 2009, First Bank acquired 10 cars for company use. The cost of each car was $15,000 and the bank estimated that each car would have a 4-year useful life and a residual value of $2,000. Required: a. Provide the journal entry needed on December 31, 2010, if four cars were sold for a total of $17,500 and First Bank uses double-declining-balance depreciation. b. Provide the journal entry needed on December 31, 2010, if four cars were sold for a total of $17,500 and First Bank uses straight-line depreciation. c. Assume instead of the above information that on December 31, 2010, one of the cars was wrecked. Provide the journal entry needed on December 31, 2010, if First Bank's insurance company paid $2,900 for the wrecked car and the company uses straight-line depreciation. Answer: a. Cash 17,500 Accumulated Depreciation, Cars 45,000 Gain on Sale of Cars 2,500 Cars 60,000 b. Cash 17,500 Accumulated Depreciation, Cars 26,000 Loss on Sale of Cars 16,500 Cars 60,000 c. Cash 2,900 Accumulated Depreciation, Cars 6,500 Loss on Ins Reimbursement 5,600 Cars 15,000 Diff: 3 Objective: L.O. 8-8
Learning Objective 8.9 Questions 1) Companies electing to revalue their fixed assets under IFRS are allowed to A) only increase the carrying value of the fixed asset. B) only decrease the carrying value of the fixed asset. C) only increase the historical cost of the fixed asset. D) only decrease the historical cost of the fixed asset. E) increase or decrease the carrying value of the fixed asset. Answer: E Diff: 2 Objective: L.O. 8-9
2) If land was acquired many years ago, and inflation has occurred over time, the value of the land on the financial statements should be increased to reflect some of the change in the land's valuation. However, the land will still be valued at a relatively conservative amount. The company does not follow IFRS. Answer: FALSE Diff: 1 Objective: L.O. 8-9
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3) Once a company begins to make revaluation adjustments for plant assets, it must continue to make them. Answer: TRUE Diff: 1 Objective: L.O. 8-9
Learning Objective 8.10 Questions 1) The entry to journalize the impairment loss on equipment would include A) debit Accumulated Depreciation, Equipment. B) credit Accumulated Depreciation, Equipment. C) credit impairment loss. D) debit Equipment. E) credit Equipment. Answer: B Diff: 1 Objective: L.O. 8-10
2) A recoverability test for impairment A) is based on the discounted present value of the future cash flows from the asset. B) requires SEC approval. C) establishes that the asset is impaired. D) only occurs when the asset is sold. E) identifies the write-up value. Answer: C Diff: 2 Objective: L.O. 8-10
3) Fairfield Company determines the following information at year end about a piece of equipment that has a net book value of $75,000. Assume the equipment will not be for sale. Present value of future expected net cash flows $52,500 Undiscounted future expected cash flows 63,500 The impairment loss is A) $22,500 B) $63,500 C) $15,500 D) $11,500 E) $52,500 Answer: A Diff: 3 Objective: L.O. 8-10
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4) Following U.S. GAAP, land is carried at historical cost A) at all times. B) never. C) unless the fair value of the land has decreased below the original cost and the land meets the recoverability test. D) unless the fair value of the land has increased above the original cost and the land meets the recoverability test. E) none of the above Answer: C Diff: 1 Objective: L.O. 8-10
5) If the net present value of the expected cash flows from the use of the asset and its disposal is greater than the carrying value of an asset, then the asset is considered to be impaired. Answer: FALSE Diff: 2 Objective: L.O. 8-10
6) A recoverability test is necessary to determine if an asset is impaired. Answer: TRUE Diff: 1 Objective: L.O. 8-10
7) When computing an impairment loss for a tangible asset, the market price shall be the fair value unless no active market exists for the asset. Answer: TRUE Diff: 1 Objective: L.O. 8-10
8) Explain the concept of asset impairment. Include in your discussion the process of computing the impairment. Answer: An asset is considered to be impaired when it ceases to have economic value to the company at least as large as the carrying value (book value) of the asset. There are two steps in determining asset impairment. The first step is a recoverability test that compares the undiscounted expected future net cash flows from the use of the asset and its eventual disposal to the carrying value of the asset. If the undiscounted future net cash flows are less than the carrying value, then the asset is impaired. The impairment loss is equal to the difference between the carrying value of the asset and its fair value. Diff: 2 Objective: L.O. 8-10
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Learning Objective 8.11 Questions 1) Which statement is FALSE? A) The economic life of an intangible asset does not always equal its legal life. B) The cost of developing an intangible asset internally is capitalized as an asset. C) Intangible assets are similar to fixed assets, in that their acquisition costs are capitalized as assets, and this cost is expensed over their estimated useful lives. D) Intangible assets are long-lived assets that are not physical in nature. E) Examples of intangible assets include patents, copyrights, and goodwill. Answer: B Diff: 2 Objective: L.O. 8-11
2) Amortization of an intangible asset is similar to which depreciation method? A) Units-of-production depreciation B) Straight-line C) Double-declining balance D) MACRS E) None of the above Answer: B Diff: 1 Objective: L.O. 8-11
3) Which statement is FALSE? A) An example of a leasehold improvement would be the installation of new paneling, walls, and a window air conditioner. B) The lessee must select the shorter of either the useful life of the leasehold improvement or the remaining life of the lease to amortize the leasehold improvement. C) Although they are technically intangible assets, leaseholds are frequently classified with plant assets on the balance sheet. D) A leasehold is a right to use a fixed asset for a specified period of time beyond one year. E) Leasehold improvements are subject to depletion. Answer: E Diff: 2 Objective: L.O. 8-11
4) In contrast to long-lived tangible assets, U.S. GAAP does not require ________ for indefinite-life intangible assets. A) a fair value test B) a recoverability test C) a historical cost test D) a present value test E) a future value test Answer: B Diff: 2 Objective: L.O. 8-11
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5) Amortization expense is computed in the same manner as straight-line depreciation. Answer: TRUE Diff: 2 Objective: L.O. 8-11
6) Trademarks are distinctive identifications of a manufactured product or of a service, taking the form of a name, a sign, a slogan, a logo, or an emblem. Answer: TRUE Diff: 1 Objective: L.O. 8-11
7) The acquisition costs for intangible assets are capitalized as assets and are then gradually amortized over the estimated useful lives of the assets. Answer: TRUE Diff: 2 Objective: L.O. 8-11
8) Franchises and licenses are legal contracts that grant the buyer the right to sell a product or service. Answer: TRUE Diff: 2 Objective: L.O. 8-11
9) A leasehold is the right to use a fixed asset for a specified period of time beyond one year. Answer: TRUE Diff: 1 Objective: L.O. 8-11
10) A privilege granted by a manufacturer or distributor to sell a product or service in accordance with specified conditions is termed a franchise. Answer: TRUE Diff: 1 Objective: L.O. 8-11
11) Research and development costs are expensed on the income statement as opposed to being capitalized on the balance sheet. Answer: TRUE Diff: 2 Objective: L.O. 8-11
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12) Formula Results signed a 10-year lease for a store in the best mall in the area. At the beginning of the seventh year of the lease, the company decided to refurbish the store. The following expenditures were made: Item Cost Useful Life Carpeting $ 6,000 3 years Lighting Fixtures $ 4,500 6 years Wall Construction $10,000 8 years All items were paid in cash. There is no residual value for any of the items noted above. a. Prepare the journal entry to record the expenditures of the above items. b. Prepare the year-end adjustment to record the expense associated with the above items. Answer: a. Leasehold Improvements 20,500 Cash 20,500 b. Amortization Expense 5,625 Leasehold Improvements* 5,625 * Carpeting $2,000 Lighting Fixtures 1,125 Wall Construction 2,500 $5,625 Diff: 2 Objective: L.O. 8-11
13) Consider each event concerning intangible assets independently: a. Moonlit Corporation purchased a patent for $476,000 on January 1, 20X3. The company paid cash. The patent has a remaining legal life of 14 years. Due to anticipated technological change, it is expected that the patent will be useless in 5 years. b. In 20X3, Beaumont Company spent $3,500,000 cash in research and development costs. However, the research did not result in a patent. Beaumont Company acquired a patent from another company for $1,000,000 on January 1, 20X3. The company paid cash. The acquired patent is expected to last 8 years. Prepare all journal entries necessitated by events in a. and b. above during the year 20X3. Answer: a. Patent 476,000 Cash 476,000 Amortization Expense 95,200 Patent 95,200 b. Research and Development Expense 3,500,000 Cash 3,500,000 Patent 1,000,000 Cash 1,000,000 Amortization Expense 125,000 Patent 125,000 Diff: 2 Objective: L.O. 8-11
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Learning Objective 8.12 Questions 1) Jets Company buys Pack Company for $11 million. Pack Company has assets with a fair value of $9 million and liabilities with a fair value of $2 million. Pack's stockholders' equity is recorded at $6 million. What goodwill should Jets Company record? A) $10 million B) $8 million C) $4 million D) $2 million E) $0 million Answer: C Diff: 2 Objective: L.O. 8-12
2) Xavier Enterprises has $500,000 of goodwill on the balance sheet. The company determines that an impairment has occurred for $100,000. Xavier Enterprises should A) recompute the original purchase and restate all subsequent statements. B) debit goodwill for $100,000. C) credit goodwill for $100,000. D) debit goodwill for $400,000. E) credit goodwill for $400,000. Answer: C Diff: 2 Objective: L.O. 8-12
3) Wall Outlets, Inc. has $600,000 of goodwill on the balance sheet from The Plug Company which was purchased 5 years ago. The goodwill amortization this year should be A) $150,000. B) $120,000. C) $140,000. D) $80,000. E) $0. Answer: E Diff: 2 Objective: L.O. 8-12
4) Goodwill is recognized when A) assets exceed liabilities B) liabilities exceed stockholders equity C) the purchase price for a company exceeds the difference between the fair value of assets and the fair value of liabilities of the company acquired D) the purchase price for a company exceeds the difference between the fair value of assets and the fair value of stockholders equity of the company acquired E) the purchase price for a company exceeds the difference between the fair value of the liabilities and the fair value of stockholders' equity of the company acquired Answer: C Diff: 2 Objective: L.O. 8-12
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5) Goodwill occurs when the purchase price of a company exceeds the fair value of all identifiable individual assets less total liabilities. Answer: TRUE Diff: 1 Objective: L.O. 8-12
6) U.S. GAAP requires the immediate write-off of goodwill at purchase. Answer: FALSE Diff: 2 Objective: L.O. 8-12
7) A goodwill write-off is a noncash expense. Answer: TRUE Diff: 1 Objective: L.O. 8-12
Learning Objective 8.13 Questions 1) Scone Industries acquired a gold mine for $8,000,000. It is estimated that 40,000 ounces of gold can be extracted from the mine. In the first year of operations, 15,000 ounces of gold were extracted. Scone Industries would recognize A) an increase in net income of $3,000,000. B) depreciation expense of $3,000,000. C) cost of goods sold of $3,000,000. D) amortization expense of $3,000,000. E) depletion expense of $3,000,000. Answer: E Diff: 2 Objective: L.O. 8-13
2) In 20X3, Little Yard Oil, Inc., purchased drilling rights for $1,000,000. At the time, the engineer estimated 20,000 barrels of oil in the field. In 20X4, 4,000 barrels were pumped and in 20X5, 5,000 barrels were pumped. Which entry below is correct? A) Credit inventory of $200,000 in 20X3 B) Debit depreciation expense of $250,000 in 20X4 C) Debit cost of goods sold of $200,000 in 20X4 D) Debit depletion expense of $250,000 in 20X5 E) Debit amortization expense of $200,000 in 20X3 Answer: D Diff: 2 Objective: L.O. 8-13
3) Platak, Inc., acquired a silver mine for $4,000,000. The company's survey estimates that 40,000 ounces of silver can be extracted from the mine, but environmental costs to close the mine will be $1,000,000. In the first year of operations, 15,000 ounces of silver were extracted. Platak, Inc., would recognize A) depletion expense of $1,500,000. B) depreciation expense of $1,500,000. C) depletion expense of $1,875,000. D) amortization expense of $1,875,000. 43 ..
E) environmental expense of $1,000,000. Answer: C Diff: 2 Objective: L.O. 8-13
4) Depletion expense is computed in the same manner as straight-line depreciation. Answer: FALSE Diff: 2 Objective: L.O. 8-13
5) Depletion follows a units-of-production approach. Answer: TRUE Diff: 2 Objective: L.O. 8-13
6) The process of allocating the cost of natural resources to the periods in which the resources are used is termed amortization. Answer: FALSE Diff: 1 Objective: L.O. 8-13
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Introduction to Financial Accounting, 11e (Horngren) Chapter 9 Liabilities and Interest Learning Objective 9.1 Questions 1) A liability is created A) when merchandise is purchased with cash. B) when owners invest in a company. C) when merchandise is sold on account. D) when salary expense is recognized before employees are paid. E) when rent is paid in advance. Answer: D Diff: 1 Objective: L.O. 9-1
2) Liabilities that fall due more than 1 year beyond the balance sheet date are A) long-term liabilities. B) delinquent liabilities. C) current liabilities. D) risky liabilities. E) contingent liabilities. Answer: A Diff: 1 Objective: L.O. 9-1
3) Examples of a current liability include all of the following except: A) Prepaid rent. B) Accrued income taxes payable. C) Accrued wages payable. D) Current portion of long-term debt. E) Accounts payable. Answer: A Diff: 1 Objective: L.O. 9-1
4) A written promise to repay a loan principal plus interest at a specific future date is A) a promissory note. B) a line of credit. C) commercial paper. D) a product warranty. E) a returnable deposit. Answer: A Diff: 1 Objective: L.O. 9-1
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5) Palto Industries pays its employees monthly. Payroll information follows: 1. The monthly gross salary for all its employees is $85,000. Palto Industries withholds 20% of the employees' gross salary for federal taxes, 6.5% for state taxes, and 7.5% for Social Security (FICA) taxes. 2. Palto Industries incurs other employee-related costs. Specifically, the company must (1) match the Social Security taxes withheld from the employees, (2) contribute 3% of the employees' gross pay to the employees' pension fund, and (3) pay 5% of the employees' gross pay for health insurance premiums on behalf of the employees. What is the journal entry to be made by Palto Industries for the gross pay and withholdings for their monthly payroll? Assume salaries will be paid two days after the journal entry. A) Compensation Expense 85,000 Salaries and Wages Payable 85,000 B) Compensation Expense 85,000 Federal Income Tax Withholding Payable 17,000 State Income Tax Withholding Payable 5,525 Social Security Withholding Payable 6,375 Salaries and Wages Payable 56,100 C) Compensation Expense 85,000 Tax Expense 28,900 Federal Tax Withholding Payable 17,000 State and FICA Tax Withholding Payable 11,900 Salaries and Wages Payable 85,000 D) Compensation Expense 85,000 Federal Tax Expense 17,000 State Tax Expense 5,525 Social Security Tax Expense 6,375 Salaries and Wages Payable 113,900 E) Compensation Expense 113,900 Federal Tax Withholding Payable 17,000 State Tax Withholding Payable 5,525 Social Security Tax Withholding Payable 6,375 Salaries and Wages Payable 85,000 Answer: B Diff: 3 Objective: L.O. 9-1
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6) Palto Industries pays its employees monthly. Payroll information follows: 1. The monthly gross salary for all its employees is $85,000. Palto Industries withholds 20% of the employees' gross salary for federal taxes, 6.5% for state taxes, and 7.5% for Social Security (FICA) taxes. 2. Palto Industries incurs other employee-related costs. Specifically, the company must (1) match the Social Security taxes withheld from the employees, (2) contribute 3% of the employees' gross pay to the employees' pension fund, and (3) pay 5% of the employees' gross pay for health insurance premiums on behalf of the employees. What is the journal entry to be made by Palto Industries for the accrual of payroll taxes for their monthly payroll? A) Employee Benefit Expense 13,175 Employer Social Security Payable 6,375 Pension Liability Payable 2,550 Health Insurance Payable 4,250 B) Compensation Expense 13,175 Employer Social Security Payable 6,375 Pension Liability Payable 2,550 Health Insurance Payable 4,250 C) Prepaid Employee Benefits 13,175 Employer Social Security Payable 6,375 Pension Liability Payable 2,550 Health Insurance Payable 4,250 D) Unearned Employee Benefits 13,175 Employer Social Security Payable 6,375 Pension Liability Payable 2,550 Health Insurance Payable 4,250 E) Compensation Expense 13,175 Employer Social Security Payable 6,375 Pension Withholding Payable 2,550 Health Insurance Withholding Payable 4,250 Answer: A Diff: 3 Objective: L.O. 9-1
7) A debt contract issued by prominent companies that allow the companies to borrow directly from investors is A) a promissory note. B) a line of credit. C) commercial paper. D) product warranties. E) returnable deposits. Answer: C Diff: 1 Objective: L.O. 9-1
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8) Master Printers, Inc. has a temporary shortfall of cash, but needs to pay its employees tomorrow. What will Master Printers, Inc., most likely do to obtain the cash? A) Go to a bank and sign a promissory note for the funds needed B) Issue commercial paper in hopes that creditors will loan the company the needed funds C) Offer a 1-day incentive to salespersons in order to increase sales and cash D) Ask employees to wait until the company has the funds to pay them E) Borrow money from their line of credit Answer: E Diff: 2 Objective: L.O. 9-1
9) Cref, Inc., estimated at January 1, 20X3, that its income before taxes for the year ended December 31, 20X3, would be $600,000. Cref, Inc.'s tax rate for the year is 40%. The company made quarterly tax payments on April, June, September, and December 15. The actual income before taxes for the year ended December 31, 20X3, for Cref, Inc., was $620,000. What was the balance in the income tax payable account at December 31, 20X3 after payment of yearly taxes? A) $0 B) $8,000 C) $15,000 D) $10,000 E) $20,000 Answer: B Diff: 2 Objective: L.O. 9-1
10) Slinger Company estimated at January 1, 20X9, that its income before taxes for the year ended December 31, 20X9, would be $5,500,000. Slinger Company's tax rate for the year is 42%. The company made quarterly tax payments on April, June, September, and December 15. The actual income before taxes for the year ended December 31, 20X9, for the Slinger Company was $5,700,000. What was the balance in the income tax payable account at December 31, 20X9? A) $0 B) $84,000 C) $100,000 D) $144,000 E) $200,000 Answer: B Diff: 2 Objective: L.O. 9-1
11) The current portion of long-term debt represents A) the amount of principal on long-term debt that comes due in the coming year. B) the amount of long-term debt that appears in the noncurrent liability section of the balance sheet. C) the amount of interest that comes due in the coming year. D) a short-term loan from a bank that has also granted a long-term loan. E) the amount of principal and interest that comes due within a coming year. Answer: A Diff: 2 Objective: L.O. 9-1
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12) Sales tax A) is a tax on sales and is an expense to the company who collects it. B) is collected from the customer and remitted to the state or local government. C) is paid daily to the state or local government and, thus, never appears as a payable. D) is classified as a long-term payable on the balance sheet. E) is not collected from customers. Answer: B Diff: 2 Objective: L.O. 9-1
13) Annual Operations Company operates in a state where there is a 6% sales tax. If a customer pays cash for merchandise with a sales price of $500, Annual Operations would record the transaction using which of the following journal entries? A) Cash 500 Sales 500 B) Cash 500 Sales Tax Payable 30 Sales 470 C) Cash 500 Sales Tax Expense 30 Sales Tax Payable 30 Sales 500 D) Cash 530 Sales Tax Payable 30 Sales 500 E) Cash 530 Sales Tax Expense 30 Sales Tax Payable 30 Sales 530 Answer: D Diff: 2 Objective: L.O. 9-1
14) Smith Lots, Inc., operates in a state where there is a 6% sales tax. If a customer pays cash for merchandise with a sales price of $500, what effect will this transaction have on Smith Lots' balance sheet? (Ignore the effect on cost of goods sold.) A) Assets increase by $530, current liabilities increase by $30, and stockholders' equity increases by $500. B) Assets increase by $500, and stockholders' equity increases by $500. C) Assets increase by $500, long-term liabilities increase by $30, and stockholders' equity increases by $500. D) Assets increase by $500, current liabilities increase by $30, and stockholders' equity increases by $470. E) Assets increase by $530, long-term liabilities increase by $30, and stockholders' equity increases by $500. Answer: A Diff: 3 Objective: L.O. 9-1
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15) Talk Unlimited began business on January 1, 2003. The company manufactures and sells cell phones cases. The company provides a warranty on its units, whereby the company will replace any defective case for two years after the sale, at no additional cost to the customer. During 2003, Talk Unlimited had sales of $850,000. The company estimates that the cost of the warranties will be 2% of sales. No warranty claims were made in 2003. During 2004, warranty claims of $15,700 were made. All warranty claims were satisfied and paid for. What journal entry, if any, is necessary for 2003 by Talk Unlimited? A) No journal entry is necessary. B) Prepaid Warranty 17,000 Liability for Warranties 17,000 C) Warranty Expense 17,000 Liability for Warranties 17,000 D) Warranty Expense 17,000 Warranty Sales 17,000 E) Warranty Expense 17,000 Unearned Warranties 17,000 Answer: C Diff: 2 Objective: L.O. 9-1
16) Talk Unlimited began business on January 1, 2003. The company manufactures and sells cell phones cases. The company provides a warranty on its units, whereby the company will replace any defective case for two years after the sale, at no additional cost to the customer. During 2003, Talk Unlimited had sales of $850,000. The company estimates that the cost of the warranties will be 2% of sales. No warranty claims were made in 2003. During 2004, warranty claims of $15,700 were made. All warranty claims were satisfied and paid for. What journal entry, if any, is necessary for 2004 by Talk Unlimited? A) No journal entry is necessary. B) Liability for Warranties 15,700 Inventory 15,700 C) Prepaid Warranties 15,700 Inventory 15,700 D) Warranty Expense 15,700 Inventory 15,700 E) Unearned Warranties 15,700 Inventory 15,700 Answer: B Diff: 2 Objective: L.O. 9-1
17) Which of the following statements is false? A) Well-known examples of returnable deposits are those for returnable containers such as soft-drink bottles and beer kegs. B) Companies that receive deposits record them as a form of receivable. C) The account, Deposits Payable, is a current liability of the company receiving the deposit. D) Ordinarily, the recipient of the cash deposit may use the cash for investment purposes from the date of deposit to the date of its return to the depositor. E) None of the above Answer: B Diff: 2 Objective: L.O. 9-1
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18) Unearned revenues A) are considered to be a type of revenue. B) are revenues that are collected before services or goods are delivered. C) normally have a debit balance. D) are credited when the sales revenue is finally earned. E) include cash donations made to universities from wealthy alumni. Answer: B Diff: 2 Objective: L.O. 9-1
19) T.J. West, publishes the Bunstelle Times. In June, he collected $96 in advance for 1-year subscriptions. He delivered the first issue in July. Assume one issue is published per month. The journal entry to record the delivery of the magazines in July would be A) Cash 8.00 Subscription Revenue 8.00 B) Unearned Subscription Revenue 8.00 Subscription Revenue 8.00 C) Prepaid Subscriptions 8.00 Subscription Revenue 8.00 D) Prepaid Subscriptions 8.00 Cash 8.00 E) Cash 8.00 Prepaid Subscriptions 8.00 Answer: B Diff: 2 Objective: L.O. 9-1
20) Sally publishes the Sunshine News. In March, she collected $600 in advance for 1-year subscriptions. The journal entry to record the receipt of $600 in March would be A) Cash 600.00 Subscription Revenue 600.00 B) Prepaid Subscriptions 600.00 Subscription Revenue 600.00 C) Prepaid Subscriptions 600.00 Cash 600.00 D) Cash 600.00 Unearned Subscriptions Revenue 600.00 E) Unearned Subscription Revenue 600.00 Subscription Revenue 600.00 Answer: D Diff: 2 Objective: L.O. 9-1
21) The portion of a long-term liability that is due within a year is still included in the long-term liability section of the balance sheet. Answer: FALSE Diff: 1 Objective: L.O. 9-1
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22) A line of credit is a written promise to repay the loan principal plus interest at a specific future date. Answer: FALSE Diff: 1 Objective: L.O. 9-1
23) A promissory note is an agreement with a bank to provide automatically short-term loans up to some pre-established maximum amount. Answer: FALSE Diff: 1 Objective: L.O. 9-1
24) Commercial paper is a debt contract issued by prominent companies that borrow directly from investors. Answer: TRUE Diff: 1 Objective: L.O. 9-1
25) Expenses that have been incurred and recognized on the income statement but not yet paid are accrued liabilities. Answer: TRUE Diff: 1 Objective: L.O. 9-1
26) A company's portion of long-term debt that includes payments due within a year should be reclassified as a current liability. Answer: TRUE Diff: 2 Objective: L.O. 9-1
27) Warranty costs are expensed at the time the item covered by the warranty is sold. Answer: TRUE Diff: 2 Objective: L.O. 9-1
28) Income tax withholdings and Social Security withholdings are a type of payroll tax that is an expense to the employer. Answer: FALSE Diff: 2 Objective: L.O. 9-1
29) Revenue collected in advance is usually a current asset. Answer: FALSE Diff: 1 Objective: L.O. 9-1
30) If warranty obligations are material, they must be accrued when products are sold because the obligation arises then, not when the actual repair services are performed. Answer: TRUE Diff: 2 Objective: L.O. 9-1
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31) Revenues that are collected before services or goods are delivered are called unearned revenue under accrual accounting. Answer: TRUE Diff: 1 Objective: L.O. 9-1
32) Deposits to a bank by customers are considered to be current liabilities by the bank. Answer: TRUE Diff: 1 Objective: L.O. 9-1
33) Corporations pay taxes in one lump sum at the end of the year. Answer: FALSE Diff: 1 Objective: L.O. 9-1
34) The journal entry to reclassify a noncurrent liability as a current liability includes a debit to the current portion of long-term obligations. Answer: FALSE Diff: 2 Objective: L.O. 9-1
35) A company selling merchandise in a state charging 6% sales tax would debit sales tax expense for 6% of gross revenue each time a sale is recorded. Answer: FALSE Diff: 2 Objective: L.O. 9-1
36) Unearned sales revenue is debited when a business receives cash in advance of performing services. Answer: FALSE Diff: 2 Objective: L.O. 9-1
37) Clean Out Clutter is located in a state where the sales tax is 7 1/4%. Total sales for the month of February were $104,000, all of which were subject to sales tax. a. Prepare a journal entry that summarizes sales (all in cash) for the month. b. Prepare a journal entry regarding the disbursement for the sales tax. Answer: a. Cash 111,540 Sales Revenue 104,000 Sales Tax Payable 7,540 b. Sales Tax Payable 7,540 Cash 7,540 Diff: 1 Objective: L.O. 9-1
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38) At the beginning of 20X3, Shingles Roofing had a liability for warranties of $7,000 on the books. During 20X3, Shingles Roofing had sales of $310,000. The company estimates that the cost of servicing products under warranty will average 2.5% of sales. Expenditures (all in cash) to satisfy warranty claims during 20X3 were $6,200, of which $2,500 was for products sold in 20X3. a. Prepare the journal entries for sales revenue and the related warranty expense for 20X3. Assume all sales are for cash. b. Prepare the journal entry for the warranty expenditures. c. Compute the December 31, 20X3, ending balance in the Liability for Warranties account. Answer: a. Cash 310,000 Sales Revenue 310,000 Warranty Expense 7,750 Liability for Warranties 7,750 b. Liability for Warranties 6,200 Cash 6,200 c. Beginning balance $7,000 Additions for 20X3 sales 7,750 Reductions for claims met (6,200) Ending balance $8,550 Diff: 2 Objective: L.O. 9-1
39) For the week ended May 16, Cheap Printing Company had a total payroll of $183,000. Three items are withheld from employee's paychecks: (1) Social Security (FICA) tax of 7.1% of payroll; (2) income taxes, which average 20% of the payroll; and (3) employees' savings that are deposited in their credit union, which are $12,020. In addition, Cheap Printing Company pays (1) Social Security tax equal to the amount withheld from employees, (2) health insurance premiums of $12,750, and (3) contributions to the employees' pension fund of $17,000. Prepare the journal entries to record the compensation expense and the employee benefit expense. Answer: Compensation Expense 183,000 Salaries & Wages Payable 121,387 Social Security Withholding Payable 12,993 Income Tax Withholding Payable 36,600 Credit Union Withholding Payable 12,020 Employee Benefit Expense Employer Social Security Payable Health Insurance Premium Payable Pension Liability Payable
42,743 12,993 12,750 17,000
Diff: 2 Objective: L.O. 9-1
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40) Manituc Beading, which resides in a 5% sales tax county, sold $13,000 worth of beads to customers in January, 2X03 for cash. The company uses the periodic inventory system. Since beads were difficult to carry home, Manituc Beading offered a convenient carrying case for customers to use with the stipulation that it should be returned by the end of the month of the original sale. If customers did not return the case by January 31, 2X03, Manituc Beading's agreement was to keep the deposit money. Customers paid $200 cash in carrying case deposits during January, 2X03 and Manituc Beading returned $170 of the money to customers by January 31, 2X03. In addition, although Manituc Beading rarely encounters batches of defective beads, it does occur on occasion. Manituc Beading estimates .5% of sales to be returned as defective, and offers a cash refund warranty for one year after purchase. Required: 1. Prepare the journal entry to record sales and sales tax for January, 2X03. 2. Prepare the journal entry to record returnable deposit money received in January, 2X03. 3. Prepare the journal entry to record deposit money returned to customers and the portion of the deposit money kept by Manituc Beading. 4. Prepare the journal entry to record estimated product warranties. Answer: 1. Cash 13,650 Sales revenue 13,000 Sales tax liability 650 2. Cash 200 Deposits payable 200 3. Deposits payable 200 Cash 170 Revenue 30 4. Warranty expense 65 Liability for warranties 65 Diff: 2 Objective: L.O. 9-1
41) Nunn Industries had the following items on its December 31, 20X3, balance sheet: Cash and cash equivalents $56,230 Accounts payable 96,640 Inventories 60,790 Additional paid-in capital 51,690 Accrued liabilities and expenses 94,100 Payments due within 1 year on long-term debt 35,380 Short-term debt 39,030 Long-term debt 97,290 Required: Prepare the current liabilities section of Nunn Industries' balance sheet. Answer: Current Liabilities: Accounts payable $ 96,640 Accrued liabilities and expenses 94,100 Payments due within 1 year on long-term debt 35,380 Short term debt 39,030 Total current liabilities $265,150 Diff: 2 Objective: L.O. 9-1
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Learning Objective 9.2 Questions 1) ________ are a form of long-term debt that is secured by the pledge of specific property. A) Convertible bonds B) Mortgage bonds C) Callable bonds D) Sinking fund bonds E) Debentures Answer: B Diff: 2 Objective: L.O. 9-2
2) ________ are bonds whose holders have claims against only the assets that remain after the claims of the more senior general creditors are satisfied. A) Subordinated debentures B) Mortgage bonds C) Callable bonds D) Sinking fund bonds E) Convertible bonds Answer: A Diff: 2 Objective: L.O. 9-2
3) ________ are subject to redemption before maturity at the option of the issuer. A) Debentures B) Mortgage bonds C) Callable bonds D) Sinking fund bonds E) Convertible bonds Answer: C Diff: 2 Objective: L.O. 9-2
4) Convertible bonds are attractive to investors because A) the issuing company cannot retire the bonds before maturity. B) they can be converted into stock by the issuing company. C) they usually carry a higher rate of interest than non-convertible bonds. D) they usually carry a lower rate of interest than non-convertible bonds. E) they can be converted into stock at the holder's option. Answer: E Diff: 2 Objective: L.O. 9-2
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5) Bonds are often called ________ financial instruments or securities because they can be transferred from one lender to another. A) private placement B) negotiable C) current liability D) long term liability E) sinking fund Answer: B Diff: 1 Objective: L.O. 9-2
6) Bonds are typically sold through A) board of directors. B) underwriters. C) corporations. D) commercial insurance companies. E) None of the above Answer: B Diff: 1 Objective: L.O. 9-2
7) The excess of a bond's issue price over its face value is known as the A) discount. B) effective interest amount. C) coupon interest amount. D) premium. E) contingent liability. Answer: D Diff: 1 Objective: L.O. 9-2
8) The interest rate that determines the amount of cash paid for interest to the bondholder is referred to as the A) effective rate. B) market rate. C) coupon rate. D) daily rate. E) imputed rate. Answer: C Diff: 1 Objective: L.O. 9-2
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9) The cash proceeds received from issuing a bond are less than the face value of the bond. It is apparent that the bond was issued at A) face value. B) a premium. C) a discount. D) par value. E) nominal value. Answer: C Diff: 2 Objective: L.O. 9-2
10) As the market rate of interest rises above the nominal or stated interest rate for a bond, the market price of the bond will A) stay the same. B) fall. C) rise. D) Cannot be determined without more information E) go in sync with the stock's price. Answer: B Diff: 2 Objective: L.O. 9-2
11) When the market interest rate is 13% and the coupon rate is 10%, a bond sells at A) a discount. B) a premium. C) par. D) liquidation value. E) Cannot be determined without more information Answer: A Diff: 2 Objective: L.O. 9-2
12) Bond interest payments are typically made A) annually. B) semiannually. C) monthly. D) quarterly. E) weekly. Answer: B Diff: 1 Objective: L.O. 9-2
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13) When the market interest rate is 7% and the coupon rate is 10%, a bond sells at A) a discount. B) a premium. C) par. D) liquidation value. E) Cannot be determined without more information Answer: B Diff: 2 Objective: L.O. 9-2
14) If a $10,000 bond, with a 12% coupon rate, is trading at 100, what can be said about the current price and current yield of the bond? A) Current Price Current Yield $10,000 Greater than 12% B) Current Price Current Yield $10,000 Equal to 12% C) Current Price Current Yield $10,000 Less than 12% D) Current Price Current Yield $11,200 Equal to 12% E) Current Price Current Yield $11,200 Less than 12% Answer: B Diff: 2 Objective: L.O. 9-2
15) Which statement is false? A) The periodic interest payment on a bond is based upon the market rate of interest. B) Typically when a company issues a bond, the company will sell the bonds to an underwriter, who in turn sells the bonds to the general public. C) The nominal rate of interest and the market rate of interest are usually different on the date the bond is issued. D) If a bond is sold at a price that is greater than face value, it is said to be sold at a premium. E) If a bond is sold at a price that is less than face value, it is said to be sold at a discount. Answer: A Diff: 2 Objective: L.O. 9-2
16) A debenture is a debt security with a general claim against the company's total assets, rather than against a particular asset. Answer: TRUE Diff: 2 Objective: L.O. 9-2
17) Protective covenants are provisions in a bond that are intended to protect the shareholders' interests. Answer: FALSE Diff: 1 Objective: L.O. 9-2
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18) A callable bond is one in which the bondholder can sell the bond back to the company, even if the company does not want the bond returned. Answer: FALSE Diff: 2 Objective: L.O. 9-2
19) Notes and bonds are common financial contracts that businesses use to raise money. Answer: TRUE Diff: 1 Objective: L.O. 9-2
20) Negotiable instruments are legal financial contracts that can be transferred from one lender to another. Answer: TRUE Diff: 1 Objective: L.O. 9-2
21) Debenture bonds may be subordinated, which means that their interest rates may vary depending on the prime rate. Answer: FALSE Diff: 1 Objective: L.O. 9-2
22) A protective covenant is a contract whereby the issuing corporation of a bond promises that it will abide by stated provisions. Answer: TRUE Diff: 2 Objective: L.O. 9-2
23) Sinking fund bonds require the issuer to make annual payments into a sinking fund. Answer: TRUE Diff: 1 Objective: L.O. 9-2
24) Convertible bonds are bonds that may be redeemed before maturity date by the issuing corporation. Answer: FALSE Diff: 2 Objective: L.O. 9-2
25) A callable bond is one in which the bondholder can sell the bond back to the company, even if the company does not want the bond returned. Answer: FALSE Diff: 2 Objective: L.O. 9-2
26) Bond prices can change very much, even though periodic interest payments will occur and the principal amount of the bond will be paid at maturity. Answer: TRUE Diff: 2 Objective: L.O. 9-2
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27) Interest expense that is not explicitly recognized in a loan agreement is referred to as coupon or nominal interest. Answer: FALSE Diff: 2 Objective: L.O. 9-2
28) Companies that have a poor credit rating will always issue a bond at a discount. Answer: FALSE Diff: 2 Objective: L.O. 9-2
29) Higher rated bonds are safer, and companies with better ratings generally pay lower interest rates. Answer: TRUE Diff: 2 Objective: L.O. 9-2
30) In items a-f, define whether the bond was issued at a premium (PR), discount, (DI), or par (PAR) when the face value of the bond was $1,000 with a 10% coupon rate. PR/DI/PAR ________ ________ ________ ________ ________ ________
a) The market rate of the bond was 11% when sold b) The issuing company received $1,050.00 c) The market rate of the bond was 9% when sold d) The issuing company received $1,000.00 e) The issuing company received $983.00 f) The market rate of the bond was 10% Answer: a) DI, b) PR, c) PR, d) PAR, e) DI, f) PAR Diff: 2 Objective: L.O. 9-2
31) What is the relation between the market interest rate and the bond issue price? Include descriptions of bond discount and premium in your explanation. Answer: The bond issue price is inversely related to the market interest rate. As the market rate of interest increases, the bond's value falls. If the market rate exceeds the coupon rate, then the bond sells for a discount. If the market rate is less than the coupon rate, then the bond sells for a premium. Diff: 2 Objective: L.O. 9-2
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Learning Objective 9.3 Questions 1) Which of the following is false? The discount on bonds payable is A) amortized over the life of the bond. B) deducted from bonds payable. C) a contra account to bonds payable. D) reported in liabilities section of the balance sheet. E) an adjunct account to bonds payable. Answer: E Diff: 2 Objective: L.O. 9-3
2) The discount on bonds payable A) serves to reduce interest expense on the income statement. B) serves to increase interest expense on the income statement. C) is never allowed by investment bankers when debt is issued. D) serves to increase the cash interest payment. E) is an adjunct account to bonds payable. Answer: B Diff: 3 Objective: L.O. 9-3
3) Which of the following is not true of bonds issued at a premium? A) The cash proceeds exceed the face amount of the bonds. B) The amortization of bond premium decreases the interest expense. C) The amount of the Premium on Bonds Payable account is subtracted from the face amount of the bonds to determine the net liability reported in the balance sheet. D) The market rate was below the coupon rate. E) Amortization of the premium decreases the carrying value of the bond. Answer: C Diff: 2 Objective: L.O. 9-3
4) Early extinguishment of debt A) is not allowed by the FASB during the first 2 years bonds are outstanding B) will never have related gains or losses recorded on the books. C) occurs when the issuer redeems its own bonds by purchases on the open market or by exercising their rights to redeem callable bonds. D) is not permitted. E) is permitted only in the banking industry. Answer: C Diff: 2 Objective: L.O. 9-3
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5) The issuance of bonds is shown on the statement of cash flows as A) a cash inflow from financing activities. B) a cash inflow from investing activities. C) a cash inflow from operating activities. D) a cash outflow from financing activities. E) a cash outflow from investing activities. Answer: A Diff: 2 Objective: L.O. 9-3
6) The spreading of bond discount over the life of the bonds as interest expense is called A) discount amortization. B) effective-interest amortization. C) compound interest amortization. D) premium amortization. E) LIBOR. Answer: A Diff: 2 Objective: L.O. 9-3
7) Which statement is true regarding zero coupon bonds? A) They provide cash interest payments during their life. B) They are sold for more than the face or maturity value. C) The investor determines their market value at the issuance date by calculating the present value of their maturity value, using the market rate of interest for bonds having similar terms and risks. D) They are also called callable debentures. E) They are also called junk bonds. Answer: C Diff: 2 Objective: L.O. 9-3
8) The market interest rate that equates the proceeds from a loan with the present value of the loan payments is called A) implicit interest rate. B) nominal interest rate. C) imputed interest rate. D) coupon interest. E) both A and C. Answer: E Diff: 2 Objective: L.O. 9-3
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9) Under the effective-interest method of amortization, the amount of discount amortized each interest period is equal to A) the amount of interest expense plus the cash paid for interest. B) the amount of interest expense less the cash paid for interest. C) the total discount divided by the number of interest payments to be made. D) the total amount of interest expense divided by the number of interest payments to be made. E) the amount of the decrease from the cash payment. Answer: B Diff: 3 Objective: L.O. 9-3
10) Boling, Inc., just made the interest payment on its $4,000,000 of outstanding bonds. The bonds are callable at 101 5/8 and the unamortized premium is currently $167,400. The entry to retire half of the bonds would include a A) debit to premium on bonds payable for $167,400. B) credit to cash for $2,000,000. C) credit to gain on early extinguishment of debt for $51,200. D) debit to loss on early extinguishment of debt for $52,500. E) debit to loss on early extinguishments of debt for $167,400. Answer: C Diff: 3 Objective: L.O. 9-3
11) The premium on bonds payable A) serves to reduce interest expense on the income statement. B) serves to increase interest expense on the income statement. C) is an adjunct account to notes payable. D) increases the cash interest payment. E) is a contra account to bonds payable Answer: A Diff: 3 Objective: L.O. 9-3
12) Under the effective-interest method of amortizing bond premium, the interest expense recorded for each semiannual interest payment A) is equal to the market rate of interest times the bond's carrying value at the beginning of the period. B) will increase over the life of the bond. C) is equal to the carrying value of the bond times the nominal rate of interest for each semiannual interest payment. D) will equal the amount of cash paid for each semiannual interest payment. E) will be the same amount each interest payment date. Answer: A Diff: 3 Objective: L.O. 9-3
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13) Under the effective-interest method of amortizing bond discount, the cash payment on each interest payment date is calculated by multiplying the A) ending net liability times the effective interest rate for the appropriate time period. B) ending net liability times the coupon interest rate for the appropriate time period. C) face value of the bonds times the effective interest rate for the appropriate time period. D) face value of the bonds times the coupon interest rate for the appropriate time period. E) difference between the market value and the liquidation value by the market rate of interest. Answer: D Diff: 3 Objective: L.O. 9-3
14) Under the effective-method of amortizing bond premium, the interest expense recorded for each semiannual interest payment A) is equal to the face value of the bond times the coupon rate of interest for each semiannual interest period. B) is equal to the selling price of the bond times the coupon rate of interest. C) will equal the amount of cash paid for each semiannual interest payment. D) will decrease over the life of the bonds. E) will increase over the life of the bonds. Answer: D Diff: 3 Objective: L.O. 9-3
15) Under the effective-interest method of amortization, interest expense each period can be calculated by multiplying the A) beginning net liability times the effective interest rate for the appropriate time period. B) beginning net liability times the coupon interest rate for the appropriate time period. C) face value of the bonds times the effective interest rate for the appropriate time period. D) face value of the bonds times the coupon interest rate for the appropriate time period. E) liquidation value times the effective interest rate for the appropriate time period. Answer: A Diff: 3 Objective: L.O. 9-3
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16) On January 1, 20X3, Dierk Company issued $200,000 in long-term bonds at par. The bonds pay interest of 12% annually on January 1. The term of the bond is 10 years. What journal entry is necessary on December 31, 20X3? A) Interest Expense 24,000 Accrued Interest Payable 24,000 B) Interest Expense 24,000 Cash 24,000 C) Accrued Interest Receivable 24,000 Interest Revenue 24,000 D) Interest Expense 24,000 Accrued Interest Payable 20,000 Bonds Payable 4,000 E) None of the above Answer: A Diff: 3 Objective: L.O. 9-3
17) On January 1, 2009, Amanda Mackenzie purchased a $24,000 car, making a $4,000 down payment, and borrowing the rest on a 4-year note at 8% interest. She agrees to make annual payments of $6,038.47, starting January 1, 2010. What is the journal entry that Amanda would make on January 1, 2010, for the first payment on the note? A) Note Payable 6,038.47 Cash 6,038.47 B) Interest Payable 1,600.00 Note Payable 4,438.47 Cash 6,038.47 C) Interest Expense 483.08 Note Payable 5,555.39 Cash 6,038.47 D) Interest Expense 1,920.00 Note Payable 4,118.47 Cash 6,038.47 E) Interest Expense 5,555.39 Note Payable 438.08 Cash 6,038.47 Answer: B Diff: 3 Objective: L.O. 9-3
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18) Westerfelt Shops issued 3,000 debentures on January 1, 20X9. The debentures were 12-year, 7% debt, which paid interest semi-annually, every June 30 and December 31. The face value of each debenture is $1,000. If the market rate of interest is 7% on January 1, 20X9, what is the journal entry to record the issuance of the bonds? A) Cash 3,000,000 Bonds Payable 3,000,000 B) Bonds Payable 3,000,000 Cash 3,000,000 C) Bonds Receivable 3,000,000 Cash 3,000,000 D) Bonds Receivable 3,000,000 Bonds Payable 3,000,000 E) Cannot be determined from the information given Answer: A Diff: 2 Objective: L.O. 9-3
19) Westerfelt Shops issued 3,000 debentures on January 1, 20X9. The debentures were 12-year, 7% debt, which paid interest semi-annually, every June 30 and December 31. The face value of each debenture is $1,000. If the market rate of interest is 7% on January 1, 20X9, what is the journal entry to record the payment of interest on June 30, 20X9? A) Bonds Payable 105,000 Cash 105,000 B) Interest Payable 105,000 Cash 105,000 C) Cash 210,000 Bonds Payable 210,000 D) Interest Expense 105,000 Cash 105,000 E) Interest Expense 210,000 Bonds Payable 210,000 Answer: D Diff: 2 Objective: L.O. 9-3
20) Waddle Enterprise issued an 8-year, 10% bond on January 1, 20X9. Each bond sold for face value, which is $1,000. The bonds pay interest semi-annually on June 30 and December 31. The bonds mature on December 31, 2X15. Using present value tables, what is the market price of each $1,000 bond on January 1, 2X11, if the market rate of interest has changed to 8%? A) $ 893.29 B) $ 912.92 C) $1,000.00 D) $1,081.15 E) $1,114.96 Answer: D Diff: 3 Objective: L.O. 9-3
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21) Interest expense on bonds exhibits the following attributes except A) interest expense is greater than the cash payment for interest when a bond is sold at a premium and effective-interest amortization is used. B) interest expense is the same dollar amount for every interest payment period, if a bond was issued at a discount and straight-line amortization is used. C) interest expense is greater than the cash payment for interest when a bond is sold at a discount, regardless of whether straight-line or effective-interest amortization is used. D) interest expense equals the cash payment for interest if a bond is sold at par. E) interest expense becomes a larger dollar amount over time when a bond is sold at a discount and effective-interest amortization is used. Answer: A Diff: 3 Objective: L.O. 9-3
22) Seesten Company was ready to sell 8-year, 10% bonds at a face value of $2,000,000 on January 1, 20X9. Because of delays and market conditions, the bonds were not sold until March 1, 20X9. The bonds pay interest every June 30 and December 31. The bonds were sold at par plus accrued interest. What are the necessary journal entries for Seesten Company on March 1, 20X9, and June 30, 20X9? March 1, 20X9 June 30, 20X9 A) Cash 2,033,333 Interest Payable 33,333 Bonds Payable 2,000,000 Interest Expense 66,667 Interest Payable 33,333 Cash 100,000 B) Cash 2,033,333 Interest Expense 100,000 Bonds Payable 2,000,000 Cash 100,000 Interest Revenue 33,333 C) Cash 2,033,333 Interest Expense 97,917 Bonds Payable 2,000,000 Premium on Bond Premium on Bond Payable 2,083 Payable 33,333 Cash 100,000 D) Cash 2,033,333 Interest Expense 66,667 Bonds Payable 2,000,000 Premium on Bond Premium on Bond Payable 33,333 Payable 33,333 Cash 100,000 E) Cash 1,066,667 Interest Payable 66,667 Bonds Payable 2,000,000 Interest Expense 133,333 Interest Payable 66,667 Cash 200,000 Answer: A Diff: 2 Objective: L.O. 9-3
23) Generally bonds are called at an amount above par, referred to as a call discount. Answer: FALSE Diff: 2 Objective: L.O. 9-3
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24) Underwriters are a group of investment bankers who buy an entire bond or stock issue from a corporation and then sell the issue to the general investing public. Answer: TRUE Diff: 2 Objective: L.O. 9-3
25) Zero coupon notes do not provide interest payments. Answer: TRUE Diff: 1 Objective: L.O. 9-3
26) Non-interest-bearing notes do not make any interest payments over the life of the note. Answer: TRUE Diff: 2 Objective: L.O. 9-3
27) A bond issued at a price above its face value is sold at a discount. Answer: FALSE Diff: 1 Objective: L.O. 9-3
28) The market or effective rate of interest is used to calculate the actual amount of interest bondholders will receive from a company issuing bonds. Answer: FALSE Diff: 2 Objective: L.O. 9-3
29) An investor purchasing bonds between interest dates must pay accrued interest on the bonds. Answer: TRUE Diff: 2 Objective: L.O. 9-3
30) Using the effective-interest method of amortization, interest expense is based on the net liability at the beginning of the current period times the effective interest rate for the interest period. Answer: TRUE Diff: 3 Objective: L.O. 9-3
31) Interest expense will increase each period if a company uses the effective-interest method of amortization and the bonds are issued at a discount. Answer: TRUE Diff: 3 Objective: L.O. 9-3
32) The net liability of bonds will decrease each interest period if the bonds were issued at a premium. Answer: TRUE Diff: 3 Objective: L.O. 9-3
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33) The effective-interest method of amortization keeps interest expense at the same percentage of the bond's carrying value for every interest payment over the bond's life. Answer: TRUE Diff: 3 Objective: L.O. 9-3
34) Coupon rate and nominal interest rate are both used to describe the rate of interest to be paid on a bond. Answer: TRUE Diff: 1 Objective: L.O. 9-3
35) The market interest rate is affected by general economic conditions. Answer: TRUE Diff: 1 Objective: L.O. 9-3
36) On the day of issuance of bonds, the proceeds to the issuer may be above par or below par, depending on market conditions. If the proceeds are above par, the bonds have been sold at a discount. Answer: FALSE Diff: 2 Objective: L.O. 9-3
37) The excess of the proceeds over the face amount of a bond is called premium on bonds. Answer: TRUE Diff: 1 Objective: L.O. 9-3
38) The spreading of the discount over the life of the bonds as interest expense is called discount amortization. Answer: TRUE Diff: 1 Objective: L.O. 9-3
39) The difference between the effective-interest amount and the cash interest payment is the amount of discount amortized for the period. Answer: TRUE Diff: 2 Objective: L.O. 9-3
40) Implicit interest is a form of interest expense that is not explicitly recognized in a loan agreement. Answer: TRUE Diff: 2 Objective: L.O. 9-3
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41) On January 1, 20X3, Middleton Industries issued $5 million of 5-year, 9% debentures at par which are dated as of January 1, 20X3. Prepare the journal entries to record the (a) issuance of the bonds. (b) the first semi-annual interest payment. (c) the payment of maturity value. Answer: (a) Cash 5,000,000 Bonds Payable 5,000,000 (b) Interest Expense 225,000 Cash 225,000 (c) Bonds Payable 5,000,000 Cash 5,000,000 Diff: 2 Objective: L.O. 9-3
42) Callton, Inc., had a 6-year, 8%, $375,000 bonds ready to be sold on January 1, 20X3. The bonds will pay interest every June 30 and December 31. However, due to market conditions, the company did not sell the bonds until March 1, 20X3, at which time the bonds was issued at par. Given the information presented above, prepare the appropriate journal entry for Callton, Inc., for each of the following dates: a. January 1, 20X3 b. March 1, 20X3 c. June 30, 20X3 d. December 31, 20X3 Answer: a. No journal entry is necessary. b. Cash 380,000 Interest Payable 5,000 Bonds Payable 375,000 c. Interest Payable 5,000 Interest Expense 10,000 Cash 15,000 d. Interest Expense 15,000 Cash 15,000 Diff: 2 Objective: L.O. 9-3
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43) Spearhead Specialties issued a 2-year, $150,000, 14% debenture on January 1, 20X3 dated as of that date. The bond will pay interest every June 30 and December 31, with the principal to be paid on December 31, 20X4. The effective interest rate on the bond is 10%, and the company uses effective-interest amortization. Given this information and using the present value tables a. determine the selling price for the bond. b. provide the journal entry on January 1, 20X3. Answer: a. $150,000 × .8227 = $123,405 $10,500 × 3.5460 = 37,233 (n = 4, i = 5) $160,638 b.
Cash 160,638 Premium on Bond Payable Bonds Payable
10,638 150,000
Diff: 2 Objective: L.O. 9-3
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44) Cola, Inc., issued a 12-year, 10%, $1,500,000 bond on January 1, 20X9 dated as of January 1, 20X9. The bond pays interest every June 30 and December 31, with the principal to be paid at the end of 12 years. The effective interest rate on the bond is 12%. The company uses effective-interest amortization. Given this information and using the present value tables a. Prepare journal entries for Cola, Inc., on each of the following dates: 1) January 1, 20X9 2) June 30, 20X9 3) December 31, 20X9 b. What is the total interest expense for the year ended December 31, 20X9? c. What is the balance sheet presentation of this bond for Cola, Inc., at December 31, 20X9? Answer: a. Issue price: $1,500,000 × .2470 = $ 370,500 $75,000 × 12.5504 = 941,280 (n = 24, i = 6) $1,311,780 1)
b.
c.
Cash Discount on Bonds Payable Bond Payable 2) Interest Expense Discount on Bond Payable Cash 3) Interest Expense Discount on Bond Payable Cash Interest expense: June 30, 20X9 December 31, 20X9 Bonds Payable Discount on Bond Payable
1,311,780 188,220 1,500,000 78,707 3,707 75,000 78,929 3,929 75,000 $ 78,707 78,929 $157,636 $1,500,000 (180,584) $ 1,319,416
Diff: 3 Objective: L.O. 9-3
45) Randolph Company issued $1,000,000 of 6.5%, 8-year bonds dated June 1, 20X3, with semiannual interest payments on June 1 and December 1. The bonds were issued on June 1, 20X3, at 103 3/8. a. Were the bonds issued at a premium, a discount, or at face value? b. Was the market rate of interest higher, lower, or the same as the coupon rate of interest? c. How much cash was received by Randolph Company upon issuance of the bonds? Answer: a. The bonds were issued at a premium. b. The market rate of interest was lower than 6.5% since the bonds were issued above face value. c. $1,000,000 × 1.03375 = $1,033,750 Diff: 2 Objective: L.O. 9-3
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46) On January 1, 20X3, Nets n' Hoops issued $5,000,000 of 9%, 10-year bonds dated January 1, 20X3, with annual interest payments on December 31. The bonds were issued for $4,692,570 yielding an effective interest rate of 10%. Nets n' Hoops uses the effective-interest method of amortization. a. Prepare the necessary journal entries to record the issuance of the bonds and the first interest payment. b. Determine the ending net liability of the bonds on December 31, 20X3. Answer: a. Jan. 1 Cash 4,692,570 Discount on Bonds Payable 307,430 Bonds Payable 5,000,000 Dec. 31 Interest Expense 469,257 Discount on Bonds Payable 19,257 Cash 450,000 b. $5,000,000 - $307,430 + $19,257 = $4,711,827 Diff: 2 Objective: L.O. 9-3
47) Rural Bell Company issued 9-year, 8%, $750,000 bonds on January 1, 20X9. The bonds pay interest every June 30 and December 31, with the principal to be paid in 9 years. The effective interest rate on the bonds is 10%, and the company uses the effective-interest method of amortization. a. Compute the initial selling price of the bonds on January 1, 20X9. b. Prepare the entry needed on June 30, 20X9. Answer: a. The initial selling price of the bond: $750,000 × .4155 = $311,625 $ 30,000 × 11.6896 = 350,688 (n = 18, i = 5) $662,313 b.
Interest Expense Cash Discount on Bonds Payable
33,116 30,000 3,116
Diff: 3 Objective: L.O. 9-3
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48) Klowdek Company purchased a $25,000 truck on January 1, 20X3. The company paid $5,000 and will pay the remaining $20,000 with a 4-year note. The note requires that the company make four equal annual payments starting on December 31, 20X3. The note charges 10% interest. Given this information and using present value tables, complete the following chart.
Year 20X3 20X4 20X5 20X6
Beginning note payable $20,000
Interest expense
End of year cash payment
Reduction of principal
End of year note payable balance
Answer: Beginning Year note payable 20X3 $20,000 20X4 $15,690.65 20X5 $10,950.37 20X6 $ 5,736.06 *$.32 rounding error
Interest End of year Reduction of expense cash payment principal $2,000.00 $6,309.35 $4,309.35 $1,569.07 $6,309.35 $4,740.28 $1,095.04 $6,309.35 $5,214.31 $ 573.61 $6,309.35 $5,735.74
Diff: 3 Objective: L.O. 9-3
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End of year note payable balance $15,690.65 $10,950.37 $ 5,736.06 $.32**
Learning Objective 9.4 Questions 1) Which of the following statements is FALSE? A) The lessee will always record the liability associated with future cash payments but never an asset associated with the property being leased. B) Leases can take the form of a capital lease or an operating lease. C) Some leases are substantially equivalent to purchases. D) A lease contract creates property rights and financial obligations. E) Almost any asset could be leased. Answer: A Diff: 2 Objective: L.O. 9-4
2) Dental Solutions leased a building for 2 years, effective May 1, 20X3. The lease was considered an operating lease. The lease required that Dental Solutions make payments of $6,000 every 3 months, beginning on May 1, 20X3. The first payment covers the period of May 1, 20X3 through July 31, 20X3. Assume an interest rate of 12%. What is the journal entry to be made by Dental Solutions on May 31, 20X3? A) Rent Expense 2,000 Prepaid Rent 2,000 B) Rent Expense 2,000 Cash 2,000 C) Rent Expense 4,000 Prepaid Rent 4,000 D) Prepaid Rent 2,000 Rent Expense 2,000 E) Prepaid Rent 4,000 Rent Expense 4,000 Answer: A Diff: 2 Objective: L.O. 9-4
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3) Gambet Labs entered into a lease agreement on January 1, 20X3, to use an x-ray machine. The machine has a useful life of 6 years. Gambet Labs will make annual lease payments of $13,000 for 6 years, beginning on December 31, 20X3. Assume a 14% interest rate. Using the present value tables, what journal entry will Gambet Labs make on January 1, 20X3? A) Machine Leasehold 50,553 Capital Lease Liability 50,553 B) Machine Leasehold 78,000 Capital Lease Liability 78,000 C) Machine Leasehold 50,553 Deferred Interest Expense 27,447 Capital Lease Obligation 78,000 D) Machine Leasehold 78,000 Interest Payable 27,447 Capital Lease Liability 50,553 E) No journal entry is necessary. Answer: A Diff: 2 Objective: L.O. 9-4
4) Gambet Labs entered into a lease agreement on January 1, 20X3, to use an x-ray machine. The machine has a useful life of 6 years. Gambet Labs will make annual lease payments of $13,000 for 6 years, beginning on December 31, 20X3. Assume a 14% interest rate. Using the present value tables, what is the journal entry to be made by Gambet Labs on December 31, 20X4, to amortize the leased asset, assuming straight-line amortization is used? A) No journal entry is necessary. B) Leasehold Amortization Expense 4,575 Machine Leasehold 4,575 C) Leasehold Amortization Expense 8,426 Machine Leasehold 8,426 D) Leasehold Amortization Expense 13,000 Machine Leasehold 13,000 E) Leasehold Amortization Expense 13,000 Capital Lease Liability 13,000 Answer: C Diff: 2 Objective: L.O. 9-4
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5) Gambet Labs entered into a lease agreement on January 1, 20X3, to use an x-ray machine. The machine has a useful life of 6 years. Gambet Labs will make annual lease payments of $13,000 for 6 years, beginning on December 31, 20X3. Assume a 14% interest rate. Using the present value tables, what is the journal entry to be made by Gambet Labs on December 31, 20X3, to record the annual lease payment? A) Rent Expense 13,000 Cash 13,000 B) Capital Lease Obligation 13,000 Cash 13,000 C) Capital Lease Obligation 2,080 Interest Expense 10,920 Cash 13,000 D) Capital Lease Obligation 5,923 Interest Expense 7,077 Cash 13,000 E) Capital Lease Obligation 11,180 Interest Expense 1,820 Cash 13,000 Answer: D Diff: 2 Objective: L.O. 9-4
6) Which of the following is not one of the conditions for a capital lease? A) The lease term exceeds 90% of the estimated economic life of the property. B) The lease term equals or exceeds 75% of the estimated economic life of the property. C) Title is transferred to the lessee by the end of the lease. D) The present value of the lease payments is at least 90% of the leased asset's fair value at the start of the lease term. E) The lease contains a bargain purchase option. Answer: A Diff: 2 Objective: L.O. 9-4
7) A lease that should be accounted for by the lessee as ordinary rent expense is A) a financing lease. B) a capital lease. C) an operating lease. D) an accounting lease. E) a sale-leaseback. Answer: C Diff: 2 Objective: L.O. 9-4
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8) All of the following would qualify as a capital lease except: A) The lease term is 80% of the asset's estimated useful life. B) The lease agreement contains a bargain purchase option. C) The present value of the lease payments equals 70% of the fair value of the leased asset. D) Title to the leased asset transfers to the lessee at the end of the lease term. E) The lease term equals 90% of the asset's estimated useful life. Answer: C Diff: 2 Objective: L.O. 9-4
9) A lessee may have a leased item on his balance sheet as an asset, even though the lessee does not have the legal title of ownership to the leased item. Answer: TRUE Diff: 2 Objective: L.O. 9-4
10) A lease is a contract whereby an owner grants the use of property to a second party in exchange for rental payments. Answer: TRUE Diff: 1 Objective: L.O. 9-4
11) The party who has the right to use leased property and makes lease payments to the lessor is called a lessee. Answer: TRUE Diff: 1 Objective: L.O. 9-4
12) There are two types of leases: capital leases and financial leases. Answer: FALSE Diff: 1 Objective: L.O. 9-4
13) A operating lease is a lease that should be accounted for by the lessee as ordinary rent expenses. Answer: TRUE Diff: 1 Objective: L.O. 9-4
14) A capital lease is a lease that transfers most of the risks and benefits of ownership to the lessee. Answer: TRUE Diff: 1 Objective: L.O. 9-4
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15) Brandy Bottling signs an agreement on January 1, 20X4, to lease office equipment for a 5-year period. The estimated useful life of the office equipment is 8 years. The market value of the office equipment is $235,000. The lease agreement calls for lease payments of $55,040. The first payment is due on December 31, 20X4, all subsequent payments are made each December 31 thereafter. The interest rate stated in the lease agreement is 8%. The present value of the lease payments is $219,758. At the end of the lease term, the equipment reverts back to the lessor. Prepare journal entries to record a. the lease agreement on January 1, 20X4. b. the first lease payment on December 31, 20X4. c. the amortization of the leased asset on December 31, 20X4. Answer: a. Jan. 1 Equipment Leasehold 219,758 Capital Lease Liability 219,758 b. Dec. 31 Interest Expense 17,581 Capital Lease Liability 37,459 Cash 55,040 c. Dec. 31 Leasehold Amortization Expense 43,952 Equipment Leasehold 43,952 Diff: 3 Objective: L.O. 9-4
16) Parmlee Inc. has several assets and liabilities on its balance sheet. For each of the items below, decide whether it is a current asset (CA), current liability (CL), long-term asset (LTA), long-term liability(LTL), or contra-liability (COL). CA/CL/LTA/LTL/COL a. 15 year lease obligation b. Discount on bonds payable c. Amounts owed to the utility company d. A leased asset e. Current portion of long-term debt f. An asset with a lease term of 75% of the estimated economic life of the property Answer: a. LTL and CL(for lease obligation due in 1 year) b. COL c. CL d. LTA e. CL f. LTA
a. ________ b. ________ c. ________ d. ________ e. ________ f. ________
Diff: 2 Objective: L.O. 9-4
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17) Decide whether each of the following lease agreements should be recorded as a capital lease or an operating lease: a) The present value of the lease payments is 75% of the fair value of the leased asset at the start of the lease. The lease term is for 6 years; the estimated useful life of the leased asset is 10 years. There is a bargain purchase agreement for the lessee to purchase the leased asset at well below fair value at the end of the lease term. b) The present value of the lease payments is 90% of the fair value of the leased asset at the start of the lease. The lease term is for 2 years; the estimated useful life of the leased asset is 10 years. The leased asset reverts back to the lessor at the end of the lease. c) The lease transfers ownership of the leased asset to the lessee at the end of the lease. The present value of the lease payments is 75% of the fair value of the leased asset at the start of the lease. The lease term is for 3 years; the estimated useful life of the leased asset is 10 years. d) The lease agreement doesn't contain a bargain purchase agreement. The leased asset reverts back to the lessor at the end of the lease agreement. The present value of the lease payments is 85% of the fair value of the leased asset at the start of the lease. The lease term is for 10 years; the estimated useful life of the leased asset is 15 years. Answer: a. capital b. capital c. capital d. operating Diff: 2 Objective: L.O. 9-4
Learning Objective 9.5 Questions 1) Accounting for postretirement benefits requires A) no liability on the balance sheet. B) no journal entries because the benefits are to be paid in the future. C) the recognition of a liability equal to the present value of the expected payments for other postretirement benefits. D) the recognition of a liability equal to the future value of the expected payments for other postretirement benefits. E) none of the above Answer: C Diff: 2 Objective: L.O. 9-5
2) In a defined contribution pension plan, A) the government pays employees a fixed pension amount upon retirement. B) the government pays employees a variable pension amount upon retirement. C) the employer makes annual contributions into a fund belonging to employees and the retirement benefit depends on the amount in the fund at retirement. D) the employer guarantees the employee a specific amount of retirement pay based on the pay earned during the final years of employment and the numbers of years of service. E) the SEC pays employees a fixed pension amount upon retirement. Answer: C Diff: 2 Objective: L.O. 9-5
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3) If the fair value of pension plan assets exceeds the present value of the pension obligation, a company reports A) a net pension liability on the balance sheet. B) a net pension asset on the balance sheet. C) nothing on the balance sheet. D) a long footnote only. E) both B and D Answer: E Diff: 2 Objective: L.O. 9-5
4) Companies must include a net long-term liability on its balance sheet for pensions if A) the pension expense is more than the pension liability. B) the fair value of the pension obligation is more than the cash invested yearly. C) the fair value of the pension obligation is less than the cash invested yearly. D) the fair value of the pension fund assets are less than the pension obligations. E) the fair value of the pension fund assets are greater than the pension obligations. Answer: D Diff: 2 Objective: L.O. 9-5
5) The unfunded portion of the obligation to provide pension benefits are reported as liabilities on the balance sheet. Answer: TRUE Diff: 2 Objective: L.O. 9-5
6) Due to accrual accounting's system of matching expenses with their associated revenues, pensions and postretirement benefits are expenses when earned by employees. Answer: TRUE Diff: 2 Objective: L.O. 9-5
7) Health insurance, life insurance, and other employee benefits paid to employees (excluding pensions) upon retirement are referred to as other postretirement benefits. Answer: TRUE Diff: 1 Objective: L.O. 9-5
8) The U.S. tax law provides incentives for companies to make payments into a pension fund that is separate from the company's assets and controlled by a trustee. Answer: TRUE Diff: 2 Objective: L.O. 9-5
9) The U.S. tax law provides incentives for companies to make payments into a postretirement benefit fund that is separate from the company's assets and controlled by a trustee. Answer: FALSE Diff: 2 Objective: L.O. 9-5
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10) Pension plan assets decrease by cash payments to retirees. Answer: TRUE Diff: 1 Objective: L.O. 9-5
11) Hi-tower Machining offers pensions and postretirement benefits to its employees. For the fiscal year ended March 31, 2X03, Hi-tower Machining's employees accumulated $16 million in additional pension benefits, but Hi-tower Machining did not contribute additional cash into the fund. In addition, Hi-tower Machining paid retirees a total of $2 million in health benefits with an actuarial gain of $1.2 million. Prepare the journal entries to 1. account for the pension fund. 2. account for the health insurance payment and gain. Answer: 1. Pension expense 16 Pension liability 16 2. Postretirement benefits liability 2 Cash Postretirement benefits liability 1.2 Actuarial gain on postretirement benefits
2 1.2
Diff: 3 Objective: L.O. 9-5
Learning Objective 9.6 Questions 1) A deferred income tax liability A) arises because of differences between U.S. income tax rules and foreign income tax rules. B) can arise because of "permanent" and "temporary" differences. C) arise because managers wish to maximize taxable income. D) can arise when a firm uses special accelerated depreciation for tax purposes while using straight-line depreciation for financial reporting. E) occurs when the company has a NOL (net operating loss). Answer: D Diff: 2 Objective: L.O. 9-6
2) A deferred tax liability that is due in 5 years is classified as a A) long-term liability. B) current liability. C) stockholders' equity account. D) long-term asset. E) current asset. Answer: A Diff: 2 Objective: L.O. 9-6
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3) Which of the following statements regarding temporary differences is false? A) Temporary differences can result in deferred liabilities and deferred assets. B) Deferred tax liabilities are found on the balance sheets of nearly every company. C) For most companies, the primary source of deferred taxes is timing differences related to depreciation. D) The deferred tax liability equals the temporary difference times the tax rate. E) Temporary differences result in the cancellation of taxes. Answer: E Diff: 2 Objective: L.O. 9-6
4) A contingent liability A) is a potential liability that depends on a future event arising out of a past transaction. B) is a liability that can always be calculated with great precision (i.e., always has a definite amount). C) does not include product safety lawsuits. D) does not include liabilities relating to environmental issues such as toxic landfills. E) is not of interest to readers of financial statements. Answer: A Diff: 2 Objective: L.O. 9-6
5) An example of a contingent liability is A) a bond that can be converted into common stock. B) any interest-bearing liability. C) a bond that was sold at a discount. D) the unrealized loss from the reduction in the fair value of a long-term liability. E) a lawsuit being filed against a company. Answer: E Diff: 2 Objective: L.O. 9-6
6) A contingent liability's dollar amount does not get reported on the balance sheet if A) the probability that the event will occur is low and if the amount cannot be reasonably estimated. B) the probability that the event will occur is high and if the amount cannot be reasonably estimated. C) the probability that the event will occur is low or if the amount cannot be reasonably estimated. D) the probability that the event will occur is high only. E) the amount cannot be reasonably estimated only. Answer: C Diff: 2 Objective: L.O. 9-6
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7) Milton Manufacturing manufactures and sells ornamental statues. Because of good styling and marketing, sales have grown briskly. Milton has no pre-existing deferred tax liability. During 20X3, the following transactions occurred: 1. On January 1, 20,000 new shares of common stock were sold at $100 per share. 2. Half of the proceeds from the stock sale were immediately invested in tax-free bonds yielding 8% per annum. The bonds were held throughout the year, resulting in interest revenue of $1,000,000 × .08 = $80,000. 3. Sales for the year were $9,000,000, with expenses of $4,300,000 reported under GAAP (not including income tax expense). 4. Tax depreciation exceeded depreciation included in item 3 above by $500,000. What are earnings before tax for shareholder reporting? A) $4,780,000 B) $4,700,000 C) $4,500,000 D) $6,780,000 E) $6,200,000 Answer: A Diff: 3 Objective: L.O. 9-6
8) Milton Manufacturing manufactures and sells ornamental statues. Because of good styling and marketing, sales have grown briskly. Milton has no pre-existing deferred tax liability. During 20X3, the following transactions occurred: 1. On January 1, 20,000 new shares of common stock were sold at $100 per share. 2. Half of the proceeds from the stock sale were immediately invested in tax-free bonds yielding 8% per annum. The bonds were held throughout the year, resulting in interest revenue of $1,000,000 × .08 = $80,000. 3. Sales for the year were $9,000,000, with expenses of $4,300,000 reported under GAAP (not including income tax expense). 4. Tax depreciation exceeded depreciation included in item 3 above by $500,000. What would Milton report as income tax payable to the tax authorities assuming a 40% tax rate? A) $1,880,000 B) $1,680,000 C) $1,714,000 D) $2,680,000 E) $2,480,000 Answer: B Diff: 3 Objective: L.O. 9-6
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9) Milton Manufacturing manufactures and sells ornamental statues. Because of good styling and marketing, sales have grown briskly. Milton has no pre-existing deferred tax liability. During 20X3, the following transactions occurred: 1. On January 1, 20,000 new shares of common stock were sold at $100 per share. 2. Half of the proceeds from the stock sale were immediately invested in tax-free bonds yielding 8% per annum. The bonds were held throughout the year, resulting in interest revenue of $1,000,000 × .08 = $80,000. 3. Sales for the year were $9,000,000, with expenses of $4,300,000 reported under GAAP (not including income tax expense). 4. Tax depreciation exceeded depreciation included in item 3 above by $500,000. What would Milton report as income tax expense for shareholder reporting using a 40% tax rate? A) $1,912,000 B) $1,880,000 C) $1,800,000 D) $1,897,000 E) $1,865,000 Answer: B Diff: 3 Objective: L.O. 9-6
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10) Milton Manufacturing manufactures and sells ornamental statues. Because of good styling and marketing, sales have grown briskly. Milton has no pre-existing deferred tax liability. During 20X3, the following transactions occurred: 1. On January 1, 20,000 new shares of common stock were sold at $100 per share. 2. Half of the proceeds from the stock sale were immediately invested in tax-free bonds yielding 8% per annum. The bonds were held throughout the year, resulting in interest revenue of $1,000,000 × .08 = $80,000. 3. Sales for the year were $9,000,000, with expenses of $4,300,000 reported under GAAP (not including income tax expense). 4. Tax depreciation exceeded depreciation included in item 3 above by $500,000. What journal entry would Milton make to record income tax expense and income tax payable at December 31? A) Income Tax Expense 1,880,000 Income Tax Payable 1,680,000 Deferred Tax Liability 200,000 B) Income Tax Expense 1,912,000 Income Tax Payable 1,880,000 Deferred Tax Liability 32,000 C) Income Tax Expense 1,800,000 Income Tax Payable 1,714,000 Deferred Tax Liability 86,000 D) Income Tax Payable 1,714,000 Deferred Tax Liability 151,000 Income Tax Expense 1,865,000 E) Income Tax Payable 1,880,000 Deferred Tax Liability 32,000 Income Tax Expense 1,912,000 Answer: A Diff: 3 Objective: L.O. 9-6
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11) Milton Manufacturing manufactures and sells ornamental statues. Because of good styling and marketing, sales have grown briskly. Milton has no pre-existing deferred tax liability. During 20X3, the following transactions occurred: 1. On January 1, 20,000 new shares of common stock were sold at $100 per share. 2. Half of the proceeds from the stock sale were immediately invested in tax-free bonds yielding 8% per annum. The bonds were held throughout the year, resulting in interest revenue of $1,000,000 × .08 = $80,000. 3. Sales for the year were $9,000,000, with expenses of $4,300,000 reported under GAAP (not including income tax expense). 4. Tax depreciation exceeded depreciation included in item 3 above by $500,000. What is the total amount of the permanent difference? A) $-0-. B) $80,000. C) $500,000. D) $85,000. E) $580,000. Answer: B Diff: 3 Objective: L.O. 9-6
12) The percentage of taxable income paid to the government by corporations is known as the tax rate. Answer: TRUE Diff: 1 Objective: L.O. 9-6
13) A contingent liability is a liability that may or may not have an estimated amount. Answer: TRUE Diff: 1 Objective: L.O. 9-6
14) Restructuring includes the closing of one or more plants, firing of a significant number of employees, and the termination or relocation of various activities. Answer: TRUE Diff: 2 Objective: L.O. 9-6
15) Permanent differences between income under the tax law and income under GAAP arise because some items are recognized at different times for tax purposes than for financial reporting purposes. Answer: FALSE Diff: 2 Objective: L.O. 9-6
16) Temporary differences in the timing of expenses and revenues always result in a liability called Deferred Tax Liability. Answer: FALSE Diff: 2 Objective: L.O. 9-6
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17) Permanent differences between income tax per GAAP and income tax per the tax law lead to deferred tax liabilities. Answer: FALSE Diff: 2 Objective: L.O. 9-6
18) Furlough Company's 20X3 income statement included the following: Income before taxes Income tax expense Net income
$299,000 89,625 $209,375
As a result of 20X3 operations, the deferred tax liability account increased by $12,000. a. Compute taxes paid to the government in 20X3. b. Prepare the journal entry to record taxes on ordinary income for 20X3. Answer: a. Tax per GAAP $89,625 Increase in liability (12,000) Taxes paid $77,625 b.
Income Tax Expense Deferred Tax Liability Cash (or Income Tax Payable)
89,625 12,000 77,625
Diff: 2 Objective: L.O. 9-6
19) Prepare journal entries, if needed, for the following scenarios: 1) Token Company is involved in a lawsuit with Bednam Industries for faulty parts. Token Company is not sure whether they need to journalize a transaction for the amount. Token Company's attorney has stated that it is probable that Token Company will lose the lawsuit and be expected to pay $2 million in damages. 2) Highlights Salon is involved in a lawsuit with Key Color. Highlights' attorney has stated that it is probable that Highlights will win $150,000. 3) Kepler Industries is involved in a lawsuit. Kepler Industries is expected to lose the lawsuit and pay $1.2 million. The probability of loss is very high. Answer: 1) Loss due to lawsuit 2,000,000 Liability due to lawsuit 2,000,000 2) no entry; gain contingencies are not recorded 3) Loss due to lawsuit 1,200,000 Liability due to lawsuit 1,200,000 Diff: 2 Objective: L.O. 9-6
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20) Define a contingent liability and give an example. How are they reported on the balance sheet? Answer: A contingent liability is a potential liability that depends on a future event arising out of a past transaction. Sometimes, it has a definite amount; more often it does not. Examples of contingent liabilities include a guarantee of another company's note payable and lawsuits. Contingent liabilities are often listed on the balance sheet after long-term liabilities but before stockholders' equity. Lawsuits, which are undecided, are subject to footnote disclosure. Diff: 2 Objective: L.O. 9-6
21) Define a "restructuring," give two examples, and explain the liabilities that may result from such an activity. Answer: A restructuring is a significant makeover of part of a company. Examples include the closing of one or more plants, firing of a significant number of employees, and the termination or relocation of various activities. Liabilities result because losses should be recognized as soon as the restructuring is announced, even though the losses or cash outflows have not yet occurred. Typical liabilities resulting from restructurings include liabilities for leases and employee terminations. Diff: 2 Objective: L.O. 9-6
Learning Objective 9.7 Questions 1) A company has a debt-to-equity ratio of 150%. The more debt a company has, and the less stockholders' equity, the A) greater the probability that the company will report a contingency. B) lower the probability that the company will report a contingency. C) riskier it is to lend money to the firm. D) riskier it is to purchase fixed assets. E) none of the above Answer: C Diff: 2 Objective: L.O. 9-7
2) The interest-coverage ratio is calculated by dividing pretax income plus interest expense by A) total shareholders' equity. B) total shareholders' equity and long-term debt. C) total assets. D) interest expense. E) total current assets. Answer: D Diff: 2 Objective: L.O. 9-7
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3) Fangled Company reports the following balance sheet: Fangled Company Balance Sheet December 31, 20X3 Current Assets: Cash Accounts Receivable Inventory Total Current Assets
$ 6,000 4,000 14,000 24,000
Current Liabilities: Accounts Payable Wages Payable Total Current Liabilities Long-term Bond Payable Total Liabilities
Long-term Assets: Fixed Assets Accumulated Depr. Net Fixed Assets Total Assets
$60,000 (17,000) 43,000 $67,000
Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity
What is the debt-to-equity ratio for Fangled Company at December 31, 20X3? A) 43.28%. B) 63.16%. C) 76.32%. D) 92.31%. E) 111.54%. Answer: C Diff: 2 Objective: L.O. 9-7
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$ 3,000 2,000 $ 5,000 24,000 $29,000
$ 12,000 26,000 38,000 $67,000
4) Fangled Company prepared the following balance sheet: Fangled Company Balance Sheet December 31, 20X3 Current Assets: Cash Accounts Receivable Inventory Total Current Assets
$ 6,000 4,000 14,000 24,000
Current Liabilities: Accounts Payable Wages Payable Total Current Liabilities Long-term Bond Payable Total Liabilities
Long-term Assets: Fixed Assets Accumulated Depr. Net Fixed Assets Total Assets
$60,000 (17,000) 43,000 $67,000
Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity
$ 3,000 2,000 $ 5,000 24,000 $29,000
$ 12,000 26,000 38,000 $67,000
What is the long-term-debt-to-total-capital ratio for Fangled Company at December 31, 20X3? A) 35.82%. B) 38.71%. C) 63.16%. D) 92.31%. E) 200.00%. Answer: B Diff: 2 Objective: L.O. 9-7
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5) Fangled Company prepared the following balance sheet: Fangled Company Balance Sheet December 31, 20X3 Current Assets: Cash Accounts Receivable Inventory Total Current Assets
$ 6,000 4,000 14,000 24,000
Current Liabilities: Accounts Payable Wages Payable Total Current Liabilities Long-term Bond Payable Total Liabilities
Long-term Assets: Fixed Assets Accumulated Depr. Net Fixed Assets Total Assets
$60,000 (17,000) 43,000 $67,000
Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Equity Total Liabilities & Stockholders' Equity
$ 3,000 2,000 $ 5,000 24,000 $29,000
$ 12,000 26,000 38,000 $67,000
What is the debt-to-total-assets ratio for Fangled Company at December 31, 20X3? A) 7.46%. B) 35.82%. C) 43.28%. D) 100.00%. E) 231.03%. Answer: C Diff: 2 Objective: L.O. 9-7
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6) The Fangled Company prepared the following income statement: Fangled Company Income Statement For The Year Ended December 31, 20X3 Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Income Interest Expense Income before Taxes Income Tax Expense Net Income
$240,000 103,000 $137,000 82,000 $ 55,000 2,000 $ 53,000 27,000 $ 26,000
What is the interest-coverage ratio for Fangled Company at December 31, 20X3? A) 8.33. B) 0.25. C) 14.00. D) 27.50. E) 28.50. Answer: D Diff: 2 Objective: L.O. 9-7
7) The ________ is calculated by dividing total liabilities by total shareholders' equity. A) debt-to-equity ratio B) long-term-debt-to-total capital ratio C) debt-to-total-assets ratio D) interest-coverage ratio E) current ratio Answer: A Diff: 1 Objective: L.O. 9-7
8) The ________ is calculated by dividing interest expense into the sum of pretax income and interest expense. A) debt-to-equity ratio B) long-term-debt-to-total capital ratio C) debt-to-total-assets ratio D) interest-coverage ratio E) current ratio Answer: D Diff: 1 Objective: L.O. 9-7
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9) Debt-to-equity ratios can vary greatly from industry to industry. Answer: TRUE Diff: 1 Objective: L.O. 9-7
10) The interest coverage ratio measures the firm's ability to meet its interest obligation. Answer: TRUE Diff: 1 Objective: L.O. 9-7
11) Total accounts receivable are one of the denominators for the debt ratios. Answer: FALSE Diff: 2 Objective: L.O. 9-7
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12) Given below are the balance sheet at December 31, 20X3 and income statement of Zeus Company for the year ended, December 31, 20X3. Determine the following: (a) The debt-to-equity ratio (b) Long-term-debt-to-total-capital ratio (c) Debt-to-total-assets ratio (d) The interest-coverage ratio. Zeus Company Balance Sheet December 31, 20X3 Current Assets: Cash Accounts Receivable Inventory Total Fixed Assets Less: Accum. Depr. Fixed Assets, net
Total Assets
$ 3,300 5,900 11,100 $20,300 $59,300 (13,800) 45,500
$65,800
Current Liabilities: Accounts Payable Interest Payable Wages Payable Total Current Liabilities Long-term Bond Payable Total Liabilities Stockholders' Equity: Common Stock $12,000 Retained Earnings 10,300 Total Liabilities & Stockholders' Equity
$ 4,900 1,500 2,100 $8,500 35,000 $43,500
22,300 $65,800
Zeus Company Income Statement For The Year Ended December 31, 20X3 Sales $94,000 Cost of Goods Sold 51,000 Gross Profit $43,000 Operating expenses 35,000 Operating income $ 8,000 Interest expense 3,000 Income before taxes $ 5,000 Income tax expense 2,300 Net Income $ 2,700 Answer: (a) Debt-to-equity ratio is $43,500/$22,300 = 195%. (b) Long-term debt-to-total-capital ratio is $35,000/($22,300 + $35,000) = 61.08%. (c) Debt-to-total-assets ratio is $43,500/$65,800 = 66.1%. (d) Interest-coverage ratio is ($5,000 + $3,000)/$3,000 = 2.67. Diff: 2 Objective: L.O. 9-7
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Learning Objective 9.8 Questions 1) The amount earned by an investor expressed as a percentage of the amount invested is called A) discount rate. B) rate of return. C) present value. D) future value. E) expected past rate. Answer: B Diff: 1 Objective: L.O. 9-8
2) An amount that is calculated by multiplying an interest rate by a principal amount that is increased each interest period by the previously accumulated interest is known as A) interest. B) simple interest. C) compound interest. D) nominal interest rate. E) stated interest. Answer: C Diff: 1 Objective: L.O. 9-8
3) What is the present value of $2,000 with 16% interest, to be received in 18 years? A) $161.61 B) $150.30 C) $155.83 D) $148.48 E) $138.20 Answer: E Diff: 2 Objective: L.O. 9-8
4) A series of equal cash flows to take place at the end of successive periods of equal length is called A) rate of return. B) an ordinary annuity. C) a serial note. D) a deferred annuity. E) a perpetuity or consul. Answer: B Diff: 2 Objective: L.O. 9-8
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5) Chris buys a note from a municipality that promises to pay $1,500 at the end of each of 3 years. How much should Chris pay for the note if she desires a rate of return of 8%, compounded annually? A) $4,000 B) $3,866 C) $3,905 D) $3,950 E) $3,750 Answer: B Diff: 2 Objective: L.O. 9-8
6) If Lauren deposits $9,000 in an account that pays 10% yearly interest, compounded annually, how much will she have in the account at the end of 3 years? A) $8,990 B) $9,750 C) $10,909 D) $11,979 E) $12,500 Answer: D Diff: 2 Objective: L.O. 9-8
7) The amount accumulated in the future, including principal and interest is the A) future value. B) annuity value. C) present value. D) rate of return. E) accumulated full value. Answer: A Diff: 1 Objective: L.O. 9-8
8) The value today of a future cash inflow or outflow is the A) present value. B) annuity value. C) future value. D) rate of return. E) estimated return. Answer: A Diff: 1 Objective: L.O. 9-8
9) Simple interest is calculated by multiplying an interest rate by an unchanging principal amount. Answer: TRUE Diff: 2 Objective: L.O. 9-8
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10) Simple interest is more frequently used than compounded interest in U.S. financial practice. Answer: FALSE Diff: 2 Objective: L.O. 9-8
11) Compound interest is calculated by multiplying an interest rate by a principal amount. The principal amount increases each time interest is earned. The accumulated interest is added to the principal to become the new principal for the next period. Answer: TRUE Diff: 2 Objective: L.O. 9-8
12) Accountants generally use future values rather than present values to record long-term liabilities. Answer: FALSE Diff: 1 Objective: L.O. 9-8
13) Discount rates are the interest rates used in determining present values. Answer: TRUE Diff: 1 Objective: L.O. 9-8
14) An ordinary annuity is a series of different cash flows to take place at the end of successive periods. Answer: FALSE Diff: 1 Objective: L.O. 9-8
15) Solve each of the following independent cases using the present value tables. The following are actual contracts signed by athletes: a. $25,000,000 contract, payable at $2,500,000 per year for 10 years. b. $25,000,000 contract, payable at $1,000,000 per year for 25 years. c. $25,000,000 contract, payable at $1,562,500 per year for 16 years. Determine the present value of each contract and indicate which contract you would prefer to have. Assume a 12% interest rate. Answer: a. $2,500,000 × 5.6502 = $14,125,500 This contract is preferred. b. $1,000,000 × 7.8431 = $7,843,100 c. $1,562,500 × 6.9740 = $10,896,875 Diff: 2 Objective: L.O. 9-8
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Introduction to Financial Accounting, 11e (Horngren) Chapter 10 Stockholders' Equity Learning Objective 10.1 Questions 1) By using ________, shareholders may express (vote) their preference without traveling to the site of the annual meeting. A) a preemptive right B) a corporate proxy C) a stock option D) a stock split E) a stock dividend Answer: B Diff: 1 Objective: L.O. 10-1
2) A preemptive right is A) the right of stockholders to acquire a proportional amount of any new issues of common stock. B) the right of stockholders to fire and replace the board of directors. C) the right of the corporation to enter into legally binding contracts without the direct approval of the shareholders. D) the right of stockholders to supersede the actions of top management. E) the right of top management to act on behalf of the stockholders. Answer: A Diff: 1 Objective: L.O. 10-1
3) Limited liability means A) that in the event of liquidation, owners need to contribute only enough additional money so as to fully pay off the creditors of a corporation. B) the creditors of a corporation can receive only up to and no more than the amount due to them. C) that the company is required to pay only current liabilities in the current year and has no obligation to pay long-term liabilities in the current year. D) that corporations can have liabilities only up to a certain amount, due to limits on the company's borrowing capability. E) the creditors of the corporation have claims on only the assets of the corporation and not the assets of the owners of the corporation. Answer: E Diff: 2 Objective: L.O. 10-1
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4) Which of the following statements is false? A) New corporations often start with a few investors and then seek additional funding as their original ideas are shown to be profitable. B) Groups of investors called venture capitalists provide financial support for new corporations. C) If the early life of the company is successful, the company may have an initial public offering (IPO). D) The IPO may be managed by an underwriting firm and shares will be sold to individual and institutional investors. E) The accounting procedures used by a company will vary significantly based upon the stage of the company's growth cycle. Answer: E Diff: 3 Objective: L.O. 10-1
5) Corporations are perpetual entities created in accordance with federal laws. Answer: FALSE Diff: 1 Objective: L.O. 10-1
6) A corporate proxy is a written authority granted by individual shareholders to others to cast the shareholders' votes. Answer: TRUE Diff: 2 Objective: L.O. 10-1
7) The ultimate power to manage a corporation is usually delegated to a corporation's top management by the common stockholders. Answer: TRUE Diff: 2 Objective: L.O. 10-1
8) Top management does not need to own a significant number of shares in order to have the authority to exert great influence on the actions of a corporation. Answer: TRUE Diff: 2 Objective: L.O. 10-1
9) In general, what are the principal rights of shareholders? Answer: Shareholders usually have the right to: (1) vote, (2) share in corporate profits, (3) share in any assets left at liquidation, and (4) possibly, acquire more shares of subsequent issues of stock. Diff: 3 Objective: L.O. 10-1
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Learning Objective 10.2 Questions 1) The total number of shares that may be issued by a corporation is known as A) issued shares. B) authorized shares. C) outstanding shares. D) treasury shares. E) preferred shares. Answer: B Diff: 1 Objective: L.O. 10-2
2) Those shares which have been sold to outside investors at one time or another are known as A) authorized shares. B) issued shares. C) outstanding shares. D) treasury shares. E) convertible shares. Answer: B Diff: 1 Objective: L.O. 10-2
3) Those shares which have been issued and that are still in the hands of shareholders are known as A) authorized shares. B) issued shares. C) treasury shares. D) outstanding shares. E) convertible shares. Answer: D Diff: 1 Objective: L.O. 10-2
4) Additional paid-in capital is the difference between the A) cash received from stockholders and par value of the stock. B) cash received from stockholders and dividends of the stock. C) dividends paid to stockholders and treasury stock purchased. D) dividends paid to stockholders and total number of shares authorized. E) total number of shares authorized and total number of shares outstanding. Answer: A Diff: 2 Objective: L.O. 10-2
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5) Tablet Trade & Commerce has 100,000 shares of common stock authorized, 10,000 shares issued and outstanding. On June 1, 20X3, the company declared a $5.00 per share dividend for those of record on July 1, 20X3, to be paid on August 1, 20X3. Which of the following journal entries would Tablet Trade & Commerce make on June 1, 20X3? A) No journal entry is necessary B) Retained Earnings 50,000 Dividends Payable 50,000 C) Dividends Payable 50,000 Cash 50,000 D) Retained Earnings 500,000 Dividends Payable 500,000 E) Retained Earnings 500,000 Cash 500,000 Answer: B Diff: 1 Objective: L.O. 10-2
6) Tablet Trade & Commerce has 100,000 shares of common stock authorized, 10,000 shares issued and outstanding. On June 1, 20X3, the company declared a $5.00 per share dividend for those of record on July 1, 20X3, to be paid on August 1, 20X3. Which of the following journal entries would Tablet Trade & Commerce make on July 1, 20X3? A) No journal entry is necessary. B) Retained Earnings 50,000 Dividends Payable 50,000 C) Retained Earnings 50,000 Cash 50,000 D) Dividends Payable 50,000 Cash 50,000 E) Retained Earnings 300,000 Dividends Payable 300,000 Answer: A Diff: 1 Objective: L.O. 10-2
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7) Tablet Trade & Commerce has 100,000 shares of common stock authorized, 10,000 shares issued and outstanding. On June 1, 20X3, the company declared a $5.00 per share dividend for those of record on July 1, 20X3, to be paid on August 1, 20X3. Which of the following journal entries would Tablet Trade & Commerce make on August 1, 20X3? A) No journal entry is necessary. B) Retained Earnings 50,000 Dividends Payable 50,000 C) Retained Earnings 50,000 Cash 50,000 D) Dividends Payable 50,000 Cash 50,000 E) Retained Earnings 500,000 Cash 500,000 Answer: D Diff: 1 Objective: L.O. 10-2
8) The account Dividends Payable is A) debited on the date of declaration. B) credited on the date of payment. C) not a legal liability of the company. D) a liability on a balance sheet prepared between the date of declaration and the date of payment. E) a contra account found in the stockholders' equity section of the balance sheet. Answer: D Diff: 2 Objective: L.O. 10-2
9) Treasury stock can be A) used for stock purchase plans. B) used to increase cash when the treasury stock is purchased. C) used to distribute to employees for bonuses. D) both A and B E) both A and C Answer: E Diff: 2 Objective: L.O. 10-2
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10) The issuance of 1,000, $.01 par value shares of common stock at $5 per share would include which of the following journal entries? A) Cash 5,000 Retained earnings 5,000 B) Common stock 4,990 Additional paid-in capital 10 Cash 5,000 C) Cash 5,000 Common stock 10 Additional paid-in capital 4,990 D) Common Stock 5,000 Cash 5,000 E) Cash 5,000 Common stock 5,000 Answer: C Diff: 2 Objective: L.O. 10-2
11) The aggregate number of shares of stock sold to the public is referred to as authorized shares of stock. Answer: FALSE Diff: 2 Objective: L.O. 10-2
12) Just because a certain number of shares are authorized does not mean that a company will ever offer that many shares to potential investors. Answer: TRUE Diff: 1 Objective: L.O. 10-2
13) The number of shares authorized are always greater than or equal to the number of shares outstanding, which are always greater than or equal to the number of shares issued. Answer: FALSE Diff: 2 Objective: L.O. 10-2
14) If 10,000 shares have been issued, and 500 are held as treasury stock, the number of shares outstanding is 9,500. Answer: TRUE Diff: 2 Objective: L.O. 10-2
15) If 100,000 shares are authorized, 95,000 are outstanding and 1,500 are held as treasury stock, the number of shares issued is 93,500. Answer: FALSE Diff: 2 Objective: L.O. 10-2
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16) Additional Paid-in Capital is also known as Capital in Excess of Par Value. Answer: TRUE Diff: 2 Objective: L.O. 10-2
17) In the United States, most corporations pay dividends every six months. Answer: FALSE Diff: 1 Objective: L.O. 10-2
18) Retained earnings is debited on the date of payment for a cash dividend. Answer: FALSE Diff: 2 Objective: L.O. 10-2
19) Dividends become a liability of the corporation on the date of payment. Answer: FALSE Diff: 2 Objective: L.O. 10-2
20) With respect to dividends, the record date comes first and is always followed by the declaration date, which is then always followed by the payment date. Answer: FALSE Diff: 1 Objective: L.O. 10-2
21) Net income must be greater than zero in order to pay dividends. Answer: FALSE Diff: 2 Objective: L.O. 10-2
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22) Florenza Establishment had 2,500,000 shares of common stock authorized. Shares issued were 1,050,000. There were 50,000 shares in treasury. a. How many shares have been sold to shareholders? b. How many shares are outstanding? c. How many shares are unissued? d. If the company declared a $2.00 per share cash dividend on January 1, 20X4, for those of record on January 15, 20X4, payable on January 31, 20X4, prepare the journal entry for each of those dates assuming there were no changes over that period in the number of shares authorized, issued, or outstanding. Answer: a. 1,050,000 shares b. 1,000,000 shares c. 1,450,000 shares d. Jan. 1 Retained Earnings 2,000,000 Dividends Payable 2,000,000 Jan. 15 No journal entry is necessary. Jan. 31 Dividends Payable Cash
2,000,000 2,000,000
Diff: 1 Objective: L.O. 10-2
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23) The stockholders' equity section of the balance sheet for Alaska Outfitters' at December 31, 2X03 follows: Common stock, $2 par, 25,000 shares authorized Additional paid-in capital Retained earnings Total contributed capital and retained earnings Less: Treasury stock, 1,000 shares at cost Total stockholders' equity
$ 20,000 10,000 80,000 110,000 10,000 $ ?
1. ________ How many shares of common stock are issued? 2. ________ How many shares of common stock are outstanding? 3. ________ How many shares of common stock will receive dividends if dividends are declared? 4. ________ What is the cost of the treasury stock per share? 5. ________ What is the value of total stockholders equity? 6. ________ Suppose Alaska Outfitters issues 10,000 additional shares of common stock and receives $50,000. What is the journal entry to record the additional issuance of stock? Answer: 1. 10,000 shares ($20,000/$2 par) 2. 9,000 shares (10,000 - 1,000 treasury stock shares) 3. 9,000 shares 4. $10 ($10,000/1,000) 5. $100,000 6. Cash $50,000 Common stock 20,000 Additional paid-in capital 30,000 Diff: 3 Objective: L.O. 10-2
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24) Hortel, Inc., had the following transactions during 2X03, its first year of operations. For each transaction, determine the effect each transaction had on the various stockholders' equity accounts by placing a plus sign (+), a minus sign (-), or an X in each column.
Common stock 1. Hortel issued 2,500 shares above par for cash 2. Hortel declared dividends 3. The date of record for dividends 4. Hortel paid dividends 5. Hortel authorized 800 additional shares Answer: Common stock 1. Hortel issued 2,500 shares above par for cash + 2. Hortel declared dividends X 3. The date of record for dividends X 4. Hortel paid dividends X 5. Hortel authorized 800 additional shares X
Additional paid-in Retained Dividends capital earnings payable Cash
Additional paid-in Retained Dividends capital earnings payable Cash
+ X
X -
X +
+ X
X X
X X
X -
X -
X
X
X
X
Diff: 2 Objective: L.O. 10-2
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25) Prepare the appropriate journal entry for Chowder Soups for each of the events below. Each event relies on some or all of the events preceding it. a. On January 1, 20X3, Chowder Soups began operations. The company issued 20,000 shares of its $1.00 par value common stock. The shares were sold for $11 per share. b. On November 1, 20X3, Chowder Soups declared a $1.20 per share common stock dividend. c. The record date for the common stock cash dividend was November 15, 20X3. d. On November 20, 20X3, Chowder Soups paid the $1.20 per share common stock dividend. Answer: a. Cash 220,000 Common Stock 20,000 Additional Paid-in Capital 200,000 b. Retained Earnings 24,000 Dividends Payable 24,000 c. No journal entry is necessary. d. Dividends Payable 24,000 Cash 24,000 Diff: 2 Objective: L.O. 10-2
Learning Objective 10.3 Questions 1) Which of the following statements is NOT true regarding common and preferred stock? A) Common stock is the most basic and common type of stock. B) All corporations issue common stock. C) Preferred stock owners do not usually have voting rights. D) Preferred stockholders have priority over common stockholders regarding dividends and the distribution of assets upon liquidation. E) With preferred shares, the amount of the dividend is generally specified and increases every year. Answer: E Diff: 3 Objective: L.O. 10-3
2) Which statement about cumulative preferred stock is FALSE? A) A company does not have to pay a preferred stock dividend every year. B) No dividends can be paid to common stockholders until all current and prior year preferred stock dividends are paid. C) All dividends in arrears must be disclosed in a footnote to a company's balance sheet. D) Any dividends in arrears are considered to be a liability since the company is obligated to pay these dividends. E) In the event of liquidation, cumulative unpaid dividends must be paid before common stockholders receive any cash. Answer: D Diff: 3 Objective: L.O. 10-3
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3) Jacklie Syndicate began operations on January 1, 20X3. The company has the following items included in the stockholders' equity section of its balance sheet on December 31, 20X3 and December 31, 20X4. 8% Preferred Stock, $100 par, 100,000 shares authorized, 25,000 shares issued and outstanding Common Stock, $3 par, 500,000 shares authorized; 150,000 shares issued and outstanding Additional paid-in capital
$2,500,000 450,000 2,250,000
Total dividends declared and paid were during 20X3 $170,000 during 20X4 210,000 during 20X5 240,000 If Jacklie Syndicate's preferred stock were noncumulative, how much of the 20X4 dividends would have been distributed to A) Preferred Stock Common Stock $110,526 $ 99,474 B) Preferred Stock Common Stock $100,962 $109,038 C) Preferred Stock Common Stock $ 2,000 $208,000 D) Preferred Stock Common Stock $200,000 $ 10,000 E) Preferred Stock Common Stock $210,000 $ 0 Answer: D Diff: 2 Objective: L.O. 10-3
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4) Jacklie Syndicate began operations on January 1, 20X3. The company has the following items included in the stockholders' equity section of its balance sheet on December 31, 20X3 and December 31, 20X4. 8% Preferred Stock, $100 par, 100,000 shares authorized, 25,000 shares issued and outstanding Common Stock, $3 par, 500,000 shares authorized; 150,000 shares issued and outstanding Additional paid-in capital
$2,500,000 450,000 2,250,000
Total dividends declared and paid were during 20X3 $170,000 during 20X4 210,000 during 20X5 240,000 If Jacklie Syndicate's preferred stock were cumulative, how much of the 20X4 dividends would have been distributed to A) Preferred Stock Common Stock $210,000 $ 0 B) Preferred Stock Common Stock $200,800 $ 9,200 C) Preferred Stock Common Stock $201,429 $ 8,571 D) Preferred Stock Common Stock $204,808 $ 5,192 E) Preferred Stock Common Stock $200,000 $10,000 Answer: A Diff: 2 Objective: L.O. 10-3
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5) Jacklie Syndicate began operations on January 1, 20X3. The company has the following items included in the stockholders' equity section of its balance sheet on December 31, 20X3, December 31, 20X4 and December 31, 20X5. 8% Preferred Stock, $100 par, 100,000 shares authorized, 25,000 shares issued and outstanding Common Stock, $3 par, 500,000 shares authorized; 150,000 shares issued and outstanding Additional paid-in capital
$2,500,000 450,000 2,250,000
Total dividends declared and paid were during 20X3 $170,000 during 20X4 210,000 during 20X5 240,000 If Jacklie Syndicate's preferred stock were cumulative, how much of the 20X5 dividends would have been distributed to A) Preferred Stock Common Stock $200,000 $40,000 B) Preferred Stock Common Stock $205,714 $34,286 C) Preferred Stock Common Stock $219,230 $20,770 D) Preferred Stock Common Stock $220,000 $20,000 E) Preferred Stock Common Stock $240,000 $ 0 Answer: D Diff: 3 Objective: L.O. 10-3
6) Features of preferred stock could include all of the following except: A) callable. B) convertible. C) cumulative. D) interest-bearing. E) participating. Answer: D Diff: 1 Objective: L.O. 10-3
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7) A characteristic of preferred stock that provides increasing dividends when common dividends increase is known as A) participating. B) callable. C) convertible. D) liquidating preference. E) cumulative. Answer: A Diff: 2 Objective: L.O. 10-3
8) A characteristic of preferred stock that gives the issuer of the stock the right to buy the stock back from the owner at a fixed price is known as A) participating. B) cumulative. C) convertible. D) liquidating preference. E) callable. Answer: E Diff: 1 Objective: L.O. 10-3
9) Which statement about preferred stock is incorrect? A) Callable preferred stock gives the issuing company the right to purchase the preferred stock back from the shareholder. B) The call price on callable preferred stock is set below the par or issue price of the stock to compensate for the call feature. C) Convertible preferred stock gives the owners of the stock the right to exchange their preferred stock for common stock. D) Convertible preferred stock can be expected to have a lower dividend percentage than a similar nonconvertible preferred stock. E) Participating preferred stock can receive a larger dividend than the prespecified dividend when a company has an especially good year. Answer: B Diff: 2 Objective: L.O. 10-3
10) Hartman Inc., is liquidating. The company owes $3,800 to creditors of which $2,300 is unsubordinated debentures and $1,500 is subordinated debentures, preferred stockholders with a liquidating value of $1,800, and common stockholders. If Hartman, Inc., has cash proceeds of $6,000, how much of the proceeds do the common stockholders receive? A) $2,700 B) $3,700 C) $ 400 D) $2,200 E) $ 0 Answer: C Diff: 2 Objective: L.O. 10-3
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11) When comparing preferred stock to common stock and bonds, which of the following is incorrectly stated? A) Preferred stock and bonds have a specific maturity date. B) Both bonds and preferred stock pay a specific return to the investor. C) Both preferred stock and common stock can pay dividends. D) Both preferred stock dividends and common stock dividends become liabilities only when the board of directors declares them. E) Common stock, and typically preferred stock, have indefinite lives. Answer: A Diff: 2 Objective: L.O. 10-3
12) Preferred stock is like common stock in that dividends are not a legal obligation until the board of directors declares them. Answer: TRUE Diff: 2 Objective: L.O. 10-3
13) Dividend arrearages occur only for noncumulative preferred stock. Answer: FALSE Diff: 2 Objective: L.O. 10-3
14) If the board of directors declares a $210,000 dividend in 20X3, current year dividends on cumulative preferred stock are $80,000, dividends in arrears on cumulative preferred stock are $60,000, and the common shareholders are entitled to $70,000 of the 20X3 dividend amount. Answer: TRUE Diff: 2 Objective: L.O. 10-3
15) A measure of the preference to receive assets in the event of corporate liquidation is referred to as liquidating value. Answer: TRUE Diff: 1 Objective: L.O. 10-3
16) Before a liquidating company can distribute any assets to common stockholders, it must pay the full liquidating value of the preferred stock to all preferred stockholders. Answer: TRUE Diff: 2 Objective: L.O. 10-3
17) Preferred stocks and bonds have some similar characteristics. Answer: TRUE Diff: 2 Objective: L.O. 10-3
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18) The owners of a business have a residual interest in the assets of the company after both current and long-term liabilities have been satisfied. Answer: TRUE Diff: 1 Objective: L.O. 10-3
19) State the appropriate accounting term for each of the definitions given below. a) A written authority granted by individual shareholders to others to cast the shareholders' votes. b) The right to acquire a proportional amount of any new issues of common stock. c) The aggregate number of shares that can be issued. d) A characteristic of preferred stock that requires that the undeclared dividends accumulate and must be paid in the future before common dividends are paid. e) A measure of the preference to receive assets in the event of corporate liquidation. f) A characteristic of preferred stock that gives the issuer the right to buy the preferred stock from the owner at a fixed price. g) A characteristic of bonds or preferred stock that gives the holder the right to exchange the security for common stock. Answer: a. Corporate proxy b. Preemptive rights c. Authorized shares d. Cumulative e. Liquidating value f. Callable g. Convertible Diff: 1 Objective: L.O. 10-1, 10-2 & 10-3
20) For each of the following items, state whether its effect will be to increase, decrease, or have no change in total stockholders' equity. a) Issue common stock at a price greater than par value b) Issue common stock at par value c) Issue preferred stock at a price greater than par value d) Issue preferred stock at par value e) Declare the current year preferred stock dividend f) Pay the declared dividend in e. above g) Not declaring any dividends on cumulative preferred stock, thus having dividends in arrears h) Declaring dividends in arrears for cumulative preferred stock i) Paying for the dividends in arrears declared in h. above j) Having a company call all callable preferred stock Answer: a. Increase f. No change b. Increase g. No change c. Increase h. Decrease d. Increase i. No change e. Decrease j. Decrease Diff: 2 Objective: L.O. 10-2 & 10-3
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21) Boardman Pet Supplies began operations on January 1, 20X3, and issued preferred and common stock. The stockholders' equity section of the Boardman Pet Supplies's balance sheet immediately after the issuance of the preferred and common stock was as follows: Preferred stock, $100 par, 9%, 100,000 shares authorized, 55,000 shares issued and outstanding Common stock, $2 par, 2,000,000 shares authorized, 1,200,000 shares issued and outstanding Additional paid-in capital, preferred Additional paid-in capital, common Retained earnings Total stockholders' equity
$ 5,500,000 2,400,000 110,000 19,200,000 0 $27,210,000
Dividend payments were as follows: 20X3 $0 20X4 $0 20X5 $1,980,000 20X6 $2,200,000 No additional shares of preferred or common stock were issued after January 1, 20X3, nor did the company ever have treasury stock. Assume there was sufficient Retained Earnings to declare dividends in each year. How would the dividends be distributed for 20X3 through 20X6 between the preferred stock and the common stock if a. the preferred stock were cumulative? b. the preferred stock were noncumulative? Answer: a. Cumulative Preferred Stock Common Stock 20X3 $0 $0 20X4 $0 $0 20X5 $1,485,000 $495,000 20X6 $495,000 $1,705,000 b. 20X3 20X4 20X5 20X6
Noncumulative Preferred Stock $0 $0 $495,000 $495,000
Common Stock $0 $0 $1,485,000 $1,705,000
Diff: 2 Objective: L.O. 10-3
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Learning Objective 10.4 Questions 1) Restricted stock has the benefit of A) increasing in value when stock prices fall. B) decreasing in value when stock prices fall. C) retaining some value even if stock prices fall. D) being retained for three additional years past the original purchase date. E) being used as treasury stock. Answer: C Diff: 2 Objective: L.O. 10-4
2) Which of the following statements regarding stock options is false? A) Options are valuable because the executives can gain the benefits of stock price increases without bearing the risks of price declines. B) Options are generally given to corporate officers as a form of incentive compensation. C) Stock options are rights granted to executives to purchase a specific number of shares of a corporation's capital stock at a specific price for a specific time period. D) Measurement of the value of stock options is simply the market value of the options at the balance sheet date. E) Footnotes in the financial statements must reveal the number and type of options outstanding and an assessment of their value. Answer: D Diff: 3 Objective: L.O. 10-4
3) Brock Investing Group granted 25,000 stock options to its employees on January 1, 2X03. Each option can be exercised to buy one share of common stock. The exercise price is $40 per share. The options vest at the end of 3 years on December 31, 2X05. At the grant date, the fair value of the options is $4 per option. The shares had a par value of $1. The stock options are all exercised on December 31, 2X05. Required: 1. Prepare the journal entry on December 31, 2X03. 2. Prepare the journal entry on December 31, 2X04. 3. Prepare the journal entries on December 31, 2X05. Answer: 1. Compensation expense $33,333 Additional paid-in capital–stock options 33,333 2. Compensation expense 33,333 Additional paid-in capital–stock options 33,333 3. Compensation expense 33,334 Additional paid-in capital–stock options 33,334 Cash (25,000 × $40) Additional paid-in capital–stock options Common stock (25,000 × $1) Additional paid-in capital–common
1,000,000 100,000 25,000 1,075,000
Diff: 2 Objective: L.O. 10-4
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4) What are stock options? Why might stock options not be exercised? Why do companies reward management with stock options as opposed to cash bonuses? Answer: Stock options are rights granted to executives to purchase a specific number of shares of a corporation's capital stock at a specific price for a specific time period. Options might not be exercised if, at a future date, the option price exceeds the current market price. Companies generally give options to corporate officers as a form of incentive compensation. Options provide a better incentive to management than do cash bonuses. Options can only be exercised in the future and only have value if the exercise price is less than the market price at the date of exercise. For these reasons, management has compelling reasons to increase the long-term value of the company, which will be reflected in the market price of the stock. Diff: 3 Objective: L.O. 10-4
Learning Objective 10.5 Questions 1) Hoffert Enterprises has 500,000 shares of common stock authorized and 100,000 shares of common stock issued and outstanding. The common stock has a par value of $6 per share. On February 1, 2X13, the company declared and issued a two-for-one stock split. Assuming that the company exchanges 200,000 new $3 par value shares for the old shares, what journal entry would be made by Hoffert Enterprises on February 1, 2X13? A) Cash 600,000 Common Stock 600,000 B) Cash 3,000,000 Common Stock 3,000,000 C) Common Stock 600,000 Additional Paid-in Capital 600,000 D) Retained Earnings 1,200,000 Common Stock 1,200,000 E) No journal entry is necessary. Answer: E Diff: 2 Objective: L.O. 10-5
2) Printers for You began operations on June 1, 2X13. The company authorized 15,000 shares of $1 par value common stock. Printers for You sold 15,000 shares of common stock for $5 per share on June 2, 2X13. On August 15, 2X13, Printers for You repurchased 1/2 of the outstanding common stock for $6 per share. On August 31, 2X13, Printers for You sold 1,000 of the treasury stock. On September 1, 2X13, the company declared a three-for-one stock split. After the split A) total stockholders' equity remained the same. B) total stockholders' equity increased. C) total stockholders' equity decreased. D) assets and liabilities increased. E) assets and liabilities decreased. Answer: A Diff: 2 Objective: L.O. 10-5
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3) Alexander Pools has 700,000 shares authorized and 250,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $60 per share. If Alexander Pools declared and issued a three-for-one stock split adjusting its par value, what would be the effect on the following items after the stock split? Assume the old shares were exchanged for 750,000 new shares. A) # of Shares Issued Par Value Market Price per Share 500,000 $2.00 $30.00 B) # of Shares Issued Par Value Market Price per Share 750,000 $1.33 $20.00 C) # of Shares Issued Par Value Market Price per Share 750,000 $4.00 $20.00 D) # of Shares Issued Par Value Market Price per Share 1,000,000 $1.00 $15.00 E) # of Shares Issued Par Value Market Price per Share 1,000,000 $12.00 $20.00 Answer: B Diff: 3 Objective: L.O. 10-5
4) Stock splits generally cause stock prices to fall. Answer: TRUE Diff: 2 Objective: L.O. 10-5
Learning Objective 10.6 Questions 1) Chorpa, Inc., has 700,000 shares authorized and 150,000 shares issued and outstanding of $3 par value common stock. The current market price of the stock is $50 per share. On December 1, 2X13, the company declared and issued a 40% stock dividend. After the stock dividend, determine the new value for each of the following items: A) # of Shares Issued Par Value Market Price per Share 210,000 $1.80 $30.00 B) # of Shares Issued Par Value Market Price per Share 210,000 $1.80 $70.00 C) # of Shares Issued Par Value Market Price per Share 210,000 $3.00 $30.00 D) # of Shares Issued Par Value Market Price per Share 210,000 $3.00 $35.71 E) # of Shares Issued Par Value Market Price per Share 430,000 $1.80 $30.00 Answer: D Diff: 3 Objective: L.O. 10-6
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2) Bettle Company has 500,000 shares authorized and 100,000 shares issued and outstanding of $4 par value common stock. The current market price of the stock is $25 per share. On May 1, 2X13, the company declared and issued a 5% stock dividend. What journal entry would the company make on May 1, 2X13? A) Retained Earnings 20,000 Common Stock 20,000 B) Retained Earnings 125,000 Common Stock 125,000 C) Retained Earnings 125,000 Common Stock 20,000 Additional Paid-in Capital 105,000 D) Retained Earnings 100,000 Common Stock 100,000 E) Retained Earnings 2,500,000 Common Stock 400,000 Additional Paid-in Capital 2,100,000 Answer: C Diff: 2 Objective: L.O. 10-6
3) Which of the following statements about large stock dividends is true? A) If the market price of the stock before a 50% stock dividend is $30, the market price after the stock dividend will be $45. B) If the market price of the stock before a 50% stock dividend is $30, the market price after the stock dividend will be $60. C) A stockholder who owned 50 shares of stock before the 50% stock dividend, will own 100 shares of stock after the stock dividend. D) With a 50% stock dividend, Retained Earnings is reduced by the par value of new shares of stock issued. E) With a 50% stock dividend, Retained Earnings is reduced by the market value of new shares of stock issued. Answer: D Diff: 2 Objective: L.O. 10-6
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4) Soxlette Company has 700,000 shares authorized and 250,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $60 per share. If Soxlette Company declared and issued a 70% stock dividend, what would be the effect on the following items after the stock dividend? A) # of Shares Issued Par Value Market Price per Share 175,000 $5.71 $85.71 B) # of Shares Issued Par Value Market Price per Share 425,000 $2.80 $42.00 C) # of Shares Issued Par Value Market Price per Share 425,000 $2.35 $35.29 D) # of Shares Issued Par Value Market Price per Share 425,000 $4.00 $35.29 E) # of Shares Issued Par Value Market Price per Share 490,000 $1.00 $15.00 Answer: D Diff: 3 Objective: L.O. 10-6
5) Soxlette Company has 700,000 shares authorized and 250,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $60 per share. If Soxlette Company declared and issued a 30% stock dividend, what journal entry would the company make? A) Retained Earnings 210,000 Common Stock 210,000 B) Retained Earnings 300,000 Common Stock 300,000 C) Retained Earnings 4,500,000 Common Stock 4,500,000 D) Retained Earnings 18,000,000 Common Stock 18,000,000 E) No journal entry is necessary. Answer: B Diff: 2 Objective: L.O. 10-6
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6) Soxlette Company has 700,000 shares authorized and 250,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $60 per share. If Soxlette Company declared and issued a 5% stock dividend, what journal entry would the company make? A) Retained Earnings 50,000 Common Stock 50,000 B) Retained Earnings 750,000 Common Stock 750,000 C) Retained Earnings 750,000 Common Stock 50,000 Additional Paid-in Capital 700,000 D) Retained Earnings 140,000 Common Stock 140,000 E) Retained Earnings 2,100,000 Common Stock 140,000 Additional Paid-in Capital 1,960,000 Answer: C Diff: 3 Objective: L.O. 10-6
7) Kimberly Conrad owns 150 shares of Dalor Organization. On January 13, 2X13, Dalor Organization declared and issued a 3% stock dividend. The market price per share of Dalor Organization's stock is $35, and the par value is $1.00 per share. What is the journal entry to be made by Dalor Organization with respect to the stock dividend distribution to Kimberly Conrad? A) Retained Earnings 4.50 Common Stock 4.50 B) Retained Earnings 9.00 Additional Paid-in Capital 148.50 Common Stock 4.50 Cash 153.00 C) Retained Earnings 157.50 Common Stock 4.50 Additional Paid-in Capital 135.00 Cash 27.00 D) Retained Earnings 157.50 Common Stock 157.50 E) Retained Earnings 157.50 Common Stock 4.50 Additional Paid-in Capital 153.00 Answer: E Diff: 3 Objective: L.O. 10-6
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8) Ronald Cummings purchased 800 shares of Barnum Corp.'s common stock for $15 per share. Barnum Corp.'s shares have a par value of $2. If Barnum Corp. declared and issued a 3% stock dividend when the market price per share was $16, what journal entry would Ronald Cummings make? A) Investment in Barnum Corp. 24 Gain from Stock Dividend 24 B) Investment in Barnum Corp. 48 Gain from Stock Dividend 48 C) Investment in Barnum Corp. 360 Gain from Stock Dividend 360 D) Investment in Barnum Corp. 384 Gain from Stock Dividend 384 E) No journal entry is necessary. Answer: E Diff: 2 Objective: L.O. 10-6
9) Ronald Cummings purchased 800 shares of Barnum Corp.'s common stock for $15 per share. Barnum Corp.'s shares have a par value of $2. Assume Barnum Corp. declared and issued a 100% stock dividend. Subsequently, Ronald Cummings sold all of his holdings in Barnum Corp. for $9 per share. What journal entry would Ronald Cummings make to record the sale of his shares of the Barnum Corp.? A) Cash 7,200 Loss on Sale 4,800 Investment in Barnum Corp. 12,000 B) Cash 7,200 Unrealized Gain 4,800 Investment in Barnum Corp. 12,000 C) Cash 14,400 Gain on Sale 2,400 Investment in Barnum Corp. 12,000 D) Cash 14,400 Loss on Sale 9,600 Investment in Barnum Corp. 24,000 E) Cash 14,400 Unrealized Gain 4,800 Investment in Barnum Corp. 12,000 Gain on Sale 7,200 Answer: C Diff: 3 Objective: L.O. 10-6
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10) Nolan Jewelry has 200,000 shares of common stock authorized and 50,000 shares of common stock issued and outstanding. The common stock has a par value of $5 per share. On March 1, 2X13, the company declared and issued a two-for-one stock split. Assuming that the company issues 50,000 new shares and accounts for it as a 100% stock dividend, what journal entry would be made by Nolan Jewelry on March 1, 2X13? A) Retained Earnings 250,000 Common Stock 250,000 B) Additional Paid-in Capital 250,000 Common Stock 250,000 C) Cash 250,000 Common Stock 250,000 D) Cash 250,000 Additional Paid-in Capital 250,000 E) No journal entry is necessary. Answer: A Diff: 3 Objective: L.O. 10-6
11) Alexander Pools has 700,000 shares authorized and 250,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $60 per share. If Alexander Pools declared and issued a three-for-one stock split by issuing 500,000 new shares and accounts for it as a stock dividend, what journal entry would be made? A) Retained Earnings 250,000 Common Stock 250,000 B) Retained Earnings 500,000 Common Stock 500,000 C) Retained Earnings 1,000,000 Common Stock 1,000,000 D) Retained Earnings 2,000,000 Common Stock 2,000,000 E) No journal entry is necessary. Answer: D Diff: 2 Objective: L.O. 10-6
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12) Ronald Cummings purchased 800 shares of Barnum Corp.'s common stock for $15 per share. Barnum Corp.'s shares have a par value of $2. If Barnum Corp. declared and issued a two-for-one stock split, what journal entry would Ronald Cummings make? A) Investment in Barnum Corp. 12,000 Gain from Stock Split 12,000 B) Investment in Barnum Corp. 12,000 Unrealized Gain 12,000 C) Investment in Barnum Corp. 12,000 Common Stock 1,600 Gain from Stock Split 10,400 D) Investment in Barnum Corp. 1,600 Common Stock 1,600 E) No journal entry is necessary. Answer: E Diff: 2 Objective: L.O. 10-6
13) Ronald Cummings purchased 800 shares of Barnum Corp.'s common stock for $15 per share. Barnum Corp.'s shares have a par value of $2. If Barnum Corp. declared and issued a two-for-one stock split, and later declared and paid on the same day a cash dividend of $1.00 per share, what journal entry would Ronald Cummings make in order to record the cash dividend from Barnum Corp.? A) Cash 800 Dividend Income 800 B) Cash 1,600 Dividend Income 1,600 C) Cash 1,600 Dividend Income 800 Gain from Stock Split 800 D) Investment in Barnum Corp. 1,600 Gain from Stock Split 1,600 E) Investment in Barnum Corp. 3,200 Cash 800 Gain from Stock Split 3,200 Dividend Income 800 Answer: B Diff: 2 Objective: L.O. 10-6
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14) Which statement is false? A) Typically the par value of common stock is adjusted for a stock split. B) There are no costs to the company when issuing stock splits or stock dividends. C) In both a stock split and a stock dividend, the shareholders have the same ownership interest after the stock split or stock dividend as they had before the stock split or stock dividend. D) Ignoring the effect of fractional shares, both stock splits and stock dividends issue shares of common stock without any additional cash payments. E) Stock splits are often used to keep a company's stock price low enough to maintain its price within a reasonable trading range. Answer: B Diff: 3 Objective: L.O. 10-6
15) When a stock dividend is less than 20% of the outstanding shares, generally accepted accounting principles require the stock dividend to be accounted for at its par value. Answer: FALSE Diff: 2 Objective: L.O. 10-6
16) When shareholders are entitled to stock dividends in amounts equal to fractional units, corporations issue additional shares for whole units plus cash equal to the market value of the fractional units. Answer: TRUE Diff: 2 Objective: L.O. 10-6
17) Stock dividends and stock splits involve additional shares of stock distributed to shareholders without any cash payment to the firm. Answer: TRUE Diff: 2 Objective: L.O. 10-6
18) Both stock dividends and stock splits involve a reduction in the par value of the stock. Answer: FALSE Diff: 2 Objective: L.O. 10-6
19) A stock split can be accounted for as a large stock dividend. Answer: TRUE Diff: 2 Objective: L.O. 10-6
20) Journal entries must be made on the books of the issuing company for all stock splits and stock dividends. Answer: FALSE Diff: 2 Objective: L.O. 10-6
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21) In substance, there is absolutely no difference between the 100% stock dividend and the two-for-one stock split. Answer: TRUE Diff: 2 Objective: L.O. 10-6
22) Kendall Corporation has 600,000 shares authorized and 150,000 shares issued and outstanding of its $4 par value common stock. The stock is currently selling for $50 per share. There is $900,000 of additional paid-in capital and the firm has $3,000,000 of retained earnings. Prepare the appropriate journal entry for Kendall Corporation for each of the alternative events below. a) 2% stock dividend b) 100% stock dividend c) 2 for 1 stock split (Assume 300,000 new shares were exchanged for the old shares) Answer: a. Retained Earnings 150,000 Common Stock 12,000 Additional Paid-in Capital 138,000 b. Retained Earnings 600,000 Common Stock 600,000 c. No journal entry is necessary. Note par value changes to $2. Diff: 2 Objective: L.O. 10-6
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23) Clifflee, Inc., reported the following amounts on its June 30, 2X09 balance sheet: Preferred stock, $5 par, 10%, 5,000 shares issued and outstanding Common stock, $1 par, 20,000 shares issued and outstanding Additional paid-in capital, common stock Total contributed capital Retained earnings Total stockholders' equity
$ 25,000 20,000 65,000 $110,000 20,000 $130,000
Clifflee, Inc. declared a 30% common stock dividend on July 12, when the market value of the stock was $25 and a 30% preferred stock dividend on July 13, when the market value of the stock was $50. Both stock dividends will be distributed on August 31, 2X09. Required: 1. Journalize the declaration of the 30% common stock dividend and the 30% preferred stock dividend. 2. Journalize the distribution of the 30% common stock dividend and the 30% preferred stock dividend. 3. Prepare the stockholders' equity section of Clifflee Inc.'s balance sheet after the effects of the two stock dividends. Answer: 1. Retained earnings 13,500 Common stock distributable 6,000 Preferred stock distributable 7,500 2. Common stock distributable 6,000 Preferred stock distributable 7,500 Common stock 6,000 Preferred stock 7,500 3. Preferred stock, $5 par, 10%, 6,500 shares issued and outstanding $32,500 Common stock, $1 par, 26,000 shares issued and outstanding 26,000 Additional paid-in capital, common stock 65,000 Total contributed capital $ 123,500 Retained earnings 6,500 Total stockholders' equity $130,000 Diff: 2 Objective: L.O. 10-6
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24) The stockholders' equity section of the balance sheet for Pental, Inc., follows before the stock dividend. Common stock, $1 par, 100,000 shares issued and outstanding $100,000 Additional paid-in capital 50,000 Retained earnings 450,000 Total stockholders' equity $600,000 Pental, Inc., declared a 5% stock dividend when the market price per share was $10. In the space next to each account, determine the amounts of each account after the stock dividend was distributed. ________
Common stock
________
Additional paid-in capital
________ Answer: $105,000 $ 95,000 $400,000
Retained earnings Common stock Additional paid-in capital Retained earnings
Diff: 2 Objective: L.O. 10-6
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25) Halton Real Estate has decided to split its common stock two-for-one, but is unsure whether they would like to reduce or retain the par value of the common stock. Currently, Halton Real Estate has 10,000 shares of $10 par value common stock outstanding with a market value of $60 per share. Under option A, Halton Real Estate would retain par value at $10 per share and under option B, Halton Real Estate would reduce par value. Under each option, determine the following: Option A 1. ________ How much is the common stock account increased by? 2. ________ How much is the retained earnings account increased by? 3. ________ How much is the total stockholders' equity increased by? 4. ________ What is the new expected market value of the common stock? 5. What is the journal entry to account for the stock split under option A? Option B 1. ________ How much is the common stock account increased by? 2. ________ How much is the retained earnings account increased by? 3. ________ How much is the total stockholders' equity increased by? 4. ________ What is the new expected market value of the common stock? 5. What is the journal entry to account for the stock split under option B? Answer: Option A 1. $100,000 (100,000 shares × $10 per share) 2. $0 3. $0 4. $30 5. Retained Earnings $100,000 Common Stock 100,000 Option B 1. $0 2. $0 3. $0 4. $30 5. No journal entry is required. Diff: 2 Objective: L.O. 10-6
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Learning Objective 10.7 Questions 1) What type of account is the Treasury stock and Additional paid-in capital? A) Treasury stock Additional paid-in capital retained earnings retained earnings B) Treasury stock Additional paid-in capital asset contra stockholders' equity C) Treasury stock Additional paid-in capital contra stockholders' equity stockholders' equity D) Treasury stock Additional paid-in capital common stock contra stockholders' equity E) Treasury stock Additional paid-in capital common stock retained earnings Answer: C Diff: 2 Objective: L.O. 10-7
2) Rondo Auto acquired 3,500 of its own shares at $32 per share. The shares are to be held in Treasury. The par value of Rondo Auto's common stock is $2.50 per share. If Rondo Auto were to resell all its treasury stock at $35 per share, what journal entry would Rondo Auto make? A) Cash 122,500 Additional Paid-in Capital 112,000 Treasury Stock 10,500 B) Cash 122,500 Additional Paid-in Capital 10,500 Treasury Stock 112,000 C) Cash 122,500 Treasury Stock 112,000 Gain on Sale of Treasury Stock 10,500 D) Cash 122,500 Additional Paid-in Capital 103,250 Treasury Stock 8,750 Gain on Sale of Treasury Stock 10,500 E) Cash 122,500 Common Stock 8,750 Treasury Stock 112,000 Gain on Sale of Treasury Stock 1,750 Answer: B Diff: 2 Objective: L.O. 10-7
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3) Ronald Cummings purchased 800 shares of Barnum Corp.'s common stock for $15 per share. Barnum Corp.'s shares have a par value of $2. If Ronald were to resell all its treasury stock at $28 per share, what journal entry would he make? A) Cash 22,400 Treasury Stock 22,400 B) Cash 22,400 Gain on Sale of Treasury Stock 10,400 Treasury Stock 12,000 C) Cash 22,400 Additional Paid-in Capital 10,400 Treasury Stock 12,000 D) Cash 22,400 Gain on Sale of Treasury Stock 22,400 E) Cash 12,000 Treasury Stock 12,000 Answer: C Diff: 2 Objective: L.O. 10-7
4) Reasons given for a company to buy back its own shares include all of the following except: A) to reduce the market price per share of its stock to make it more affordable to potential investors. B) to permanently reduce shareholder claims. C) to temporarily hold shares for later use. D) to decrease the likelihood that a company will be the object of a takeover bid. E) to distribute in an employee stock purchase plan. Answer: A Diff: 2 Objective: L.O. 10-7
5) Treasury stock is A) shares owned by the directors of a company. B) shares owned by the management of a company. C) shares that are not yet sold but could be sold at any time by a company. D) previously issued shares of a company that are now held by the company. E) shares of a company held in reserve to eventually retire the debt of the company. Answer: D Diff: 1 Objective: L.O. 10-7
6) Repurchasing shares A) has no effect on the number of shares outstanding or on earnings per share. B) increases the number of shares outstanding and increases earnings per share. C) reduces the number of shares outstanding and reduces earnings per share. D) increases the number of shares outstanding and decreases earnings per share. E) reduces the number of shares outstanding and increases earnings per share. Answer: E Diff: 2 Objective: L.O. 10-7
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7) Sandstone Company has the following stockholders' equity section: Common Stock, 500,000 shares authorized: 400,000 shares issued and outstanding Additional Paid-in Capital Retained Earnings Total Stockholders' Equity
$700,000 4,900,000 7,300,000 $12,900,000
What is the journal entry to be made by Sandstone Company if the company purchases and retires 15,000 shares of its own common stock when the market price of the stock is $20 per share? A) Common Stock 26,250 Retained Earnings 273,750 Cash 300,000 B) Common Stock 26,250 Additional Paid-in Capital 273,750 Cash 300,000 C) Common Stock 26,250 Retained Earnings 90,000 Additional Paid-in Capital 183,750 Cash 300,000 D) Common Stock 26,250 Retained Earnings 136,875 Additional Paid-in Capital 136,875 Cash 300,000 E) Common Stock 26,250 Retained Earnings 163,801 Additional Paid-in Capital 109,949 Cash 300,000 Answer: C Diff: 3 Objective: L.O. 10-7
8) Sandstone Company has the following stockholders' equity section: Common Stock, 500,000 shares authorized: 400,000 shares issued and outstanding Additional Paid-in Capital Retained Earnings Total Stockholders' Equity
$700,000 4,900,000 7,300,000 $ 12,900,000
What is the book value per share for the Sandstone Company? A) $1.40 B) $1.75 C) $25.80 D) $32.25 E) $14.00 Answer: D Diff: 2 Objective: L.O. 10-7
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9) By repurchasing shares of its own stock, a corporation liquidates some shareholders' claims, and total shareholders' equity decreases by the amount of the repurchase. Answer: TRUE Diff: 3 Objective: L.O. 10-7
10) When a corporation retires shares of issued common stock, the common stock account is credited for the par value of the stock. Answer: FALSE Diff: 2 Objective: L.O. 10-7
11) Treasury stock is a contra account with a debit balance in the stockholders' equity section of a company's balance sheet. Answer: TRUE Diff: 2 Objective: L.O. 10-7
12) Any differences between the acquisition costs and the resale proceeds of treasury stock must never be reported as losses, expenses, revenues, or gains in the income statement. Answer: TRUE Diff: 2 Objective: L.O. 10-7
13) Earnings per share will tend to increase with the purchase of treasury stock. Answer: TRUE Diff: 3 Objective: L.O. 10-7
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14) The following selected information is available for Lindale Corp., as of December 31, 2X13: Additional Paid-in Capital, Common Additional Paid-in Capital, Preferred Common Stock, $1 par, 1,000,000 shares authorized, 480,000 shares issued Dividends Payable Long-term Investment in the Broomfield Company Marketable Securities Retained Earnings Treasury Stock, Common, 20,000 shares 10% Cumulative Preferred Stock, $25 par, callable at $28; 200,000 shares authorized, 100,000 shares issued and outstanding
$1,050,000 150,000 ? 280,000 400,000 60,000 1,800,000 500,000
?
Given the above information, prepare the stockholders' equity section of the Lindale Corp.'s balance sheet dated December 31, 2X13. Answer: Lindale Corp. Stockholders' Equity Section of the Balance Sheet December 31, 2X13 10% Cumulative Preferred Stock, $25 par value, callable at $28; 200,000 shares authorized, 100,000 shares issued and outstanding Common Stock, $1 par value; 1,000,000 shares authorized; 480,000 shares issued, and 460,000 shares outstanding Additional Paid-in Capital, Preferred Additional Paid-in Capital, Common Total Paid-in Capital Retained Earnings Total Paid-in Capital and Retained Earnings Less: Treasury Stock, Common, 20,000 shares Total Stockholders' Equity
$2,500,000
480,000 150,000 1,050,000 $4,180,000 1,800,000 $5,980,000 (500,000) $5,480,000
Diff: 2 Objective: L.O. 10-7
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15) On August 10, 20X9, Steel Wool, Inc., reacquired 1,000 shares of its own $3 par value common stock at $28 per share. These shares were not permanently retired. On November 3, 20X9, the company sold 600 of the treasury shares for $26 per share. On December 15, 20X9, the company sold the remaining 400 shares for $32 per share. Prepare journal entries for Steel Wool, Inc., for August 10, November 3, and December 15. Answer: Aug. 10 Treasury Stock 28,000 Cash 28,000 Nov. 3 Cash 15,600 Additional Paid-in Capital 1,200 Treasury Stock 16,800 Dec. 15 Cash 12,800 Additional Paid-in Capital 1,600 Treasury Stock 11,200 Diff: 3 Objective: L.O. 10-7
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Learning Objective 10.8 Questions 1) Joino Manufacturing issued 2,000 shares of $100 par 9% convertible preferred stock for $112 per share. Each share of preferred stock can be converted into 8 shares of $2 par value common stock. On June 20, 2X13, 300 shares of preferred stock were converted when the market price per share of preferred stock was $115, and the market price per share for common stock $15. What is the journal entry for Joino Manufacturing on June 20, 2X13? A) Preferred Stock 30,000 Additional Paid-in Capital, Preferred Stock 3,600 Common Stock 4,800 Additional Paid-in Capital, Common 28,800 B) Preferred Stock 30,000 Additional Paid-in Capital, Preferred Stock 3,600 Loss on Conversion of Preferred Stock 2,400 Common Stock 4,800 Additional Paid-in Capital, Common 31,200 C) Preferred Stock 30,000 Additional Paid-in Capital, Preferred Stock 4,500 Loss on Conversion of Preferred Stock 1,500 Common Stock 4,800 Additional Paid-in Capital, Common 31,200 D) Preferred Stock 30,000 Additional Paid-in Capital, Preferred Stock 4,500 Loss on Conversion of Preferred Stock 1,950 Common Stock 4,800 Additional Paid-in Capital, Common 31,650 E) Preferred Stock 30,000 Additional Paid-in Capital, Preferred Stock 3,600 Loss on Conversion of Preferred Stock 1,500 Common Stock 4,800 Additional Paid-in Capital, Common 30,300 Answer: A Diff: 3 Objective: L.O. 10-8
2) A company issues its capital stock to acquire a building. Both parties in the transaction should record the transaction using the: A) fair value of the capital stock B) fair value of the building C) book value of the building D) fair value of the capital stock or the fair value of the building, whichever is easier to determine objectively E) book value of the capital stock Answer: D Diff: 2 Objective: L.O. 10-8
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3) When a corporation issues common stock on a preferred stock conversion, the common stock account is credited for the fair market value of the preferred stock on the date of conversion. Answer: FALSE Diff: 2 Objective: L.O. 10-8
Learning Objective 10.9 Questions 1) TLJ, Inc., has the following stockholders' equity accounts and amounts before paying dividends: Paid-in Capital $ 100,000 Retained Earnings 25,000 Total $125,000 Deduct: Treasury Stock 10,000 Total Stockholders' Equity $ 115,000 Assuming that TLJ, Inc., is restricted from declaring dividends that would cause stockholders' equity to be less than total paid-in capital, what is the maximum amount of dividends TLJ, Inc.'s board could declare? A) $70,000 B) $15,000 C) $25,000 D) $65,000 E) $10,000 Answer: B Diff: 2 Objective: L.O. 10-9
2) Restrictions of retained earnings are also called appropriated retained earnings or reserves. Answer: TRUE Diff: 1 Objective: L.O. 10-9
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Learning Objective 10.10 Questions 1) ROE A) stands for return on earnings. B) focuses on the company's profitability based on the book value of the common and preferred equity. C) remains relatively stable among different companies and different industries. D) is calculated by dividing net income minus preferred dividends by average common equity. E) evaluates how effectively the company uses resources provided by the bondholders Answer: D Diff: 3 Objective: L.O. 10-10
2) What is the market-to-book ratio? A) market value of total company divided by book value per share B) total stockholders' equity divided by the number of common shares outstanding C) total stockholders' equity divided by the book value of common stock D) market price per share divided by book value of assets E) market price per share divided by book value per share Answer: E Diff: 3 Objective: L.O. 10-10
3) Which of the following statements incorrectly describes the relationship between a company's book value per share and its market price per share? A) If the book value per share is below the market value per share, then shareholders are paying for the future earnings power of the company. B) If a company has unrecorded assets or appreciated assets, the market value per share is likely to be greater than the book value per share. C) Since the book value per share is based on historical costs, the book value per share can never be greater than the market price per share. D) Use of the book value per share can be highly questionable for many companies, since it is based on balance sheet amounts that in turn are based upon historical costs. E) If the market value of a company's assets is much greater than the assets' historical costs, then the market price per share will likely be greater than the book value per share. Answer: C Diff: 2 Objective: L.O. 10-10
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4) The following balance sheet is available: Tabler Company Stockholders' Equity Section of the Balance Sheet At December 31, 2X14 and 2X13
11% Preferred stock, 50,000 shares authorized; 30,000 shares issued and outstanding Common stock, $3 par, 2,000,000 shares authorized Additional paid-in capital-preferred Additional paid-in capital-common Total paid-in capital Retained Earnings Total paid-in capital and retained earnings Treasury stock, 6,000 shares of common Total Stockholders' equity
2X14
2X13
$ 3,000,000
$3,000,000
2,700,000 180,000 4,400,000 $10,280,000 11,400,000 21,680,000 (156,000) $21,524,000
2,700,000 180,000 4,400,000 $10,280,000 7,900,000 18,180,000 (156,000) $18,024,000
Net income in 2X14 was $5,000,000 and the market price was $61.56 per share of common stock. What is the book value per share of common stock for Tabler Company at December 31, 2X14? A) $9.17 B) $18.44 C) $18.56 D) $20.38 E) $20.52 Answer: E Diff: 3 Objective: L.O. 10-10
5) Market value per share divided by book value per share is commonly referred to as earnings per share. Answer: FALSE Diff: 2 Objective: L.O. 10-10
6) A company's market value per share and book value per share are not expected to be equal. Answer: TRUE Diff: 2 Objective: L.O. 10-10
7) A market value well above book value may be appropriate for a company if it has many unrecorded assets. Answer: TRUE Diff: 3 Objective: L.O. 10-10
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8) Net income plus preferred dividends divided by average common equity is referred to as rate of return on common equity. Answer: FALSE Diff: 2 Objective: L.O. 10-10
9) Caston Company had net income of $5,000,000 for the year ended December 31, 2X10. The stockholders' equity section of the Caston Company at December 31, 2X10 and 20X9, is as follows: Caston Company Stockholders' Equity Section of the Balance Sheet December 31, 2X10 and 20X9
11% Preferred stock, $100 par, noncumulative, 75,000 shares authorized; 20,000 shares issued and outstanding Common stock, $1.25 par, 4,000,000 shares authorized; 1,100,000 and 1,050,000 shares issued Additional paid-in capital-preferred Additional paid-in capital-common Total paid-in capital Retained earnings Total paid-in capital and retained earnings Treasury stock, 12,000 and 10,000 shares of common stock Total stockholders' equity
12/31/2X10
12/31/2X09
$ 2,000,000
$ 2,000,000
1,375,000 100,000 15,200,000 $18,675,000 17,900,000 $36,575,000
1,312,500 100,000 14,437,500 $17,850,000 14,600,000 $32,450,000
(180,000) $36,395,000
(150,000) $32,300,000
Determine a. the book value per share of common stock at the end of 2X10. b. the rate of return on common equity for 2X10. c. the amount of cash dividends on common stock declared during 2X10. Answer: a. ($36,395,000 - $2,100,000)/1,088,000 shares of common stock outstanding = $31.52 per share b. ($5,000,000 - $220,000)/[($36,395,000 - $2,100,000) + ($32,300,000 - $2,100,000)]/2 = 14.82% c. Beginning retained earnings $14,600,000 Add: Net income 5,000,000 Less: Preferred stock dividends declared (220,000) Less: Common stock dividends declared * Ending retained earnings $17,900,000 * Common stock dividends declared =
$1,480,000
Diff: 3 Objective: L.O. 10-10
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Introduction to Financial Accounting, 11e (Horngren) Chapter 11 Intercorporate Investments and Consolidations Learning Objective 11.1 Questions 1) Consolidated financial statements A) are used to offset gains and losses on the parent company's income statement. B) combine the financial records of two or more separate legal entities. C) make clear distinctions between principal and secondary long-term asset owners. D) provide a depiction of process costs. E) must provide predetermined overhead costs with earnings per share in the annual report. Answer: B Diff: 1 Objective: L.O. 11-1
2) If an investment is to be held only for a short time, it should be classified on the balance sheet as a ________. A) current liability B) noncurrent asset, which appears in a separate investments category C) noncurrent asset, which appears as part of other assets below the plant assets category D) current asset E) liquid asset Answer: D Diff: 1 Objective: L.O. 11-1
3) The key to classifying a marketable security as short-term is A) whether or not it is a government issued security. B) whether or not management has a written contract to sell the asset within the next 3 months. C) the type of security held (i.e., Is it a note, bond, or stock?). D) whether or not management expects to convert it into cash within a year after the date on the balance sheet (or operating cycle if longer). E) the small dollar amount. Answer: D Diff: 2 Objective: L.O. 11-1
4) When deciding whether to report an investment among current or long-term assets, companies base their decision on their purpose or intent when holding the investment. Answer: TRUE Diff: 1 Objective: L.O. 11-1
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Learning Objective 11.2 Questions 1) The method of accounting for trading securities and available-for-sale securities in which the assets are valued at market value on the balance sheet is known as the A) balance sheet method. B) market method. C) equity method. D) consolidated method. E) maturity method. Answer: B Diff: 1 Objective: L.O. 11-2
2) Accumulated other comprehensive income in stockholders' equity shows the difference between historical cost and market for which account(s)? A) Trading securities B) Held-to-maturity securities C) Available-for-sale securities D) Trading securities and available-for-sale securities E) Trading securities and held-to-maturity securities Answer: C Diff: 2 Objective: L.O. 11-2
3) ________ are current investments in equity or debt securities held for short-term profit. A) Short-term equity securities B) Trading securities C) Held-to-maturity securities D) Available-for-sale securities E) Cash equivalents Answer: B Diff: 1 Objective: L.O. 11-2
4) ________ are investments in debt securities that are not held for active trading but that may be sold before maturity. A) Short-term equity securities B) Held-to-maturity securities C) Trading securities D) Available-for-sale securities E) Cash equivalents Answer: D Diff: 1 Objective: L.O. 11-2
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5) ________ are debt securities that the investor expects to hold until maturity. A) Short-term equity securities B) Trading securities C) Cash equivalents D) Available-for-sale securities E) Held-to-maturity securities Answer: E Diff: 1 Objective: L.O. 11-2
6) Which of the following securities are accounted for at market value? 1. Trading securities 2. Held-to-maturity securities 3. Available for sale securities A) 1 only B) 2 only C) 3 only D) 1 and 3 E) 1 and 2 Answer: D Diff: 1 Objective: L.O. 11-2
7) Which of the following statements is false? A) Trading securities are short-term investments with unrealized gains and losses due to changes in market value that are recognized in the income statement. B) The unrealized gains and losses from changes in market value of available-for-sale securities are not recognized in the income statement, but rather are carried in a separate account in the stockholders' equity section. C) Held-to-maturity securities are always classified as long-term investments. D) Available for sale securities are accounted for at market value. E) Held-to-maturity securities are accounted for at amortized cost. Answer: C Diff: 2 Objective: L.O. 11-2
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8) Natin Filling Corporation purchased 20, $1,000 6% U.S. Treasury bonds for $18,600, as a short-term investment on December 16, 2X13. Natin classified these bonds as available-for-sale securities on their balance sheet. On December 31, 2X14, the U.S. Treasury bonds were trading at 94 (94% of face value). The rise in market price is believed to be a temporary fluctuation. Which of the following statements is correct? A) Since it is a temporary fluctuation, no gain is recognized. B) Since the bonds are still owned by Natin Filling Corporation, no gain is recognized. C) Because Natin Filling Corpoation bought US Treasury bonds, which are risk-free, no gain is recognized. D) A gain of $200 is recognized as a stockholders' equity account, therefore there is no income statement effect. E) A gain of $200 is recognized on the income statement. Answer: D Diff: 2 Objective: L.O. 11-2
9) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Company Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net gain or loss reported on the income statement of Eleston Printing for the 3 month period ending March 31, 2X12? A) $250 B) $(250) C) $900 D) $1,100 E) $2,000 Answer: A Diff: 3 Objective: L.O. 11-2
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10) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Company Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net gain or loss reported on the income statement of Eleston Printing for the three month period ending June 30, 2X12? A) $250 B) $(400) C) $(200) D) $(1,300) E) ($500) Answer: E Diff: 3 Objective: L.O. 11-2
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11) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Compan Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net gain or loss reported on the income statement of Eleston Printing for the 3 month period ending September 30, 2X12? A) $(400) B) $250 C) $-0D) $(250) E) $400 Answer: B Diff: 3 Objective: L.O. 11-2
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12) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Company Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net gain or loss reported on the income statement of Eleston Printing for the 3 month period ending December 31, 2X12? A) $(500) B) $-0C) $(250) D) $300 E) $500 Answer: C Diff: 3 Objective: L.O. 11-2
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13) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Company Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net increase or decrease included in Accumulated Other Comprehensive Income in the stockholders' equity section of the balance sheet for the 3 month period ending March 31, 2X12? A) $(200) B) $200 C) $900 D) $1,100 E) $2,000 Answer: D Diff: 3 Objective: L.O. 11-2
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14) Eleston Printing acquired the following short-term equity securities on January 1, 2X12: Company Color, Inc. Black, Inc. White, Inc.
# of Shares 250 300 500
Price/share $22 22 14
Total Cost $ 5,500 6,600 7,000 $19,100
The quarter-end prices per share were as follows: Company Color, Inc. Black, Inc. White, Inc.
03/31/2X12 $23 24 15
06/30/2X12 $21 20 14
09/30/2X12 $22 23 13
12/31/2X12 $21 24 13
Eleston Printing considers Color, Inc. stock to be a trading security and Black, Inc. and White, Inc. to be available-for-sale securities. What will be the net increase or decrease included in Accumulated Other Comprehensive Income in the stockholders' equity section of the balance sheet for the three month period ending September 30, 2X12? A) $-0B) $(200) C) $(400) D) $200 E) $400 Answer: E Diff: 3 Objective: L.O. 11-2
15) Trading securities and available-for-sale securities are reported on the balance sheet as: A) Trading securities Available-for-sale securities market value market value B) Trading securities Available-for-sale securities market value historical cost C) Trading securities Available-for-sale securities historical cost market value D) Trading securities Available-for-sale securities historical cost historical cost Answer: A Diff: 2 Objective: L.O. 11-2
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16) ________ are government- and business-issued notes and bonds with maturities of 1 year or less. A) Certificates of deposit B) Commercial paper C) U.S. Treasury obligations D) Cash equivalents E) Short-term debt securities Answer: E Diff: 1 Objective: L.O. 11-2
17) U.S. Treasury obligations are interest-bearing notes, bonds, and bills issued by the U.S. federal government. Answer: TRUE Diff: 2 Objective: L.O. 11-2
18) Comprehensive income includes both net income and the change in market value of available-for-sale securities. Answer: TRUE Diff: 2 Objective: L.O. 11-2
19) The market method applies to short-term debt securities classified as trading securities and, as a result, a drop in market value below cost will result in a write-down of the investment. Answer: TRUE Diff: 2 Objective: L.O. 11-2
20) Marketable securities are notes, bonds, or stocks that can be readily sold on stock exchanges or overthe-counter markets. Answer: TRUE Diff: 1 Objective: L.O. 11-2
21) Debt security investments include short-term obligations of banks and short-term notes payable issued by large corporations with top credit ratings. Answer: TRUE Diff: 2 Objective: L.O. 11-2
22) Trading securities include both debt and equity securities. Answer: TRUE Diff: 1 Objective: L.O. 11-2
23) The accounting for investments differs depending upon the purpose of the investment. Answer: TRUE Diff: 1 Objective: L.O. 11-2
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24) Held-to-maturity securities are equity securities that the company purchases with the intent to hold them to a maturity date. Answer: FALSE Diff: 1 Objective: L.O. 11-2
25) As the market value of trading securities changes, companies report the gains from increases in market value and losses from decreases in market value on the income statement. Answer: TRUE Diff: 2 Objective: L.O. 11-2
26) As the market value of available-for-sale securities changes, companies report the gains from increases in market value and losses from decreases in market value on the income statement. Answer: FALSE Diff: 2 Objective: L.O. 11-2
27) Even if a company holds part of its portfolio of short-term investments for more than 1 year, that portion of the portfolio will not be reclassified as a long-term investment. Answer: TRUE Diff: 2 Objective: L.O. 11-2
28) Available-for-sale securities are debt securities that the company purchases with the intent to hold them until they mature. Answer: FALSE Diff: 1 Objective: L.O. 11-2
29) Increases in the market value of available-for-sale securities increase total stockholders' equity, but increases in the market value of trading securities do not increase total stockholders' equity. Answer: FALSE Diff: 3 Objective: L.O. 11-2
30) Debt securities classified as available-for-sale securities are carried at amortized cost on the balance sheet. Answer: FALSE Diff: 2 Objective: L.O. 11-2
31) Held-to-maturity securities are carried on the balance sheet at amortized cost. Answer: TRUE Diff: 2 Objective: L.O. 11-2
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32) On September 1, 2X12, Yelter Oil purchased trading securities consisting of common and preferred stocks. The portfolio consists of: Company Haring Jacker
# of shares 400 200
purchase price/share $24 $16
market value (9/30/2X12) $20 $19
What will be the net gain or loss recorded on Yelter Oil's income statement for the quarter ended September 30, 2X12? Answer: Haring Company: ($24 - $20) × 400 shares = $(1,600) Jacker Company: ($19 - $16) × 200 shares = $600 Net loss $(1,000) Diff: 2 Objective: L.O. 11-2
33) On September 1, 2X12, Tundra Greenhouses purchased available-for-sale securities consisting of common and preferred stocks. The portfolio consists of 100 shares of Blooming Company (purchased at $37 per share) and 305 shares of Leaf Company (purchased at $29 per share). The market value of the securities on a per share basis on September 30 were $35 for Blooming and $26 for Leaf. Prepare the journal entry that will need to be made on September 30, 20X12. Answer: Blooming Company ($35 - $37) × 100 shares = $ (200) Leaf Company ($26 - $29) × 305 shares = $ (915) Total Decrease $ (1,115) Unrealized loss Marketable Securities
1,115 1,115
Diff: 2 Objective: L.O. 11-2
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34) Direct Solutions held two securities. Direct Solutions purchased 100 Bucket Organization, Inc., securities on January 1, 2X09 for $15 per share and classified it as a trading security and purchased 80 Sunk Options Company securities on the same day for $34 per share and classified it as an available-forsale security. Market values for both securities as of December 31, for 2X09, 2X10, 2X11, 2X12 follow. Dec. 31, Dec. 31, Dec. 31, Dec. 31, 2X09 2X10 2X11 2X12 Bucket Organization
17
13
15
14
Sunk Options
32
31
34
35
1. Prepare journal entries for the investment in Bucket Organization, Inc. as of a. December 31, 2X09. b. December 31, 2X10. c. December 31, 2X11. d. December 31, 2X12. 2. Prepare journal entries for the investment in Sunk Options Company as of the dates in (1) above. 3. Where would gains and losses recorded in (1) and (2) above be reported for: a. Bucket Organization, Inc.? b. Sunk Options Company? Answer: 1. a. Marketable securities 200 Unrealized gain 200 b. Unrealized loss 400 Marketable securities 400 c. Marketable securities 200 Unrealized gain 200 d. Unrealized loss 100 Marketable securities 100 2. a. Unrealized loss 160 Marketable securities 160 b. Unrealized loss 80 Marketable securities 80 c. Marketable securities 240 Unrealized gain 240 d. Marketable securities 80 Unrealized gain 80 3. a. Income statement for Bucket Organization, Inc. b. Other comprehensive income in a combined statement of income and comprehensive income or in a separate statement of comprehensive income. In addition, the Unrealized gains and losses would be adjustments to Accumulated Other Comprehensive Income reported in the stockholders' equity section of the balance sheet. Diff: 2 Objective: L.O. 11-2
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Learning Objective 11.3 Questions 1) Bond discounts are amortized by taking the difference between the A) interest based on the effective interest rate and the interest based on the coupon interest rate. B) interest based on the nominal interest rate and the interest based on the coupon interest rate. C) interest based on the stated rate of interest and the interest based on the coupon interest rate. D) interest based on the effective interest rate and the interest based on the market rate of interest. E) interest based on the nominal interest rate and the interest based on the stated rate of interest. Answer: A Diff: 1 Objective: L.O. 11-3
2) If bonds are purchased at less than face value, then the amortization of the discount ________ the interest revenue of the investors. A) increases B) decreases C) does not change D) increases or decreases depending on the current market rate E) Cannot be determined without more information Answer: A Diff: 3 Objective: L.O. 11-3
3) If bonds are purchased at more than face value, then the amortization of the premium ________ the interest revenue of the investors. A) increases or decreases depending on the current market rate B) increases C) decreases D) does not change E) Cannot be determined without more information Answer: C Diff: 3 Objective: L.O. 11-3
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4) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. What is the journal entry to be made by Soothing Massage Company on January 1, 2X13, if the bonds were purchased at a price to yield 12%? A) Investment in Bonds 9,543.40 Cash 9,543.40 B) Investment in Bonds 11,037.28 Cash 11,037.28 C) Investment in Bonds 17,705.90 Cash 17,705.90 D) Investment in Bonds 20,000.00 Cash 20,000.00 E) Investment in Bonds 22,492.64 Cash 22,492.64 Answer: C Diff: 2 Objective: L.O. 11-3
5) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. What is the journal entry to be made by Soothing Massage Company on January 1, 2X13, if the bonds were purchased at a price to yield 8%? A) Investment in Bonds 14,108.10 Cash 14,108.10 B) Investment in Bonds 17,507.76 Cash 17,507.76 C) Investment in Bonds 20,000.00 Cash 20,000.00 D) Investment in Bonds 22,718.30 Cash 22,718.30 E) Investment in Bonds 25,912.90 Cash 25,912.90 Answer: D Diff: 2 Objective: L.O. 11-3
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6) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. If the bonds were purchased by Soothing Massage Company to yield 12% and were acquired for $17,705.90, what is the journal entry to be made by Soothing Massage Company with respect to interest on June 30, 2X13? A) Cash 1,000.00 Investment in Bonds 62.35 Interest Revenue 1,062.35 B) Cash 1,000.00 Investment in Bonds 1,200.00 Interest Revenue 2,200.00 C) Cash 1,200.00 Investment in Bonds 137.65 Interest Revenue 1,062.35 D) Cash 1,200.00 Investment in Bonds 200.00 Interest Revenue 1,000.00 E) Cash 2,000.00 Investment in Bonds 124.71 Interest Revenue 2,124.71 Answer: A Diff: 3 Objective: L.O. 11-3
7) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. If the bonds were purchased by Soothing Massage Company to yield 12%, and were acquired for $17,705.90, what is the interest revenue to be recognized by Soothing Massage Company with respect to the interest to be received on December 31, 2X13? A) $1,200.00 B) $1,062.35 C) $1,066.10 D) $1,000.00 E) $2,124.71 Answer: C Diff: 3 Objective: L.O. 11-3
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8) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. If the bonds were purchased by Soothing Massage Company to yield 8%, and were acquired for $22,718.30, what is the journal entry to be made by Soothing Massage Company with respect to interest on June 30, 2X13? A) Cash 800.00 Investment in Bonds 200.00 Interest Revenue 1,000.00 B) Cash 800.00 Investment in Bonds 335.92 Interest Revenue 1,135.92 C) Cash 1,000.00 Investment in Bonds 91.27 Interest Revenue 908.73 D) Cash 1,000.00 Investment in Bonds 200.00 Interest Revenue 800.00 E) Cash 2,000.00 Investment in Bonds 182.54 Interest Revenue 1,817.46 Answer: C Diff: 3 Objective: L.O. 11-3
9) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. If the bonds were purchased by Soothing Massage Company to yield 8% and were acquired for $22,718.30, what is the interest revenue to be recognized by Soothing Massage Company with respect to interest on December 31, 2X13? A) $1,817.46 B) $905.08 C) $908.73 D) $1,000.00 E) $800.00 Answer: B Diff: 3 Objective: L.O. 11-3
17 ..
10) On January 1, 2X13, Soothing Massage Company acquired, as a long-term investment, 20 bonds with a face value of $1,000 each. The bonds have a 10-year life, a 10% coupon rate, and pay interest semiannually every June 30 and December 31. If the bonds were purchased by Soothing Massage Company to yield 12% and were acquired for $17,705.90, what journal entry would Soothing Massage Company make on June 30, 2X13, if the company sold the bonds for $18,000.00? Assume the bonds were sold after Soothing Massage Company properly recorded the receipt of the June 30, 2X13, interest payment. A) Cash 18,000.00 Loss on Disposal of Bonds 2,000.00 Investment in Bonds 20,000.00 B) Cash 18,000.00 Loss on Disposal of Bonds 905.90 Investment in Bonds 18,905.90 C) Cash 18,000.00 Gain on Disposal of Bonds 94.10 Investment in Bonds 17,905.90 D) Cash 18,000.00 Gain on Disposal of Bonds 231.75 Investment in Bonds 17,768.25 E) Cash 18,000.00 Gain on Disposal of Bonds 294.10 Investment in Bonds 17,705.90 Answer: D Diff: 3 Objective: L.O. 11-3
11) If a company calls a bond early and the carrying value of the bond is less than the cash received by the investor for the bond, the difference for the issuing company A) decreases bonds payable. B) increases bonds payable. C) is not recognized. D) is a gain. E) is a loss. Answer: E Diff: 3 Objective: L.O. 11-3
12) The investor will debit Investment in Bonds when the premium on a held-to-maturity security is amortized. Answer: FALSE Diff: 3 Objective: L.O. 11-3
13) Although the issuer of bonds typically keeps a separate account for unamortized discounts and premiums, investors do not. Answer: TRUE Diff: 2 Objective: L.O. 11-3
14) If an investor acquires a 10% long-term bond at a price that yields the investor 12%, interest revenue 18 ..
will decrease over the life of the bond. Answer: FALSE Diff: 3 Objective: L.O. 11-3
15) The investor will increase Interest Revenue when the discount on a held-to-maturity security is amortized. Answer: TRUE Diff: 3 Objective: L.O. 11-3
16) On January 1, 20X9, Stack 'em Up acquired a $550,000 face value bond. The bond has a 10% coupon rate and pays interest semi-annually every June 30 and December 31. The bond matures in 10 years. Stack 'em Up acquired the bond at a price that would yield 8%. Using the present value tables, determine the balance sheet presentation of the bond on the December 31, 20X9, balance sheet of Stack 'em Up. The company plans to hold the bond until maturity. The company uses the effective interest method of discount or premium amortization. Answer: Purchase price of the bond: $550,000 × .4564 (n = 20; i = 4) = $251,020.00 $ 27,500 × 13.5903 = 373,733.25 Total $624,753.25 Jan. 1, 20X9 Purchase of bond
$624,753.25
June 30, 20X9 Premium amortization *$27,500 - ($624,753.25 × .08 × 1/2) = $2,509.87
(2,509.87)*
Dec. 31, 20X9 Premium amortization (2,610.27)** Net book value $619,633.11 **$27,500 - [($624,753.25 - $2,509.87) × .08 × 1/2] = $2,610.27 Long-term Assets: Investment in Bonds
$619,633.11
Diff: 3 Objective: L.O. 11-3
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17) Palatino Ranchers acquired a $300,000 15-year, 10% callable bond on January 1, 20X9, for cash of $258,702. The bond was acquired at a price to yield 12%. The bond pays interest every June 30 and December 31. On December 31, 20X9, after interest had been received, the bond owned by Palatino Ranchers was called at a price of 101 (101% of face value). Assume the company intends to hold the bond until maturity and the company uses the effective interest method of discount or premium amortization. Prepare the appropriate journal entry for each of the following events: a. The purchase of the bond on January 1, 20X9 b. The receipt of the June 30, 20X9, interest payment c. The receipt of the December 31, 20X9, interest payment d. The bond being called on December 31, 20X9 Answer: a. Investment in Bond 258,702.00 Cash 258,702.00 $300,000 × .1741(PV n = 30, i = 6%) = 5% × $300,000 × 13.7648 (PV annuity n = 30, i = 6) =
b.
Cash Investment in Bond Interest Revenue
$52,230 206,472 $258,702
15,000.00 522.12 15,522.12
258,702 × .06 × 1 = 15,522.12 300,000 × .05 × 1 = 15,000.00 c.
d.
Cash Investment in Bond Interest Revenue
15,000.00 553.45
(258,702 + 522.12) × .06 × 1 = 300,000 × .05 × 1 =
15,553.45 15,000.00
Cash Gain on Disposal of Bonds Investment in Bonds
303,000.00
15,553.45
43,222.43 259,777.57
Cash 1.01 × 300,000 = 303,000 Investment (258,702 + 522.12 + 553.45) = 259,777.57 Diff: 3 Objective: L.O. 11-3
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Learning Objective 11.4 Questions 1) Highland Cutlery acquired as a long-term investment some of the common stock of LTS Company on December 31, 2X12. During 2X13, LTS Company had net income of $300,000 and declared and paid cash dividends of $90,000. What journal entry would Highland Cutlery make for 2X13 to recognize the net income of LTS Company, assuming that Highland Cutlery acquired 12% of the outstanding common stock of LTS Company? A) Deferred Investment Income 36,000 Unrealized Gain on Long-term Investment 36,000 B) Investment in LTS Company 36,000 Investment Revenue 36,000 C) Investment in LTS Company 36,000 Unearned Revenue 36,000 D) Investment in LTS Company 36,000 Unrealized Gain on Long-term Investments 36,000 E) No journal entry is necessary. Answer: E Diff: 2 Objective: L.O. 11-4
2) Highland Cutlery acquired as a long-term investment some of the common stock of LTS Company on December 31, 2X12. During 2X13, LTS Company had net income of $300,000 and declared and paid cash dividends of $90,000. What journal entry would Highland Cutlery make for 2X13 to recognize dividends received from LTS Company, assuming Highland Cutlery acquired 12% of the outstanding stock of LTS Company? A) Cash 10,800 Dividend Revenue 10,800 B) Cash 10,800 Investment in LTS Company 10,800 C) Cash 10,800 Realized Gain on Long-term Investments 10,800 D) Cash 10,800 Unearned Revenue 10,800 E) Investment in LTS Company 10,800 Dividend Revenue 10,800 Answer: A Diff: 2 Objective: L.O. 11-4
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3) Highland Cutlery acquired as a long-term investment some of the common stock of LTS Company on December 31, 2X12. During 2X13, LTS Company had net income of $300,000 and declared and paid cash dividends of $90,000. What journal entry would Highland Cutlery make for 2X13 to recognize the net income of LTS Company, assuming that Highland Cutlery acquired 40% of the outstanding common stock of LTS Company? A) Deferred Investment Income 120,000 Unrealized Gain on Long-term Investment 120,000 B) Investment in LTS Company 120,000 Investment Revenue 120,000 C) Investment in LTS Company 120,000 Unearned Revenue 120,000 D) Investment in LTS Company 120,000 Unrealized Gain on Long-term Investments 120,000 E) No journal entry is necessary. Answer: B Diff: 2 Objective: L.O. 11-4
4) Highland Cutlery acquired as a long-term investment some of the common stock of LTS Company on December 31, 2X12. During 2X13, LTS Company had net income of $300,000 and declared and paid cash dividends of $90,000. What journal entry would Highland Cutlery make for 2X13 to recognize dividends received from LTS Company, assuming Highland Cutlery acquired 40% of the outstanding stock of LTS Company? A) Cash 36,000 Dividend Revenue 36,000 B) Cash 36,000 Investment in LTS Company 36,000 C) Cash 36,000 Realized Gain on Long-term Investments 36,000 D) Cash 36,000 Unearned Revenue 36,000 E) Investment in LTS Company 36,000 Dividend Revenue 36,000 Answer: B Diff: 2 Objective: L.O. 11-4
5) If the level of ownership changes such that the investor must change the accounting method to report the investment, the investor should A) continue to use the same method to abide by the consistency principle B) continue to use the same method, but change the book value of the investment going forward C) discontinue the old method and sell the investment D) discontinue the old method and adopt the new method going forward E) none of the above Answer: D Diff: 1 Objective: L.O. 11-4
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6) Which of the following ownership percentages is the correct one(s) for deciding whether an investor has significant influence over an investee? A) up to 20% B) up to 50% C) between 20% and 50% D) between 25% and 50% E) above 20% Answer: C Diff: 1 Objective: L.O. 11-4
7) GAAP requires companies using the equity method to report equity investments on the balance sheet at market. Answer: FALSE Diff: 2 Objective: L.O. 11-4
8) An affiliated company is one that has 20% to 50% of its voting shares owned by another company. Answer: TRUE Diff: 1 Objective: L.O. 11-4
9) When a company owns 20% to 50% of the voting stock in another company, the market method generally will not reflect the economic relationship between the investor and the investee. Answer: TRUE Diff: 2 Objective: L.O. 11-4
10) Under the market method, the investor recognizes revenue when dividends are received. Answer: TRUE Diff: 1 Objective: L.O. 11-4
11) Under the equity method, the investor recognizes revenue based upon an appropriate share of the investee's net income. Answer: TRUE Diff: 2 Objective: L.O. 11-4
12) Under the market method, the investment in another company's stock is recorded at acquisition cost and is adjusted for the investor's share of dividends and for any earnings or losses experienced by the investee after the date of investment. Answer: FALSE Diff: 2 Objective: L.O. 11-4
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13) The major reason for using the equity method instead of the market method for an investment is that the equity method does a better job of recognizing increases or decreases in the economic resources that the investor can influence. Answer: TRUE Diff: 2 Objective: L.O. 11-4
14) When equity ownership of another company is below 20%, the market method is required. Answer: TRUE Diff: 1 Objective: L.O. 11-4
15) GAAP allow investments under the equity method to be carried at adjusted cost or current market value on the balance sheet. Answer: TRUE Diff: 2 Objective: L.O. 11-4
16) Market Research Syndicate acquired 100 shares of Catskill Tools for $450,000 on January 1, 2X13. During 2X13, Catskill Tools declared and paid a total of $8,000 in dividends and reported net income of $50,000. Market Research Syndicate plans on holding the investment for a long time. 1. Assuming Market Research Syndicate owns 40% of Catskill Tools, prepare journal entries for Market Research Syndicate for the following events: a) acquisition b) recognition of net income c) dividends 2. Assuming Market Research Syndicate owns 10% of Catskill Tools, prepare journal entries for Market Research Syndicate for the following events: a) acquisition b) recognition of net income c) dividends Answer: 1. a) Investment in Catskill Tools 450,000 Cash 450,000 b) Investment in Catskill Tools 20,000 Investment revenue 20,000 c) Cash 3,200 Investment in Catskill Tools 3,200 2. a) Investment in Catskill Tools 450,000 Cash 450,000 b) No entry for recognition of net income c) Cash 800 Dividend revenue 800 Diff: 2 Objective: L.O. 11-4
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Learning Objective 11.5 Questions 1) A spin-off is when A) a company buys a security for a very short period of time and then sells it. B) a bond is retired through the issuance of another bond. C) part of a company which is usually a distinct business unit is separated from the parent company and shares of the divested company are distributed to the parent's stockholders. D) a company acquires another company in a different industry. E) a company acquires another company in the same industry. Answer: C Diff: 1 Objective: L.O. 11-5
2) A subsidiary is a corporation owned or controlled by a parent company through the ownership of A) more than 10% of the voting stock. B) more than 20% of the voting stock. C) more than 25% of the voting stock. D) more than 50% of the voting stock. E) 100% of the voting stock. Answer: D Diff: 1 Objective: L.O. 11-5
3) Which of the following statements is false in regards to the consolidation of financial statements? A) GAAP and IFRS have different consolidation requirements. B) Under GAAP, completion of consolidated financial statements occurs when a parent company has control over another company. C) Under GAAP, a parent company may own less than 50% of the voting shares of another company yet still qualify to consolidate financial statements. D) Under GAAP, consolidation is generally restricted to situations where a parent company has control of over 20% of the voting shares of another company. E) Under GAAP, there are circumstances when a parent company owns a majority of the voting stock of another company but does not prepare consolidated financial statements. Answer: D Diff: 2 Objective: L.O. 11-5
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4) Platek Enterprises is 100% owned by Cory Industries. On December 30, 2X13, Platek sold inventory, costing $3,500 on account to Cory for $5,000. Platek uses a perpetual inventory system. What consolidation journal entry, if any, is needed on December 31, 2X13, as a result of this transaction? A) Accounts Payable, Platek 5,000 Accounts Receivable, Cory 5,000 B) Accounts Payable, Platek 5,000 Accounts Receivable, Cory 5,000 Retained Earnings, Platek 1,500 Inventory, Cory 1,500 C) Accounts Payable, Cory 5,000 Accounts Receivable, Platek 5,000 Sales, Platek 5,000 Cost of Sales, Platek 3,500 Inventory, Cory 1,500 D) Retained Earnings, Platek 1,500 Inventory, Platek 1,500 E) No journal entry is necessary. Answer: C Diff: 3 Objective: L.O. 11-5
5) Hybud Recreation Center acquired all the stock of Cloverleaf Floors by purchasing the shares from their current owners for $400,000 paid in cash. Cloverleaf Floors has assets with a fair value of $400,000. How would Hybud Recreation Center account for the acquisition? A) Hybud would increase Paid-in Capital by $400,000 and decrease Cash by $400,000. B) Hybud would increase Property, Plant, and Equipment by $400,000 and decrease Cash by $400,000. C) Hybud would increase Investment in Cloverleaf Floors by $400,000 and decrease Cash by $400,000. D) Hybud would decrease Property, Plant, and Equipment by $400,000 and decrease Cash by $400,000. E) Hybud would not need to make a journal entry. Answer: C Diff: 2 Objective: L.O. 11-5
6) Tell Tale Books acquired all the stock of Ringlet Publishing by purchasing the shares from their current owners for $50 million paid in cash. Ringlet Publishing has assets with a fair value of $50 million. How would Ringlet Publishing account for the acquisition? A) No journal entry is necessary. B) Ringlet Publishing would increase Cash by $50 million and decrease Property, Plant, and Equipment by $50 million. C) Ringlet Publishing would increase Cash by $50 million and increase Paid-in Capital by $50 million. D) Ringlet Publishing would increase Cash by $20 million and decrease Property, Plant, and Equipment by $20 million. E) Ringlet Publishing would increase Cash by $50 million; decrease Property, Plant, and Equipment by $20 million; and increase Paid-in Capital by $30 million. Answer: A Diff: 2 Objective: L.O. 11-5
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7) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. What journal entry will Handel Company make on January 1, 2X13? A) Cash 140 Common Stock 140 B) Cash 140 Investment by Tallton Co. 140 C) Cash 140 Treasury Stock 140 D) Cash 140 Accounts Payable 20 Long-term Bonds Payable 120 Fixed Assets 210 Cash 70 E) No journal entry is necessary. Answer: E Diff: 1 Objective: L.O. 11-5
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8) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. What journal entry will Tallton Company make on January 1, 2X13? A) Common Stock of Handel Company 140 Cash 140 B) Investment in Handel Company 140 Cash 140 C) Stockholders' Equity of Handel Company 140 Cash 140 D) Fixed Assets 210 Cash 70 Accounts Payable 20 Long-term Bonds Payable 120 E) Fixed Assets 210 Investment in Handel Company 140 Cash 70 Accounts Payable & Long-term Bonds Payable 140 Stockholders' Equity 140 Answer: B Diff: 2 Objective: L.O. 11-5
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9) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. Which of the following statements regarding the consolidated balance sheet immediately after the acquisition is not correct? A) Total liabilities will be $360. B) Total cash will be $170. C) Total assets will be $730. D) Total net fixed assets will be $420. E) Total stockholders' equity will be $230. Answer: C Diff: 3 Objective: L.O. 11-5
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10) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. What elimination journal entry will be necessary in order to prepare a consolidated balance sheet immediately after the acquisition? A) Cash 140 Investment in Handel Company 140 B) Investment in Handel Company 140 Stockholders' Equity, Handel 140 C) Stockholders' Equity, Handel 140 Cash 140 D) Stockholders' Equity, Handel 140 Investment in Handel Company 140 E) No journal entry is necessary. Answer: D Diff: 2 Objective: L.O. 11-5
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11) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. If Handel Company generated net income during 2X13 of $22, and none of the income resulted from intercompany sales, what would be the amount of the elimination entry at the end of 2X13? A) $22 B) $-0C) $118 D) $140 E) $162 Answer: E Diff: 3 Objective: L.O. 11-5
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12) Presented below are the balance sheets of Tallton Company and Handel Company at January 1, 2X13: Handel Company Balance Sheet January 1, 2X13
Tallton Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 70 210 $280
Cash Net Fixed Assets Total Assets
$240 210 $450
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 20 120 140 $280
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 70 150 230 $450
On January 1, 2X13, Tallton Company acquired 100% of the outstanding common stock of Handel Company for $140 in cash. Assume the book value of Handel's assets and liabilities equals the market value. If the net income for 2X13 was $22 and $30 for Handel Company and Tallton Company, respectively, and none of the income resulted from intercompany sales, what would be the net income on the consolidated income statement? Assume Tallton's net income includes the equity in earnings of Handel Company. A) $52.00 B) $22.0 C) $26.00 D) $30.00 E) $-0Answer: D Diff: 3 Objective: L.O. 11-5
13) "Due diligence" is the phrase for carefully investigating a target company for a merger. Answer: TRUE Diff: 2 Objective: L.O. 11-5
14) Spin-offs often separate similar business segments. Answer: FALSE Diff: 2 Objective: L.O. 11-5
15) When a company is acquired and becomes a subsidiary of another company, the books of the subsidiary are completely changed on the date of the acquisition. Answer: FALSE Diff: 2 Objective: L.O. 11-5
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16) There are three sets of books after a consolidation: the parent's books, the subsidiary's books, and the consolidated entity's books. Answer: FALSE Diff: 2 Objective: L.O. 11-5
17) In consolidation, elimination of intercompany balances are necessary when the parent and subsidiary do business together (e.g., when the subsidiary sells goods or products to the parent). Answer: TRUE Diff: 2 Objective: L.O. 11-5
18) When ownership of another company is greater than 50%, consolidation is required. Answer: TRUE Diff: 1 Objective: L.O. 11-5
19) When ownership of another company is at least 20% and up to and including 50%, consolidation is required. Answer: FALSE Diff: 1 Objective: L.O. 11-5
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20)
Elltol Company Balance Sheet January 1, 2X13
Ingrad Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 40 90 $130
Cash Net Fixed Assets Total Assets
$120 130 $250
Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
$ 20 60 50
Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
$ 30 100 120
$130
$250
On January 1, 2X13, Ingrad Company acquired 100% of the outstanding shares of Elltol Company for $50 in cash. During 2X13, Elltol Company had net income of $10, and Ingrad Company had net income of $25. All net income for both companies is in the form of additional cash. Prepare the following: a. The journal entry necessary for Ingrad Company on January 1, 2X13. b. The journal entry necessary for Elltol Company on January 1, 2X13. c. The consolidated balance sheet immediately after the acquisition. d. The one elimination entry necessary on December 31, 2X13, assuming none of the income for either company resulted from intercompany sales. e. The consolidated balance sheet at December 31, 2X13. Answer: a. Investment in Elltol Company 50 Cash 50 b. No journal entry is necessary. c. Consolidated Balance Sheet January 1, 2X13 Cash $110 Accounts Payable $ 50 Net Fixed Assets 220 Long-term Bond Payable 160 Stockholders' Equity 120 Total Liab. & Total Assets $330 Stockholders' Equity $330 d. Stockholders' Equity, Elltol 60 Investment in Elltol Company 60 e. Consolidated Balance Sheet December 31, 2X13 Cash $145 Accounts Payable Net Fixed Assets 220 Long-term Bond Payable Stockholders' Equity Total Liab. & Total Assets $365 Stockholders' Equity Diff: 3 Objective: L.O. 11-5
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$ 50 160 155 $365
21) Harris Enterprises owns 100% of the outstanding stock of Staton Company. The following transactions occurred during 2X13: a) Harris Enterprises sold inventory costing $2,750 on account to Staton Company for $3,800. As of yearend, the amount due had not been paid. Harris Enterprises and Staton Company use a perpetual inventory system. b) Staton Company borrowed $8,000 from Harris Enterprises on December 31, 2X13, and signed a 2-year note. For each item, prepare the necessary intercompany elimination entry that is needed, if at all, in order to prepare a year-end consolidated balance sheet. Be certain to specifically identify whether an account is on the books of Harris Enterprises or Staton Company. Answer: a. Accounts Payable, Staton 3,800 Accounts Receivable, Harris 3,800 Sales Revenue, Harris 3,800 Cost of Goods Sold, Harris 2,750 Inventory, Staton 1,050 b. Note Payable, Staton 8,000 Note Receivable, Harris 8,000 Diff: 2 Objective: L.O. 11-5
22) List and explain why a company would create subsidiaries instead of integrating the smaller companies into the larger parent to create a single entity. Answer: Parents companies may create subsidiaries to 1. take advantage of income tax savings. Tax advantages can occur for a seller when an acquisition involves selling capital stock of a going concern instead of individual assets. 2. conform to government regulations if a parent company obtains ownership of another company and the government labels the acquisition a violation of antitrust laws. 3. face more favorable treatment from their country of residence. Foreign subsidiaries may face more favorable treatment from their country of residence than a foreign parent corporation would experience. 4. limit the liabilities in a risky venture. By keeping a subsidiary company separate from a parent company, risky liabilities are kept off the parent company's balance sheet, thus, hopefully retaining stock market prices and potential funding options. 5. maintain the ability to easily sell or spin off a subsidiary company. If a parent company would like to rid itself of a portion of its business, it is easier and less costly to sell or spin off that portion when it is already accounted for separately. Diff: 2 Objective: L.O. 11-5
23) Describe spin-offs including the benefits to spinning off a segment. Answer: A spin-off creates a segment of a company which is usually a distinct business unit with shares of the divested company distributed to stockholders. A spin-off often creates opportunities for more creative and innovative growth. In addition, the managers of the spin-off company can be compensated more directly on their performance since their activities generally have a larger impact on the new, smaller company. Diff: 2 Objective: L.O. 11-5
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24) Describe reasons and benefits to corporate mergers. Answer: Companies often purchase smaller companies to gain access to new technologies and ideas, but may purchase larger companies to eliminate duplications and save costs. In addition, if the two companies have similar operations; best practices can be created combining the best of both companies into one while often eliminating redundant, repetitive tasks. Diff: 2 Objective: L.O. 11-5
Learning Objective 11.6 Questions 1) ________ represent the rights of nonmajority shareholders in the assets and earnings of a company that is consolidated into the accounts of its majority shareholder. A) Parent interests B) Noncontrolling interests C) Subsidiary interests D) Consolidated interests E) Intercompany interests Answer: B Diff: 1 Objective: L.O. 11-6
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2) Presented below are the balance sheets of Blanco, Inc. and Stalle Company at January 1, 2X13: Blanco, Inc. Balance Sheet January 1, 2X13
Stalle Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 35 265 $300
Cash Net Fixed Assets Total Assets
$250 450 $700
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 30 100 170 $300
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 90 200 410 $700
On January 1, 2X13, Stalle Company acquired 70% of the outstanding common stock of Blanco, Inc., for $119 in cash. Assume the book value of Blanco's assets and liabilities equals the market value. What journal entry will Blanco, Inc. make on January 1, 2X13? A) Cash 119 Common Stock 119 B) Cash 119 Investment by Stalle Co. 119 C) Cash 119 Treasury Stock 119 D) Cash 119 Accounts Payable 21 Long-term Bonds Payable 70 Fixed Assets 186 Cash 24 E) No journal entry is necessary. Answer: E Diff: 2 Objective: L.O. 11-6
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3) Presented below are the balance sheets of Blanco, Inc. and Stalle Company at January 1, 2X13: Blanco, Inc. Balance Sheet January 1, 2X13
Stalle Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 35 265 $300
Cash Net Fixed Assets Total Assets
$250 450 $700
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 30 100 170 $300
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 90 200 410 $700
On January 1, 2X13, Stalle Company acquired 70% of the outstanding common stock of Blanco, Inc., for $119 in cash. Assume the book value of Blanco's assets and liabilities equals the market value. What journal entry will Stalle Company make on January 1, 2X13? A) Investment in Blanco, Inc. 119 Cash 119 B) Investment in Blanco, Inc. 170 Cash 119 Noncontrolling Interest 51 C) Common Stock, Blanco 170 Cash 119 Noncontrolling Interest 51 D) Stockholders' Equity 170 Cash 119 Noncontrolling Interest 51 E) Net Fixed Assets 265 Cash 84 Accounts Payable 30 Long-term Bonds Payable 100 Noncontrolling Interest 51 Answer: A Diff: 2 Objective: L.O. 11-6
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4) Presented below are the balance sheets of Blanco, Inc. and Stalle Company at January 1, 2X13: Blanco, Inc. Balance Sheet January 1, 2X13
Stalle Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 35 265 $300
Cash Net Fixed Assets Total Assets
$250 450 $700
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 30 100 170 $300
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 90 200 410 $700
On January 1, 2X13, Stalle Company acquired 70% of the outstanding common stock of Blanco, Inc., for $119 in cash. Assume the book value of Blanco's assets and liabilities equals the market value. Which of the following statements regarding the consolidated balance sheet immediately after the acquisition is not correct? A) Total assets will be $881. B) Total cash will be $166. C) Total liabilities will be $420. D) Total net fixed assets will be $715. E) Total stockholders' equity will be $580. Answer: E Diff: 3 Objective: L.O. 11-6
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5) Presented below are the balance sheets of Blanco, Inc. and Stalle Company at January 1, 2X13: Blanco, Inc. Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets
$ 35 265 $300
Stalle Company Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 30 100 170 $300
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$250 450 $700 $ 90 200 410 $700
On January 1, 2X13, Stalle Company acquired 70% of the outstanding common stock of Blanco, Inc., for $119 in cash. Assume the book value of Blanco's assets and liabilities equals the market value. What elimination journal entry will be necessary in order to prepare a consolidated balance sheet immediately after the acquisition? A) Cash 119 Noncontrolling Interest 51 Investment in Blanco 170 B) Cash 119 Noncontrolling Interest 51 Stockholders' Equity, Blanco 170 C) Stockholders' Equity, Blanco 170 Investment in Blanco Company 119 Noncontrolling Interest 51 D) Stockholder's Equity, Blanco 119 Investment in Blanco Company 119 E) No journal entry is necessary. Answer: C Diff: 2 Objective: L.O. 11-6
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6) Presented below are the balance sheets of Blanco, Inc. and Stalle Company at January 1, 2X13: Blanco, Inc. Balance Sheet January 1, 2X13
Stalle Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets
$ 35 265 $300
Cash Net Fixed Assets Total Assets
$250 450 $700
Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 30 100 170 $300
Accounts Payable Long-term Bonds Pay. Equity Total Liab. & Equity
$ 90 200 410 $700
On January 1, 2X13, Stalle Company acquired 70% of the outstanding common stock of Blanco, Inc., for $119 in cash. Assume the book value of Blanco's assets and liabilities equals the market value. If Blanco, Inc., generated net income during 2X13 of $10, and none of the income was the result of intercompany sales, what journal entry would Stalle Company make to reflect this event? A) No journal entry is necessary. B) Investment in Blanco, Inc. 7 Investment Revenue 7 C) Investment in Blanco, Inc. 7 Noncontrolling Interest 3 Investment Revenue 10 D) Investment in Blanco, Inc. 10 Investment Revenue 10 E) Investment in Blanco, Inc. 10 Investment Revenue 7 Noncontrolling Interest 3 Answer: B Diff: 2 Objective: L.O. 11-6
7) Noncontrolling interests do not affect the balance sheet of the consolidated financial statements. Answer: FALSE Diff: 2 Objective: L.O. 11-6
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8)
Kenter Company Balance Sheet January 1, 20X9
Maffitt Company Balance Sheet January 1, 20X9
Cash Net Fixed Assets Total Assets
$ 20 90 $110
Cash Net Fixed Assets Total Assets
$110 240 $350
Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
$ 10 40 60
Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
$ 40 130 180
$110
$350
On January 1, 20X9, Maffitt Company acquired 70% of the outstanding shares of common stock of Kenter Company for $42 in cash. Assume the book value of Kenter's assets and liabilities equals the market value. During 20X9, Kenter Company had net income of $10, and Maffitt Company had net income of $30. None of the net income for either company was the result of intercompany sales. All net income for both companies is in the form of additional cash. Prepare the following: a. The journal entry necessary for Maffitt Company on January 1, 20X9. b. The journal entry necessary for Kenter Company on January 1, 20X9. c. The consolidated balance sheet immediately after the acquisition. d. The elimination entry necessary on December 31, 20X9 assuming no other intercompany transactions during the year. Answer: a. Investment in Kenter Company 42 Cash 42 b. No journal entry is necessary. c. Consolidated Balance Sheet January 1, 20X9 Cash $ 88 Accounts Payable $ 50 Net Fixed Assets 330 Long-term Bonds Payable 170 Noncontrolling Interest 18 Stockholders' Equity 180 Total Liabilities & Total Assets $418 Stockholders' Equity $ 418 d. Stockholders' Equity, Kenter 70 Noncontrolling Interest 21 Investment in Kenter Company 49 Diff: 3 Objective: L.O. 11-6
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9) What is a "noncontrolling interest"? How is it accounted for on the subsidiary's, the parent's, and the consolidated financial statements? Answer: A noncontrolling interest is the outside shareholders' interests, as opposed to the parent's interests, in a subsidiary corporation. If a parent owns 90% of the subsidiary stock, then outsiders to the consolidated group own the other 10%. Noncontrolling interest does not appear in either the subsidiary or the parent's financial statements. Instead it appears in the stockholders' equity section of the consolidated balance sheet and before net income on the consolidated income statement to determine net income to the consolidated entity. Diff: 2 Objective: L.O. 11-6
Learning Objective 11.7 Questions 1) Presented below are the balance sheets of Dental Works and Forgash Company at January 1, 2X13: Dental Works Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 23 127 $150 $ 15 85 50 $150
Forgash Company Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$110 290 $400 $ 35 140 225 $400
On January 1, 2X13, Forgash Company paid $80 for 100% of the outstanding shares of Dental Works. The fair market values of the assets and liabilities of Dental Works are the same as the book values. What journal entry will Forgash Company make on January 1, 2X13? A) Investment in Dental Works 80 Cash 80 B) Investment in Dental Works 50 Goodwill 30 Cash 80 C) Investment in Dental Works 50 Goodwill 17 Fixed Assets 13 Cash 80 D) Investment in Dental Works 63 Goodwill 17 Cash 80 E) Investment in Dental Works 67 Fixed Assets 13 Cash 80 Answer: A Diff: 2 Objective: L.O. 11-7
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2) Presented below are the balance sheets of Dental Works and Forgash Company at January 1, 2X13: Dental Works Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$ 23 127 $150 $ 15 85 50 $150
Forgash Company Balance Sheet January 1, 2X13 Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Pay. Stockholders' Equity Total Liab. & Equity
$110 290 $400 $ 35 140 225 $400
On January 1, 2X13, Forgash Company paid $80 for 100% of the outstanding shares of Dental Works. The fair market values of the assets and liabilities of Dental Works are the same as the book values. What elimination journal entry would be necessary in order to prepare a consolidated balance sheet immediately after the acquisition? A) Stockholders' Equity, Dental Works 50 Goodwill 30 Investment in Dental Works 80 B) Stockholders' Equity, Dental Works 80 Investment in Dental Works 80 C) Goodwill 80 Investment in Dental Works 80 D) Stockholders' Equity, Dental Works 80 Goodwill 50 Investment in Dental Works 30 E) Investment in Dental Works 50 Goodwill 30 Stockholders' Equity, Dental Works 80 Answer: A Diff: 2 Objective: L.O. 11-7
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3) If the book value of net assets of a subsidiary are less than the fair market value of net assets of the subsidiary at the time the subsidiary is acquired, which of the following procedures is incorrect with respect to the subsidiary, parent, and consolidated accounts? A) Only on consolidation are the book values of the subsidiary accounts written up to their revised fair market values. B) The parent records the difference between the subsidiary's book value of net assets and its fair market value of net assets as a separate asset on the parent's balance sheet. C) The subsidiary continues as a going concern with its accounts valued at the lower book value amounts. D) The parent records the acquisition of the subsidiary at its acquisition cost. E) Any part of the acquisition price that cannot be attributed to the revised fair market value of the subsidiary's assets and liabilities will be considered goodwill on the consolidated balance sheet. Answer: B Diff: 2 Objective: L.O. 11-7
4) Which statement is correct? A) Current U. S. generally accepted accounting principles (GAAP) allow for the amortization of goodwill to be up to 40 years. B) Goodwill shall be reduced if impairment is in evidence. C) Although goodwill amortization amounts can be large in absolute terms, often they are relatively small as compared to net income. D) Current U. S. GAAP do not allow an immediate write-off of goodwill. E) Goodwill impairments are included as an extraordinary item on the income statement. Answer: B Diff: 2 Objective: L.O. 11-7
5) Goodwill can only be recognized when a company is acquired by another company. Answer: TRUE Diff: 1 Objective: L.O. 11-7
6) Recorded goodwill is considered to exist unless impaired. Answer: TRUE Diff: 1 Objective: L.O. 11-7
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7) Fruit King Company purchased 100% of the outstanding common shares of Berries, Inc., for $23,750 on January 1, 2X13. Berries Inc.'s balance sheet just before the acquisition was as follows: Cash $ 4,500 Net fixed assets 12,000 Total Assets $16,500 Liabilities Stockholders' equity Total Liabilities & Stockholders' Equity
$11,000 5,500 $16,500
The fair market value of Berries Inc.'s assets and liabilities were equal to their book value. On January 1, 2X13, compute the amount of goodwill (if any) Fruit King Company would recognize on this purchase. Where would this goodwill appear on Fruit King Company's financial statements? Answer: Goodwill = cash paid less fair market value of net assets Goodwill = $23,750 - ($16,500 - $11,000) = $18,250 Goodwill appears on the consolidated balance sheet with other long-term assets. Diff: 1 Objective: L.O. 11-7
8) On February 1, 2X09, Bodner, Inc. acquired a 100% interest in Bolenski Company by paying $34 million for 100% of the outstanding stock of Bolenski Company. The book value of the net assets amounted to $25 million, but an independent appraiser valued the printing press at $1.5 million over its book value. The book value and fair value of the remaining assets and liabilities were equal. Required: 1. On February 1, 2X09, prepare the eliminating entry by Bodner, Inc. after the acquisition. 2. What will occur if the goodwill decreases in value after the acquisition? Answer: 1. Stockholders' equity, Bolenski 25.0 Goodwill 7.5 Equipment(printing press) 1.5 Investment in Bolenski 34.0 2. If the value of the goodwill decreases after the acquisition, impairment of goodwill occurs and the goodwill account must be reduced. Diff: 2 Objective: L.O. 11-7
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9)
Fruit Company Balance Sheet January 1, 2X13
Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
Veggie Company Balance Sheet January 1, 2X13 $ 50 100 $150 $ 20 70 60 $150
Cash Net Fixed Assets Total Assets Accounts Payable Long-term Bonds Payable Stockholders' Equity Total Liab. & Stockholders' Equity
$120 280 $400 $ 30 120 250 $400
On January 1, 2X13, Veggie Company paid $80 in cash for 100% of the outstanding shares of Fruit Company. The fair market value of all Fruit Company's accounts was equivalent to their book value. During 2X13, Fruit Company had net income of $10, and Veggie Company had net income of $40. None of the net income for either company was the result of intercompany sales. All net income for both companies is in the form of additional cash. Prepare the following: a) The journal entry necessary for Veggie Company on January 1, 2X13 b) The journal entry necessary for Fruit Company on January 1, 2X13 c) The consolidated balance sheet immediately after the acquisition Answer: a. Investment in Fruit Company 80 Cash 80 b. No journal entry is necessary. c. Veggie Company Consolidated Balance Sheet January 1, 2X13 Cash $ 90 Accounts Payable $ 50 Net Fixed Assets 380 Long-term Bond Payable 190 Goodwill 20 Stockholders' Equity 250 Total Liab. & Total Assets $490 Stockholders' Equity $490 Diff: 2 Objective: L.O. 11-7
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Introduction to Financial Accounting, 11e (Horngren) Chapter 12 Financial Statement Analysis Learning Objective 12.1 Questions 1) In addition to annual reports, financial information regarding a company can come from all of the following sources EXCEPT A) a company's own press releases. B) the popular press. C) stockbrokers. D) a company's Web site. E) the Internal Revenue Service. Answer: E Diff: 2 Objective: L.O. 12-1
2) When analyzing the financial statements of a potential debtor, the primary concerns of creditors include A) interest revenue. B) dividend revenue. C) short-term liquidity only. D) long-term solvency only. E) short-term liquidity and long-term solvency. Answer: E Diff: 2 Objective: L.O. 12-1
3) A pro forma statement is A) a comparative financial statement of the current year's results versus the prior year's results. B) a statement by management, commenting on the results of the current operating period. C) a projected financial statement based on predicted results. D) an agreement between a company and its lenders, describing details concerning the loan payback. E) a statement by the Internal Revenue Service, accepting a company's tax returns. Answer: C Diff: 2 Objective: L.O. 12-1
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4) Which of the following statement(s) describe the principal reason(s) why investors and creditors use financial statement analysis? 1. To assess the risks associated with expected returns 2. To evaluate top and middle level management 3. To predict the amount of expected returns 4. To establish recommended dividend and interest payments A) 1 and 2 B) 1, 2, and 3 C) 1 and 3 D) 1 and 4 E) 2, 3, and 4 Answer: C Diff: 2 Objective: L.O. 12-1
5) Short-term liquidity is A) a company's ability to turn plant assets into cash. B) a company's ability to meet current payments as they become due. C) current assets divided by current liabilities. D) a company's ability to sell intangible assets. E) a company's ability to shift current liabilities into long-term liabilities. Answer: B Diff: 2 Objective: L.O. 12-1
6) List the assets in the order from most liquid to least liquid. A) Inventory, accounts receivable, cash B) Inventory, cash, accounts receivable C) Accounts receivable, inventory, cash D) Cash, inventory, accounts receivable E) Cash, accounts receivable, inventory Answer: E Diff: 2 Objective: L.O. 12-1
7) With respect to creditors and equity investors, which of the following statements is incorrect? A) Creditors are concerned with assessing the short-term liquidity of a company. B) Creditors are concerned with assessing the long-term solvency of a company. C) Equity investors are concerned about dividend payments. D) Both creditors and equity investors are concerned about profitability. E) Creditors are more concerned about future security prices than equity investors. Answer: E Diff: 2 Objective: L.O. 12-1
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8) The Internet is a powerful, useful tool used by investors. Which statement is false regarding the Internet as it relates to investors? A) The Internet provides almost immediate access to company press releases including company profitability. B) Investors can purchase and sell securities online without the use of a broker. C) The Internet is always an accurate source of company information. D) An investor can use the Internet to get useful information about potential companies to invest in. E) Often purchasing and selling stock online is free, but there are instances when an investor must have a brokerage account and pay for services. Answer: C Diff: 2 Objective: L.O. 12-1
9) Since financial statements report on past results, they are not particularly useful to investors and creditors, who want to predict future returns and their risks. Answer: FALSE Diff: 1 Objective: L.O. 12-1
10) A pro forma statement is a carefully formulated expression of predicted results conveyed in a statement. Answer: TRUE Diff: 1 Objective: L.O. 12-1
11) Short-term liquidity refers to an organization's ability to generate enough cash to repay long-term debts as they mature. Answer: FALSE Diff: 1 Objective: L.O. 12-1
12) Long-term solvency refers to an organization's ability to meet current payments as they become due. Answer: FALSE Diff: 1 Objective: L.O. 12-1
13) Annual reports and 10K filings for the Securities and Exchange Commission are timely, since they usually precede the events being reported. Answer: FALSE Diff: 1 Objective: L.O. 12-1
14) Investors purchase capital stock expecting to receive dividends and an increase in the value of the stock. Answer: TRUE Diff: 1 Objective: L.O. 12-1
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15) A management discussion and analysis (MD&A) of financial results, as well as footnotes to the financial statements, are part of a company's annual report. Answer: TRUE Diff: 2 Objective: L.O. 12-1
16) The disclosure practices that have evolved in the United States have the specific and only purpose of providing information to tax authorities. Answer: FALSE Diff: 2 Objective: L.O. 12-1
17) Describe several advantages and several disadvantages to investor access to the Internet. Answer: Some advantages to investors when they gain access to the Internet include easier and faster access to company press releases that include profitability, availability to check investment information on potential companies to invest in, and the ability to purchase and sell securities online often at no cost. However, disadvantages include the possibility of immediate access to information that might cause investors to make hasty decisions when the information is incorrect and investors believe they have enough knowledge to invest in a company when they do not. Financial planners have assisted investors in the past, but the trend is toward individual, independent trading because of the availability of online information. Diff: 2 Objective: L.O. 12-1
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Learning Objective 12.2 Questions 1) Fulton Company has the following data available: Wage Expense, For the Year Ending December 31, 2X13 Wage Expense, For the Year Ending December 31, 2X12
$95 $90
What is the percentage increase or (decrease) in wage expense from 2X12 to 2X13 for Fulton Company? A) 5.3% B) (5.3)% C) 2.6% D) (5.6)% E) 5.6% Answer: E Diff: 2 Objective: L.O. 12-2
2) Fulton Company has the following data available: Interest Expense, For the Year Ending December 31, 2013 Interest Expense, For the Year Ending December 31, 2012
$15 $10
What is the percentage increase or (decrease) in interest expense from 2012 to 2013 for Fulton Company? A) 33.3% B) (50.0)% C) (33.3)% D) (100.0)% E) 50.0% Answer: E Diff: 2 Objective: L.O. 12-2
3) Fulton Company has the following information available: Gross Profit, For the Year Ending December 31, 2013 Gross Profit, For the Year Ending December 31, 2012
$430 $360
What is the percentage increase or (decrease) in gross profit from 2012 to 2013 for Fulton Company? A) (19.4)% B) (12.5)% C) 6.8% D) 12.5% E) 19.4% Answer: E Diff: 2 Objective: L.O. 12-2
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4) Frank Company has the following income statements available: 2X13 2X12 Sales $900 $800 Less Cost of Goods Sold 470 440 Gross Profit $430 $360 Operating Expenses: Wage Expense $ 95 $ 90 Rent Expense 35 30 Miscellaneous Expense 20 15 Depreciation Expense 25 20 Total Operating Expenses $175 $155 Operating Income $255 $205 Less Other Expenses: Interest Expense 15 10 Income Before Taxes $240 $195 Less Income Tax Expense 110 85 Net Income $130 $110 What is the percentage increase or (decrease) in operating income and income before taxes from 2X12 to 2X13 for Frank Company? Operating Income Income Before Taxes A) 24.4% 23.1% B) 19.4% 24.4% C) 18.8% 19.6% D) 19.6% 18.8% E) 24.4% 18.8% Answer: A Diff: 3 Objective: L.O. 12-2
5) Fulton Company has the following data available: Wage Expense, For the Year Ending December 31, 2X13 Wage Expense, For the Year Ending December 31, 2X12 Sales, For the Year Ending December 31, 2X13 Sales, For the Year Ending December 31, 2X12 Net Income, For the Year Ending December 31, 2X13 Net Income, For the Year Ending December 31, 2X12
$95 $90 $900 $800 $130 $110
If a common size income statement were prepared, what percentage would be attributable to the 2X12 wage expense of Fulton Company? A) 10.5% B) 81.8% C) 46.2% D) 58.1% E) 11.3% Answer: E Diff: 2 Objective: L.O. 12-2
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6) Fulton Company has the following data available: Wage Expense, For the Year Ending December 31, 2X13 Wage Expense, For the Year Ending December 31, 2X12 Sales, For the Year Ending December 31, 2X13 Sales, For the Year Ending December 31, 2X12 Net Income, For the Year Ending December 31, 2X13 Net Income, For the Year Ending December 31, 2X12
$95 $90 $900 $800 $130 $110
If a common size income statement were prepared, what percentage would be attributable to the 2X13 wage expense of Fulton Company? A) 10.6% B) 11.2% C) 46.2% D) 58.1% E) 81.8% Answer: A Diff: 2 Objective: L.O. 12-2
7) Fulton Company has the following data available: Cost of Goods Sold, For the Year Ending December 31, 2013 Cost of Goods Sold, For the Year Ending December 31, 2012 Sales, For the Year Ending December 31, 2013 Sales, For the Year Ending December 31, 2012 Net Income, For the Year Ending December 31, 2013 Net Income, For the Year Ending December 31, 2012
$470 $440 $900 $800 $130 $110
If a common size income statement were prepared, what percentage would be attributable to the 2013 cost of goods sold of Fulton Company? A) 52.2% B) 19.4% C) 28.3% D) 2.2% E) 100% Answer: A Diff: 2 Objective: L.O. 12-2
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8) Fulton Company has the following data available: Cost of Goods Sold, For the Year Ending December 31, 2013 Cost of Goods Sold, For the Year Ending December 31, 2012 Sales, For the Year Ending December 31, 2013 Sales, For the Year Ending December 31, 2012 Net Income, For the Year Ending December 31, 2013 Net Income, For the Year Ending December 31, 2012
$470 $440 $900 $800 $130 $110
If a common size income statement were prepared, what percentage would be attributable to the 2013 sales of Fulton Company? A) 2.2% B) 19.4% C) 28.3% D) 52.2% E) 100% Answer: E Diff: 1 Objective: L.O. 12-2
9) Manchester Technology has the following data available: Wages Payable, December 31, 2013 $20 Wages Payable, December 31, 2012 $15 What is the percentage increase or (decrease) in wages payable from 2012 to 2013 for Manchester Technology? A) (33.3)% B) (25.0)% C) (12.5)% D) 25.0% E) 33.3% Answer: E Diff: 2 Objective: L.O. 12-2
10) Manchester Technology has the following data available: Accounts Receivable, December 31, 2013 $220 Accounts Receivable, December 31, 2012 $100 What is the percentage increase or (decrease) in accounts receivable from 2012 to 2013 for Manchester Technology? A) (120.0)% B) (54.5)% C) 27.3% D) 54.5% E) 120.0% Answer: E Diff: 2 Objective: L.O. 12-2
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11) Manchester Technology has the following data available: Inventory, December 31, 2013 $120 Inventory, December 31, 2012 $200 What is the percentage increase or (decrease) in inventory from 2012 to 2013 for Manchester Technology? A) (120.0)% B) 120.0% C) 40.0% D) 62.5% E) (40.0)% Answer: E Diff: 2 Objective: L.O. 12-2
12) What issue would be of most concern on behalf of banks or other creditors of Manchester Technology? A) Prepaid insurance decreased 62.5%. B) The current portion of long-term notes payable increased by 300%. C) Accounts receivable increased 20%. D) Fixed assets decreased 9%. E) Total liabilities increased 7%. Answer: B Diff: 3 Objective: L.O. 12-2
13) Manchester Technology has the following data available: Long-term Note Payable, December 31, 2013 $90 Long-term Note Payable, December 31, 2012 $180 Total Assets, December 31, 2013 $630 Total Assets, December 31, 2012 $585 Total Liabilities, December 31, 2013 $320 Total Liabilities, December 31, 2012 $300 If a common size balance sheet were prepared, what percentage would be attributable to the 2012 longterm note payable of Manchester Technology? A) 30.8% B) 60.0% C) 63.2% D) 69.2% E) 100.0% Answer: A Diff: 2 Objective: L.O. 12-2
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14) Manchester Technology has the following data available: Inventory, December 31, 2013 $120 Inventory, December 31, 2012 $200 Total Assets, December 31, 2013 $630 Total Assets, December 31, 2012 $585 Total Liabilities, December 31, 2013 $320 Total Liabilities, December 31, 2012 $300 If a common size balance sheet were prepared, what percentage would be attributable to the 2013 inventory of Manchester Technology? A) 19.0% B) 21.6% C) 38.7% D) 52.2% E) 60.0% Answer: A Diff: 2 Objective: L.O. 12-2
15) The Management Discussion and Analysis (MDA) section of the annual report concentrates on A) analyzing the possible acquisition of other companies, and how those new acquisitions would mesh within the current corporate structure. B) describing the background of management personnel, how long they have held their current position, and how long and in what capacities each manager has worked for the company. C) examining how the company is performing relative to other companies in the industry. D) explaining the major changes in the operating results, liquidity and capital resources. E) explaining the auditor report. Answer: D Diff: 2 Objective: L.O. 12-2
16) Segment reporting can disclose information on all except which of the following? A) Each top executive's area of responsibility B) Segments by product line C) Sales revenue and net profits of each segment D) Geographic segments E) Total assets of each segment Answer: A Diff: 2 Objective: L.O. 12-2
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17) Trend analysis can be used A) only with income statement accounts. B) only with balance sheet accounts. C) only with statement of stockholders' equity accounts. D) only with common-size financial statements. E) on any financial statement. Answer: E Diff: 2 Objective: L.O. 12-2
18) Trend analysis involves comparing data on one financial statement with other data on the same financial statement. Answer: FALSE Diff: 2 Objective: L.O. 12-2
19) Trend analysis prompts investors to ask themselves what could cause the trends to end. Answer: TRUE Diff: 1 Objective: L.O. 12-2
20) For a given account, both the amount of the change from one year to the next and the percentage change are needed to recognize trends and understand their true meaning. Answer: TRUE Diff: 2 Objective: L.O. 12-2
21) Common-size statements aid in comparing companies of different sizes. Answer: TRUE Diff: 1 Objective: L.O. 12-2
22) The common-size income statement percentages use Cost of Goods Sold as the base amount at 100%. Answer: FALSE Diff: 1 Objective: L.O. 12-2
23) Each element on a common-size balance sheet is compared to total liabilities. Answer: FALSE Diff: 1 Objective: L.O. 12-2
24) Component percentages are line items of income statements that express each line item as a percentage of the total sales revenue. Answer: TRUE Diff: 2 Objective: L.O. 12-2
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25) The MD&A section of a corporation's annual report contains information about changes in the income statement, liquidity, and capital resources. Answer: TRUE Diff: 2 Objective: L.O. 12-2
26) Floatlin Company has the following income statements available: Floatlin Company Comparative Statements of Income For the Years Ending December 31, 2X13 and 2X12 2X13 2X12 Sales $750 $690 Cost of Goods Sold 440 400 Gross Profit $310 $290 Less: Operating Expenses 220 205 Operating Income $ 90 $ 85 Less: Income Tax Expense 40 37 Net Income $ 50 $ 48 Determine the increase or decrease in dollars and percentage for each line in the income statement. Answer: Dollar and percentage change for Floatlin Company income statement: Increase/(Decrease) Dollar Percentage Sales $ 60 8.7 Cost of Goods Sold 40 10.0 Gross Profit $ 20 6.9 Operating Expenses 15 7.3 Operating Income $5 5.9 Income Tax Expense 3 8.1 Net Income $2 4.2 Diff: 2 Objective: L.O. 12-2
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27) Floatlin Group has the following balance sheets available:
Current Assets: Cash Accounts Receivable Inventory Total Current Assets Long-Term Assets: Equipment Less: Accum. Depr. Total Long-Term Assets
Total Assets
Floatlin Group Comparative Balance Sheets December 31, 2X13 and 2X12 2X13 2X12 Current Liabilities: $ 20 $ 15 Accounts Payable 45 37 Taxes Payable 60 70 Note Payable $125 $122 Total Current Liab. Long-Term Liabilities $290 $200 Total Liabilities (160) (140) Stockholders' Equity: $130 $ 60 Common Stock Retained Earnings Total Stockholders' Equity Total Liab. & $255 $182 Stockholders' Equity
2X13
2X12
$ 24 11 7 $ 42 80 $122
$ 20 15 18 $ 53 30 $ 83
$ 40 93 $133
$ 40 59 $ 99
$255
$182
Determine the increase or decrease in dollars and percentage for each line on the balance sheet. Answer: Dollar and percentage change for Floatlin Group balance sheet: Increase/(Decrease) Dollars Percentage Current Assets: Cash Accounts Receivable Inventory Total Current Assets
$5 8 (10) $3
Long-Term Assets: Equipment Accum. Depreciation Total Long-Term Assets
$90 20 $ 70
Total Assets
$ 73
Increase/(Decrease) Dollars Percentage Current Liabilities: 33.3 Accounts Payable $4 20.0 21.6 Taxes Payable (4) (26.7) (14.3) Note Payable (11) (61.1) 2.5 Total Current Liabilities $(11) (20.8) LT Liabilities 50 166.7 45.0 Total Liabilities $ 39 47.0 14.3 Stockholders' Equity: 116.7 Common Stock $ -0-0Retained Earnings 34 57.6 Total Stk. Equity 34 34.3 Total Liab. & 40.1 Stockholders' Equity $ 73 40.1
Diff: 2 Objective: L.O. 12-2
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28) Comparative income statements are available for Floatlin Company: Floatlin Company Comparative Statements of Income For the Years Ending December 31, 2X13 and 2X12 2X13 2X12 Sales $750 $690 Cost of Goods Sold 440 400 Gross Profit $310 $290 Less: Operating Expenses 220 205 Operating Income $ 90 $ 85 Less: Income Tax Expense 40 37 Net Income $ 50 $ 48 Prepare common-size income statements for Floatlin Company for 2X13 and 2X12. Answer: Floatlin Company Comparative Statements of Income For the Years Ending December 31, 2X13 and 2X12
Sales Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Income Less: Income Tax Expense Net Income
2X13 $750 440 $310 220 $ 90 40 $ 50
2X12 $690 100.0% 400 58.0% $290 42.0% 205 29.7% $ 85 12.3% 37 5.4% $ 48 7.0%
100.0% 58.7% 41.3% 29.3% 12.0% 5.3% 6.7%
Diff: 2 Objective: L.O. 12-2
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29) Comparative balance sheets are available for Floatlin Group:
Current Assets: Cash Accounts Receivable Inventory Total Current Assets Long-Term Assets: Equipment Less: Accum. Depr. Total Long-Term Assets
Total Assets
Floatlin Group Comparative Balance Sheets December 31, 2X13 and 2X12 2X13 2X12 Current Liabilities: $ 20 $ 15 Accounts Payable 45 37 Taxes Payable 60 70 Note Payable $125 $122 Total Current Liab. Long-Term Liabilities $290 $200 Total Liabilities (160) (140) Stockholders' Equity: $130 $ 60 Common Stock Retained Earnings Total Stockholders' Equity Total Liab. & $255 $182 Stockholders' Equity
2X13
2X12
$ 24 11 7 $ 42 80 $122
$ 20 15 18 $ 53 30 $ 83
$ 40 93 $133
$ 40 59 $ 99
$255
$182
Prepare a common-size balance sheet for Floatlin Group at December 31, 2X13. Answer: Floatlin Group Balance Sheet December 31, 2X13 2X13 Current Assets: Cash Accounts Receivable Inventory Total Current Assets Long-Term Assets: Equipment Less: Accum. Depr. Total Long-Term Assets
Total Assets
2X13
$ 20 45 60 $125
7.8% 17.6% 23.5% 49.0%
$290 (160) $130
113.7% (62.7%) 51.0%
$255
100.0%
Current Liabilities: Accounts payable Taxes Payable Note Payable Total Current Liab. Long-Term Liabilities Total Liabilities Stockholders' Equity: Common Stock Retained Earnings Total Stockholders' Eq. Total Liabilities & Stockholders' Equity
Diff: 2 Objective: L.O. 12-2
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24 9.4% 11 4.3% 7 2.7% $ 42 16.5% 80 31.4% $122 47.8% $ 40 15.7% 93 36.5% $133 52.2% $255 100.0%
30) Trend analysis and common-size financial statements are important analytical techniques used to evaluate the strength of published financial statements. a. Define: 1. trend analysis 2. common-size financial statements b. How is each of these techniques helpful in the analysis of financial statements? Answer: a1. Trend analysis involves the presentation of the dollar change and the percentage change in elements on the financial statements (income statement and balance sheet) from one year to the next. a2. Common-size financial statements are financial statements reporting each element or line item as a percentage of some given total, such as sales on the income statement and total assets on the balance sheet. b. The dollar amounts of changes in the financial statement elements occurring from year to year are important to know, but the calculation of the percentage change improves our ability to use the dollar amounts for analysis. For example, if sales, cost of goods sold, and gross profit have all increased over a three-year period, presentation of the percentage change for each item helps determine whether each of these items is increasing at approximately the same rate. Likewise, presentation of each financial statement item as a percentage of a total helps determine how relationships change from year to year. It also facilitates comparison with other companies or with industry averages. Diff: 2 Objective: L.O. 12-2
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Learning Objective 12.3 Questions 1) How is working capital calculated? A) (total current assets) minus (total current liabilities) B) (total current assets) minus (inventories and prepaid assets) C) (total current assets) divided by (total current liabilities) D) (total current assets) E) (total current liabilities) Answer: A Diff: 1 Objective: L.O. 12-3
2) Montreal Electronics has the following data available: 2X13 2X12 Sales $999 $800 Cost of Goods Sold $399 $336 Gross Profit $600 $464 What is the gross profit rate for Montreal Electronics in 2X13? Has the gross profit rate improved or not improved since 2X12? A) 58.0%, improved B) 39.9%, not improved C) 58.0%, not improved D) 39.9%, improved E) 60.1%, improved Answer: E Diff: 2 Objective: L.O. 12-3
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3) Montreal Electronics has the following data available: Current Assets: Cash Accounts Receivable Accrued Interest Receivable Inventory Prepaid Rent Total Current Assets Current Liabilities: Accounts Payable Accrued Wages Payable Accrued Income Taxes Payable Accrued Interest Payable Unearned Sales Revenue Current Portion of Long-Term Notes Payable Total Current Liabilities Long-Term Liabilities: Notes Payable Total Liabilities
2X13 $150 95 15 20 10 $290
2X12 $ 57 70 15 60 -$202
$ 90 24 16 9 --
$ 65 10 12 9 5
80 $219
-$101
40 $259
120 $221
What is the working capital for Montreal Electronics in 2X13? Has the working capital improved or not improved since 2X12? A) $101, not improved B) $101, improved C) $ 71, improved D) $ 71, not improved E) $150, not improved Answer: D Diff: 2 Objective: L.O. 12-3
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4) Montreal Electronics has the following data available: Current Assets: Cash Accounts Receivable Accrued Interest Receivable Inventory Prepaid Rent Total Current Assets
2013 $150 95 15 20 10 $290
2012 $ 57 70 15 60 -$202
Current Liabilities: Accounts Payable Accrued Wages Payable Accrued Income Taxes Payable Accrued Interest Payable Unearned Sales Revenue Current Portion of Long-Term Notes Payable Total Current Liabilities
$ 90 24 16 9 --
$ 65 10 12 9 5
80 $219
-$101
Long-Term Liabilities: Notes Payable Total Liabilities
40 $259
120 $221
What is the current ratio for Montreal Electronics in 2013? Has the current ratio improved or not improved since 2012? A) 2.0, improved B) 1.3, improved C) 1.3, not improved D) 0.5, improved E) 2.0, not improved Answer: C Diff: 2 Objective: L.O. 12-3
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5) Montreal Electronics has the following data available: Current Assets: Cash Accounts Receivable Accrued Interest Receivable Inventory Prepaid Rent Total Current Assets Current Liabilities: Accounts Payable Accrued Wages Payable Accrued Income Taxes Payable Accrued Interest Payable Unearned Sales Revenue Current Portion of Long-Term Notes Payable Total Current Liabilities Long-Term Liabilities: Notes Payable Total Liabilities
2013 $150 95 15 20 10 $290
20 12 $ 57 70 15 60 -$202
$ 90 24 16 9 --
$ 65 10 12 9 5
80 $219
-$101
40 $259
120 $221
What is the quick ratio for Montreal Electronics in 2013? Has the quick ratio improved or not improved since 2012? A) 2.0, not improved B) 1.2, not improved C) 1.3, improved D) 1.1, improved Answer: B Diff: 2 Objective: L.O. 12-3
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6) Montvale Company has the following information available: Credit Sales, For the Year Ending December 31, 2013 Credit Sales, For the Year Ending December 31, 2012 Accounts Receivable, December 31, 2013 Accounts Receivable, December 31, 2012 Accounts Receivable, December 31, 2011 Cost of Goods Sold, For the Year Ending December 31, 2013 Cost of Goods Sold, For the Year Ending December 31, 2012 Inventory, December 31, 2013 Inventory, December 31, 2012 Inventory, December 31, 2011
$998 $800 $95 $70 $60 $399 $336 $20 $60 $50
What is the average collection period in days for Montvale in 2013? Has the average collection period in days improved or not improved since 2012? A) 30.0, not improved B) 10.0, unknown C) 10.0, improved D) 30.0, improved E) 30.2, not improved Answer: E Diff: 3 Objective: L.O. 12-3
7) Monday Corporation has the following data available: Credit Sales, For the Year Ending December 31, 2013 Credit Sales, For the Year Ending December 31, 2012 Accounts Receivable, December 31, 2013 Accounts Receivable, December 31, 2012 Accounts Receivable, December 31, 2011 Cost of Goods Sold, For the Year Ending December 31, 2013 Cost of Goods Sold, For the Year Ending December 31, 2012 Inventory, December 31, 2013 Inventory, December 31, 2012 Inventory, December 31, 2011
$999 $800 $95 $70 $60 $399 $336 $20 $60 $50
What is the inventory turnover for Monday Corporation in 2013? Has the inventory turnover improved or not improved since 2012? A) 10.0, improved B) 10.0, unknown C) 10.0, not improved D) 30.0, improved E) 30.0, not improved Answer: A Diff: 2 Objective: L.O. 12-3
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8) Montreal Electronics has the following data available: 2013 Net Income $ 90 Preferred Dividends Per Share $0 Weighted Average Number of Common Shares Outstanding During Year 200 Annual Common Dividends Per Share $ .40 Closing Market Price Common Stock, 12/31 $9.00
2012 $ 80 $0 200 $ .20 $6.00
What are the earnings per share for Montreal Electronics in 2013? Has the earnings per share improved or not improved since 2012? A) $.40, improved B) $.40, not improved C) $.40, unknown D) $.45, not improved E) $.45, improved Answer: E Diff: 1 Objective: L.O. 12-3
9) Montreal Electronics has the following data available: 2013 Net Income $ 90 Preferred Dividends Per Share $0 Weighted Average Number of Common Shares Outstanding During Year 200 Annual Common Dividends Per Share $ .40 Closing Market Price Common Stock, 12/31 $9.00
2012 $ 80 $0 200 $ .20 $6.00
What is the price-earnings ratio for Montreal Electronics in 2013? Has the price-earnings ratio improved or not improved since 2012? A) 15, not improved B) 15, improved C) 15, unknown D) 20, improved E) 20, not improved Answer: D Diff: 3 Objective: L.O. 12-3
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10) Montreal Electronics has the following data available: 2013 Net Income $ 90 Earnings Per Share $ .45 Annual Common Dividends Per Share $ .40 Closing Market Price Common Stock, 12/31 $9.00
2012 $ 80 $ .40 $ .20 $6.00
What is the dividend-yield for Montreal Electronics in 2013? Has the dividend-yield increased or decreased since 2012? A) 10.0%, decreased B) 3.3%, decreased C) 4.4%, increased D) 4.4%, decreased E) 3.3%, increased Answer: C Diff: 3 Objective: L.O. 12-3
11) Montreal Electronics has the following data available: 2013 Net Income $ 90 Earnings Per Share $ .45 Annual Common Dividends Per Share $ .40 Closing Market Price Common Stock, 12/31 $9.00
2012 $ 80 $ .40 $ .20 $6.00
What is the dividend-payout for Montreal Electronics in 2013? Has the dividend-payout increased or decreased since 2012? A) 100%, increased B) 89%, decreased C) 89%, increased D) 50%, increased E) 50%, decreased Answer: C Diff: 3 Objective: L.O. 12-3
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12) Tulsa Company has the following data available:
Sales (all credit sales) Less Cost of Goods Sold Gross Profit
2X13 $800 525 $275
2X12 $740 490 $250
2X11 $675 450 $225
What is the gross profit rate for Tulsa Company in 2X13? Has the gross profit rate improved or not improved since 2X12? A) 23.3%, improved B) 34.4%, improved C) 34.4%, not improved D) 52.4%, improved E) 52.4%, not improved Answer: B Diff: 2 Objective: L.O. 12-3
13) Tulip Company has the following data available:
Sales (all credit sales) Less Cost of Goods Sold Gross Profit
2X13 $800 525 $275
2X12 $740 490 $250
2X11 $675 450 $225
Total Liabilities Total Stockholders' Equity
$125 $125
$105 $110
$85 $90
What is the total asset turnover for Tulip Company in 2X13? Has the total asset turnover improved or not improved since 2X12? A) 1.2, improved B) 1.2, not improved C) 3.2, improved D) 3.4, improved E) 3.4, not improved Answer: E Diff: 2 Objective: L.O. 12-3
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14) Lorna Company has the following data available: Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Total Long-term Assets Current Liabilities: Accounts Payable Wages Payable Taxes Payable Current Long-Term Debt Total Current Liabilities Total Long-term Liabilities
2X13 $ 25 90 65 10 $190 $60
2X12 $ 20 70 50 15 $155 $60
2X11 $ 15 60 40 5 $120 $55
$ 50 20 10 10 $ 90 $35
$ 30 10 5 15 $ 60 $45
$ 20 5 15 5 $ 45 $50
What is the working capital for Lorna Company in 2X13? Has the working capital improved or not improved since 2X12? A) $125, improved B) $100, improved C) $100, not improved D) $60, improved E) $125, not improved Answer: B Diff: 2 Objective: L.O. 12-3
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15) Purple Company has the following data available: Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Total Long-term Assets Current Liabilities: Accounts Payable Wages Payable Taxes Payable Current Long-Term Debt Total Current Liabilities Total Long-term Liabilities
2X13 $ 25 90 65 10 $190 $60
2X12 $ 20 70 50 15 $155 $60
2X11 $ 15 60 40 5 $120 $55
$ 50 20 10 10 $ 90 $35
$ 30 10 5 15 $ 60 $45
$ 20 5 15 5 $ 45 $50
What is the current ratio for Purple Company in 2X13? Has the current ratio improved or not improved since 2X12? A) 2.11, improved B) 0.76, improved C) 0.76, not improved D) 0.36, improved E) 2.11, not improved Answer: E Diff: 2 Objective: L.O. 12-3
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16) Yellow Company has the following data available: Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets Total Long-term Assets Current Liabilities: Accounts Payable Wages Payable Taxes Payable Current Long-Term Debt Total Current Liabilities Total Long-term Liabilities
2X13 $ 25 90 65 10 $190 $60
2X12 $ 20 70 50 15 $155 $60
2X11 $ 15 60 40 5 $120 $55
$ 50 20 10 10 $ 90 $35
$ 30 10 5 15 $ 60 $45
$ 20 5 15 5 $ 45 $50
What is the quick ratio for Yellow Company in 2X13? Has the quick ratio improved or not improved since 2X12? A) 2.11, not improved B) 55, not improved C) 1.39, improved D) 1.39, not improved E) 55, improved Answer: D Diff: 2 Objective: L.O. 12-3
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17) Redwing Company has the following data:
Sales (all credit sales) Less Cost of Goods Sold Gross Profit
2X13 $800 525 $275
2X12 $740 490 $250
2X11 $675 450 $225
Current Assets: Cash Accounts Receivable Inventory Prepaid Rent Total Current Assets
$ 25 90 65 10 $190
$ 20 70 50 15 $155
$ 15 60 40 5 $120
What is the average collection period in days for Redwing Company in 2X13? Has the average collection period in days improved or not improved since 2X12? A) 41.1, improved B) 36.5, improved C) 36.5, not improved D) 8.9, improved E) 41.1, not improved Answer: C Diff: 3 Objective: L.O. 12-3
18) Zeman Company has the following data:
Sales (all credit sales) Less Cost of Goods Sold Gross Profit
2X13 $800 525 $275
2X12 $740 490 $250
2X11 $675 450 $225
Operating Profit Net Income
$125 $64
$110 $56
$100 $52
What is the return on sales for Zeman Company in 2X13? Has the return on sales improved or not improved since 2X12? A) 8.0%, improved B) 8.0%, not improved C) 14.4%, improved D) 34.4%, improved E) 34.4%, not improved Answer: A Diff: 2 Objective: L.O. 12-3
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19) Kornowski Company has the following data:
Sales (all credit sales) Less Cost of Goods Sold Gross Profit
2X13 $800 525 $275
2X12 $740 490 $250
2X11 $675 450 $225
Inventory
$65
$50
$40
What is the inventory turnover for Kornowski Company in 2X13? Has the inventory turnover improved or not improved since 2X12? A) 8.10, improved B) 8.10, not improved C) 9.13, improved D) 9.13, not improved E) 91, not improved Answer: D Diff: 2 Objective: L.O. 12-3
20) Wetzel Company has the following data:
Current Liabilities: Accounts Payable Wages Payable Taxes Payable Current Long-Term Debt Total Current Liabilities Long-Term Liabilities: Long-Term Debt Total Liabilities Stockholders' Equity: Common Stock $5 par Retained Earnings Total Stockholders' Equity Total Liab. & Stk. Equity
2X13
2X12
2X11
$ 50 20 10 10 $ 90
$ 30 10 5 15 $ 60
$ 20 5 15 5 $ 45
35 $125
45 $105
40 $ 85
$ 50 75 $125 $250
$ 50 60 $110 $215
$ 50 40 $ 90 $175
What is the total-debt-to-total-assets ratio for Wetzel Company in 2X13? Has the total-debt-to-total-assets ratio improved or not improved since 2X12? A) 0.14, improved B) 0.18, improved C) 0.18, not improved D) 0.50, improved E) 0.50, not improved Answer: E Diff: 2 Objective: L.O. 12-3
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21) Cider Company has the following data:
Current Liabilities: Accounts Payable Wages Payable Taxes Payable Current Long-Term Debt Total Current Liabilities Long-Term Liabilities: Long-Term Debt Total Liabilities Stockholders' Equity: Common Stock $5 par Retained Earnings Total Stockholders' Equity Total Liab. & Stk. Equity
2X13
2X12
2X11
$ 50 20 10 10 $ 90
$ 30 10 5 15 $ 60
$ 20 5 15 5 $ 45
35 $125
45 $105
40 $ 85
$ 50 75 $125 $250
$ 50 60 $110 $215
$ 50 40 $ 90 $175
What is the total-debt-to-total-equity ratio for Cider Company in 2X13? Has the total-debt-to-total equity ratio improved or not improved since 2X12? A) 0.28, improved B) 0.36, improved C) 0.36, not improved D) 1.00, improved E) 1.00, not improved Answer: E Diff: 2 Objective: L.O. 12-3
22) Beck Company has the following data available:
Net Income
2X13 $ 64
2X12 $ 56
2X11 $ 52
Stockholders' Equity: Common Stock $5 par Retained Earnings Total Stockholders' Equity
$ 50 75 $125
$ 50 60 $110
$ 50 40 $ 90
What are the earnings per share for Beck Company in 2X13? Have the earnings per share improved or not improved since 2X12? A) $1.28, improved B) $1.28, not improved C) $6.40, improved D) $6.40, not improved E) $12.80, not improved Answer: C Diff: 2 Objective: L.O. 12-3
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23) Valdo Vinyls has the following data available:
Sales Less Cost of Goods Sold Gross Profit
2X13 $ 930 410 $520
2X12 $700 235 $465
Income Before Interest and Taxes Net Income
$200 $138
$222 $122
What is the return on sales for Valdo Vinyls in 2X13? Has the return on sales improved or not improved since 2X12? A) 17.6%, not improved B) 14.8%, not improved C) 14.8%, improved D) 10.0%, improved E) 9.0%, improved Answer: B Diff: 2 Objective: L.O. 12-3
24) Vivian Company has the following data available:
Total Current Assets Total Long-term Assets Total Stockholders' Equity
2X13 $338 $468 $467
2X12 $182 $508 $389
2X11 $150 $400 $300
Sales Less Cost of Goods Sold Gross Profit
$ 930 410 $520
$700 235 $465
$600 300 $300
What is the total asset turnover for Vivian Company in 2X13? Has the total asset turnover improved or not improved since 2X12? A) 1.2, improved B) 1.2, not improved C) 1.5, improved D) 1.6, improved E) 1.6, not improved Answer: A Diff: 2 Objective: L.O. 12-3
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25) Grady Company's inventory turnover was 8.2 in 2X13. After analyzing several similar, competing companies, Grady Company found that the average inventory turnover for those companies was 11.8. What should Grady Company consider doing? A) Increase inventory by purchasing inventory on credit B) Increase inventory by purchasing inventory with cash C) Change the number of days Grady Company uses to calculate inventory turnover D) Increase inventory by decreasing sales. E) Decrease inventory by increasing sales Answer: E Diff: 2 Objective: L.O. 12-3
26) Ontario Appliances has the following data:
Sales Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Income Less: Other Expense: Interest Expense Income before Tax Less: Income Tax Expense Net Income
2X13 $ 930 410 520 260 260 (30) 230 92 $138
2X12 $700 235 465 231 234 (30) 204 82 $122
What is the interest coverage for Ontario Appliances in 2X13? Has the interest coverage improved or not improved since 2X12? A) 12.7, unknown B) 7.7, not improved C) 7.7, improved D) 8.7, improved E) 8.7, not improved Answer: D Diff: 2 Objective: L.O. 12-3
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27) Product Line Inc. has the following data:
Sales (all credit sales) Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Income Less: Other Expense: Interest Income before Tax Less: Income Tax Expense Net Income
2X13 $800 525 $275 150 $125 10 $115 51 $ 64
2X12 $740 490 $250 140 $110 8 $102 46 $ 56
2X11 $675 450 $225 125 $100 5 $ 95 43 $ 52
What is the interest coverage for Product Line Inc. in 2X13? Has the interest coverage improved or not improved since 2X12? A) 12.5, not improved B) 6.4, not improved C) 11.5, improved D) 12.5, improved E) 6.4, improved Answer: A Diff: 2 Objective: L.O. 12-3
28) The cornerstone of financial statement analysis is the use of ratios. Answer: TRUE Diff: 1 Objective: L.O. 12-3
29) A comparison of a company's financial ratios with its own historical ratios is referred to as a crosssectional comparison. Answer: FALSE Diff: 2 Objective: L.O. 12-3
30) A cross-sectional evaluation of financial ratios involves comparing a company's financial ratios with the ratios of other companies. Answer: TRUE Diff: 2 Objective: L.O. 12-3
31) Liquidity focuses on whether there are sufficient current assets to satisfy current liabilities as they become due. Answer: TRUE Diff: 2 Objective: L.O. 12-3
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32) The quick ratio is calculated as current assets divided by current liabilities. Answer: FALSE Diff: 1 Objective: L.O. 12-3
33) The following financial statements are available for Jerry Company: Comparative Income Statements For the Years Ending December 31, 2X13 and 2X12 2X13 2X12 Sales(all credit) $750 $690 Cost of Goods Sold 440 400 Gross Profit $310 $290 Less: Operating Expenses 220 205 Operating Income $ 90 $ 85 Less: Income Tax Expense 40 37 Net Income $ 50 $ 48
Current Assets: Cash Accounts Receivable Inventory Total Current Assets Long-Term Assets: Equipment Less: Accum. Depr. Total Long-Term Assets
Total Assets
Comparative Balance Sheets December 31, 2X13 and 2X12 2X13 2X12 Current Liabilities: $ 20 $ 15 Accounts Payable 45 37 Taxes Payable 60 70 Note Payable $125 $122 Total Current Liab. Long-Term Liabilities $290 $200 Total Liabilities (160) (140) Stockholders' Equity: $130 $ 60 Common Stock Retained Earnings Total Stockholders' Equity Total Liab. & $255 $182 Stockholders' Equity
Use the above information to determine the following ratios for 2X13: a. Quick ratio b. Average collection period in days c. Total-debt-to-total-equity d. Pretax return on assets (ROA) e. Return on common stockholder's equity (ROE)
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2X13
2X12
$ 24 11 7 $ 42 80 $122
$ 20 15 18 $ 53 30 $ 83
$ 40 93 $133
$ 40 59 $ 99
$255
$182
Answer: a. Quick ratio: ($20 + $45)/$42 = 1.55 b. Accounts Receivable Turnover = $750/[($45+$37)/2] = 18.29 Average collection period in days: 365/18.29 = 20 days c. Total-debt-to-total-equity: $122/$133 = 91.7% d. Pretax return on assets: $90/[($255 + $182)/2] = 41.2% e. Return on common stockholders' equity: $50/[($133 + $99)/2] = 43.1% Diff: 2 Objective: L.O. 12-3
34) For each of the following categories, give two examples of financial statement ratios that fit within that category. a. Short-term liquidity ratios b. Long-term solvency ratios c. Profitability ratios d. Market price and dividend ratios Answer: Any two of the following ratios within each category: a. Short-term liquidity ratios: Current ratio Quick ratio Accounts receivable turnover Average collection period in days Inventory turnover b. Long-term solvency ratios: Total-debt-to-total assets Total-debt-to-total-equity Interest coverage c. Profitability ratios: Return on common stockholders' equity Gross profit rate Return on sales Total asset turnover Return on assets Earnings per share EBIT to sales d. Market price and dividend ratios: Price-earnings ratio Dividend-yield Dividend-payout Book-value per common share Market-to-book value Diff: 2 Objective: L.O. 12-3
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35) For each of the following transactions, indicate whether the current ratio increases (IN), decreases (DE), or is not affected (NA). a. Purchased equipment for cash b. Paid a current liability c. Cash received from outstanding accounts receivable d. Cash sale of a long-term asset for a gain e. Purchased inventory on credit Answer: a. DE b. IN c. NA d. IN e. DE Diff: 2 Objective: L.O. 12-3
36) State whether the following ratios are classified as a. ratios that measure long-term solvency, b. ratios that measure profitability, c. ratios used to analyze the company's stock as an investment, or d. ratios that measure short-term liquidity. 1. ________ Return on sales 2. ________ Earnings per share 3. ________ Dividend-yield 4. ________ Average collection period in days 5. ________ Total-debt-to-total assets ratio 6. ________ Price-earnings ratio 7. ________ Quick ratio 8. ________ Total-debt-to-total-equity Answer: 1. b 2. b 3. c 4. d 5. a 6. c 7. d 8. a Diff: 2 Objective: L.O. 12-3
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37) Based on the information for the following three companies, a) compute the number of days' sales in receivables for 2X13 for each company assuming 365 days in a year and b) analyze each company in accordance with a 45-day credit policy.
Net credit sales Cost of goods sold
2X13 2X12 2X13 2X12 2X13 2X12 2X13 2X12
Hadman $122,000 120,000 54,000 51,000 14,000 16,000 26,000 20,000
Accounts receivable (ending balance) Inventory (ending balance) Answer: a) Accounts receivable turnover Hadman 8.13 $122,000/ [(14,000+16,000)/2] Teltor 5.03 $ 98,000/ [(21,000+18,000)/2] Comdok 11.13 $178,000/[(19,000+13,000)/2]
Teltor $98,000 99,000 44,000 39,000 21,000 18,000 19,000 20,000
Comdok $178,000 169,000 78,000 61,000 19,000 13,000 9,000 13,000
Number of days' sales in receivables Hadman 44.9 (365/8.13) Teltor 72.6 (365/5.03) Comdok 32.8 (365/11.13) b) Hadman is collecting accounts receivable at a rate approximately equal to the credit policy term of 45 days. Teltor collected each dollar of accounts receivable in 72.6 days, which is above the 45-day credit policy by almost 28 days or approximately one month. Comdok is collecting below the 45-day credit policy by 12 days. The credit department at Comdok is doing an extraordinary job or Comdok is doing business with profitable companies who are willing and able to pay in advance. Alternatively, Comdok may offer a higher discount for early payment than the other companies and, as a result, collects accounts receivable faster. Diff: 3 Objective: L.O. 12-3
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38) Based on the information for the following three companies, a) compute the accounts receivable turnover ratio for each company for 2X13 and b) determine which company is in the best liquidity position based on the calculation in part a.
Net credit sales Cost of goods sold
2X13 2X12 2X13 2X12 2X13 2X12 2X13 2X12
Hadman $110,000 120,000 54,000 51,000 14,000 16,000 26,000 20,000
Teltor $120,000 99,000 44,000 39,000 21,000 18,000 19,000 20,000
Comdok $200,000 169,000 78,000 61,000 19,000 13,000 9,000 13,000
Accounts receivable (ending balance) Inventory (ending balance) Answer: a) Accounts receivable turnover Hadman 7.33 $110,000/ [(14,000+16,000)/2] Teltor 6.15 $120,000/ [(21,000+18,000)/2] Comdok 12.5 $200,000/[(19,000+13,000)/2] b) Comdok is in the best liquidity position since it collects its accounts receivable balances 12.5 times per year. Teltor seems to be having difficulty collecting its balances since it only collects them approximately 6 times per year. Diff: 3 Objective: L.O. 12-3
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Learning Objective 12.4 Questions 1) Xemen Company has the following data:
Sales Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Income Less: Other Revenue/Other Expense: Interest Revenue Interest Expense Income before Tax Less: Income Tax Expense Net Income Total Common Stockholders' Equity Preferred Dividend Per Share
2X13 $ 930 410 520 284 236
2X12 $700 235 465 255 210
24 (30) 230 92 $138
24 (30) 204 82 $122
$467 $0
$389 $0
2X11
$300 $0
What is the return on common stockholders' equity for Xemen Company in 2X13? Has the return on common stockholders' equity improved or not improved since 2X12? A) 32.2%, improved B) 32.2%, not improved C) 29.6%, not improved D) 31.6%, not improved E) 29.6%, improved Answer: B Diff: 2 Objective: L.O. 12-4
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2) Steve Harvey Company has the following data:
Sales (all credit sales) Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Operating Income Less: Other Expense: Interest Income before Tax Less: Income Tax Expense Net Income
2X13 $800 525 $275 150 $125 10 $115 51 $ 64
2X12 $740 490 $250 140 $110 8 $102 46 $ 56
2X11 $675 450 $225 125 $100 5 $ 95 43 $ 52
Total Common Stockholders' Equity Preferred Dividends Per Share
$125 $0
$110 $0
$90 $0
What is the return on common stockholders' equity for Steve Harvey Company in 2X13? Has the return on common stockholders' equity improved or not improved since 2X12? A) 25.6%, improved B) 25.6%, not improved C) 54.5%, improved D) 54.5%, not improved E) 128.0%, improved Answer: D Diff: 2 Objective: L.O. 12-4
3) Ramirez Company has a weighted-average after-tax cost of capital of 12%; $320,000 in long term assets; $80,000 in current assets; and $400,000 in capital. In order to create Economic Value Added, net operating profit after taxes must exceed A) $26,400. B) $38,400. C) $ 7,200. D) $16,800. E) $48,000. Answer: E Diff: 2 Objective: L.O. 12-4
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4) Debt is often a more attractive vehicle for financing long-term investments for which of the following reasons? 1. Debt is less risky than common stock. 2. Debt may be converted into common stock in a tax-free exchange. 3. Interest payments are tax deductible, and dividend payments are not. 4. Ownership rights are kept by the present stockholders. A) 3 and 4 B) 1 and 3 C) 2 and 4 D) 1 and 2 E) 1, 2, 3, and 4 Answer: A Diff: 2 Objective: L.O. 12-4
5) ROE = Return on sales × Total asset turnover × Financial Leverage. Answer: TRUE Diff: 2 Objective: L.O. 12-4
6) Financial management is concerned with where a company gets cash and how it uses that cash to its benefit. Answer: TRUE Diff: 1 Objective: L.O. 12-4
7) The rate of return on investment is equal to invested capital divided by income. Answer: FALSE Diff: 2 Objective: L.O. 12-4
8) Different measures of income such as net income and earnings before interest and taxes are used to calculate different financial ratios. Answer: TRUE Diff: 2 Objective: L.O. 12-4
9) A disadvantage of debt for long-term financing is that the interest expense incurred on debt reduces net income. Answer: TRUE Diff: 2 Objective: L.O. 12-4
10) Trading on the equity refers to using money borrowed at fixed interest rates to try to enhance the rate of return on common shareholders' equity. Answer: TRUE Diff: 2 Objective: L.O. 12-4
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11) Economic value added is a performance measure stating that a company must earn more than it must pay for its capital if it is to increase in value. Answer: TRUE Diff: 2 Objective: L.O. 12-4
12) The use of debt is generally less costly to corporations than is preferred stock because interest is taxdeductible. Answer: TRUE Diff: 2 Objective: L.O. 12-4
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13) The following table describes certain financial results for three companies during 2X11, 2X12 and 2X13:
2X11
Standard, Inc. Platinum, Inc. Gold, Inc.
2X12
Standard, Inc. Platinum, Inc. Gold, Inc.
2X13
Standard, Inc. Platinum, Inc. Gold, Inc.
Income Before Interest and Taxes $50,000 50,000 50,000 Income Before Interest and Taxes $30,000 30,000 30,000 Income Before Interest and Taxes $15,000 15,000 15,000
Each company has total assets of $250,000 in each year. Standard, Inc., has no debt, Platinum, Inc., has $100,000 of debt at an interest rate of 10%, and Gold, Inc., has $150,000 of debt at a 14% interest rate. Platinum and Gold have no other debt or liabilities. Assume no taxes. a. For each company, and for each year, determine 1. the rate of return on total assets, and 2. the rate of return on common stockholders' equity. b. For each company, and for each year, state whether the company's use of debt leverage is favorable, unfavorable, or not applicable. Answer: Note: ROA = rate of return on total assets ROE = rate of return on common stockholders' equity F = favorable use of debt leverage U = unfavorable use of debt leverage NA = the use of debt leverage is not applicable a. Standard, Inc. Platinum, Inc. Gold, Inc.
2X11 ROA ROE 20% 20% 20% 27% 20% 29%
2X12 ROA ROE 12% 12% 12% 13% 12% 9%
2X13 ROA ROE 6% 6% 6% 3% 6% (6%)
Standard, Inc. Platinum, Inc. Gold, Inc.
2X11 NA F F
2X12 NA F U
2X13 NA U U
b.
Diff: 3 Objective: L.O. 12-4
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14) With respect to whether a company should issue debt or preferred stock to finance an investment in plant assets, provide three issues that need to be considered before such a decision is made. Answer: a. Interest is tax-deductible, so its after-tax cost can be considerably less than dividends on preferred stock. Therefore, net income available to common shareholders can be substantially higher if debt is used. Key concept - The tax-deductibility of interest b. Interest is an expense, whereas dividends are not. Therefore, net income is higher if preferred stock is used. Key concept - Net income is higher when issuing preferred stock c. Failure to pay interest can lead to bankruptcy, which gives creditors significant rights to control or liquidate the company. Key concept - Debt is riskier because the principal and interest must be paid at specific dates Diff: 2 Objective: L.O. 12-4
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Learning Objective 12.5 Questions 1) Big Apple Cabins has net income of $725,000. Throughout the year, the company had 150,000 shares of common stock outstanding. Also, the company has 25,000 shares of preferred stock that pay a dividend of $5.00 per share that is convertible into 5 shares of common stock for each share of preferred. The preferred stock is considered to be dilutive. The tax rate for Big Apple Cabins is 40%. What are the basic earnings per share for Big Apple Cabins? A) $2.50 B) $2.71 C) $2.86 D) $3.64 E) $4.00 Answer: E Diff: 2 Objective: L.O. 12-5
2) Big Apple Cabins has net income of $725,000. Throughout the year, the company had 150,000 shares of common stock outstanding. Also, the company has 25,000 shares of preferred stock that pay a dividend of $5.00 per share that is convertible into 5 shares of common stock for each share of preferred. The preferred stock is considered to be dilutive. The tax rate for Big Apple Cabins is 40%. What are the diluted earnings per share for Big Apple Cabins? A) $2.00 B) $2.25 C) $2.50 D) $2.64 E) $4.00 Answer: D Diff: 3 Objective: L.O. 12-5
3) Diluted earnings per share assume the conversion or exercise of all potentially dilutive securities at the beginning of the period. Answer: TRUE Diff: 2 Objective: L.O. 12-5
4) The denominator in the basic earnings per share ratio is the number of common shares outstanding at the end of the period. Answer: FALSE Diff: 1 Objective: L.O. 12-5
5) When companies have potentially dilutive securities outstanding, the diluted earnings per share exceed the basic earnings per share. Answer: FALSE Diff: 2 Objective: L.O. 12-5
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6) Whispering Woods Retreat has net income of $400,000. The company's tax rate is 40%. The company had 100,000 shares of common stock outstanding throughout the year. The company also has two other securities: a. Preferred stock; 6%; $100 par; 5,000 shares issued and outstanding. Each share of preferred stock is convertible into 4 shares of common stock. b. 12% long-term bonds payable; $300,000 face value. Each $1,000 bond is convertible into 25 shares of common stock. Prepare the earnings per share information required for Whispering Woods Retreat. Answer: Basic earnings per share: ($400,000 - $30,000 preferred dividends)/(100,000 shares of common) = $370,000/100,000 shares = $3.70 per share Diluted earnings per share: [$400,000 + ($36,000 interest expense × 0.60)] 100,000 shares of common stock + 20,000 shares from preferred stock + (300 bonds × 25 shares) = $421,600/127,500 shares = $3.31 per share Diff: 3 Objective: L.O. 12-5
7) The following data is available for Xandua Company: Net income Cash dividends on preferred stock Cash dividends on common stock Weighted average number of common shares outstanding Market price per share of common stock, 12/31/2X10
$210,000 14,000 36,000 100,000 $25.00
Calculate the following ratios: 1. a) Basic earnings per share-common b) Dividend yield 2. Why are earnings per share important to investors? Answer: 1. a.) Basic earnings per share $1.96 = ($210,000-$14,000) / 100,000 b.) Dividend yield 1.44% = ($36,000/100,000) / $25.00 2. Investors place considerable importance on earnings per share since it indicates the earnings earned by the company per common stockholder. Earnings per share are found on the income statement so investors can locate the amount easily and watch its growth or decline. Diff: 2 Objective: L.O. 12-3, 12-5
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Learning Objective 12.6 Questions 1) Over the Top, Inc. sells one of its four swing sets. The company regularly sells seasonal outdoor furniture. How shall the gain on the sale be classified on the income statement? A) Extraordinary item B) Ordinary income C) Accounting Change D) Discontinued Operation E) Recapture Answer: B Diff: 1 Objective: L.O. 12-6
2) It is now 2X09 and Jump N' Fun is restructuring operations by closing and selling its retail stores in 2X09. All employees that work in these stores will be terminated. A) The restructuring loss will be included in the income statement in 2X09. B) The restructuring loss will be included in the income statement in 2X10. C) Jump N' Fun can take the loss over time so as to manage earnings. D) The restructuring loss must be reported in the income statement over a five year period. E) This type of event will have no effect unless there is a gain on the sale of the retail stores. Answer: A Diff: 1 Objective: L.O. 12-6
3) Extraordinary items occur when A) a company sells an entire segment of the business. B) an event is unusual in nature but not infrequent in occurrence C) an event is infrequent in occurrence but not unusual in nature D) the event is unusual in nature and infrequent in occurrence. E) a company records an impairment loss on goodwill. Answer: D Diff: 2 Objective: L.O. 12-6
4) How are discontinued operations and extraordinary items reported on the income statement? A) Discontinued operations and extraordinary items are added together as one line item. B) Both items are reported net of taxes and as separate line items. C) Discontinued operations are reported net of taxes as a separate line item. Extraordinary items are not reported net of taxes, but they are reported as a separate line item. D) Discontinued operations are not reported net of taxes, but they are reported as a separate line item. Extraordinary items are reported net of taxes as a separate line item. E) Both items are not reported on the income statement. Answer: B Diff: 2 Objective: L.O. 12-6
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5) When a financial analyst evaluates a company's operating performance, the evaluation should exclude extraordinary items. Answer: TRUE Diff: 2 Objective: L.O. 12-6
6) To be considered an extraordinary item, it must be both unusual in nature and infrequent in occurrence. Answer: TRUE Diff: 2 Objective: L.O. 12-6
7) A change in accounting principle occurs when a company voluntarily changes from one acceptable accounting principle to another and when a standard-setting authority issues a new accounting standard that requires the change in accounting principle. Answer: TRUE Diff: 2 Objective: L.O. 12-6
8) The write-downs of receivables and inventory are generally regarded as extraordinary items. Answer: FALSE Diff: 1 Objective: L.O. 12-6
9) The loss from discontinued operations is reported in the income statement after the tax effect. Answer: TRUE Diff: 2 Objective: L.O. 12-6
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10) Glass Manufacturing has an income tax rate of 40% and income from continuing operations before income taxes of $100. The following additional activity occurred during the year, 2X10: 1) Glass Manufacturing disposed of a plant asset by selling it to Paper Company. The sale resulted in a $7 loss. 2) Glass Manufacturing had a gain of $4 on the extinguishment of long-term debt that was a current liability. 3) Glass Manufacturing incurred a loss of $28 due to a flood in a place that has floods once in 100 years. Prepare the following: a. Beginning with income from continuing operations before income taxes of $100, complete the remainder of Glass Manufacturing's income statement. b. Prepare the necessary earnings per share disclosure, assuming that Glass Manufacturing has no convertible securities or common stock equivalents and has 25 common shares outstanding throughout the year. There are no preferred dividends. Answer: a. Glass Manufacturing Partial Income Statement For the Year Ending December 31, 2X10 Income from continuing operations before income taxes Income tax expense Income before extraordinary items Extraordinary item: Loss due to flood (net of taxes of $11.2) Net income b. Glass Manufacturing Earnings per Share Income before extraordinary item $2.40 Less: extraordinary items (0.67) Net income $1.73 Diff: 3 Objective: L.O. 12-6
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$100.0 40.0 $60.0 (16.8) $43.2
Learning Objective 12.7 Questions 1) When the PEG ratio for a stock is less than 0.5, this indicates that the A) market believes the earnings growth estimate reflected in the consensus forecast is too low. B) market expects the future EPS growth to be greater than currently reflected in the analysts' consensus forecast EPS. C) stock is overvalued. D) stock is undervalued. E) stock is correctly valued. Answer: D Diff: 2 Objective: L.O. 12-7
2) If a company capitalizes costs that it should have expensed in 2X13 (assume no income tax effect), A) cash flows will be overstated in 2X13. B) cash flows will be understated in 2X13. C) net income will be understated in 2X13. D) net income will be overstated in 2X13. E) no income statement effect will occur. Answer: D Diff: 1 Objective: L.O. 12-7
3) To compute the PEG ratio, divide the P-E ratio by the earnings growth rate. Answer: TRUE Diff: 2 Objective: L.O. 12-7
4) Growth stocks generally have a PEG ratio less than one. Answer: FALSE Diff: 2 Objective: L.O. 12-7
5) Earnings quality is a well-defined and well-understood concept. Answer: FALSE Diff: 2 Objective: L.O. 12-7
6) a. Describe earnings quality. b. How is knowledge of earnings quality helpful in the analysis of financial statements? Answer: a. Earnings quality is not a well-defined concept. In general, earnings should have relevance for the users and accounting choices should not diminish the relevance. Thus, earnings quality has the attributes that revenues not be recognized prematurely and expenses not be deferred inappropriately. b. The analysis of financial statements should lead to "optimum" decisions whether to buy, sell, or hold a security. If earnings quality is reduced by accounting choices and the financial statement analysis compensates for the reduction, then the "optimum" decision can still be achieved. If financial statement analysis does not compensate for poor earnings quality, then the "wrong" investment decision is possible. Diff: 2 Objective: L.O. 12-7
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